Originally published on Forbes.com.
As Presidential candidates have been announcing tax plans, I have been assiduosly studying them. I haven’t caught all the Republican plans. They are tough to keep up with and I have probably given more attention to Bernie Sanders. Nonetheless, I have tried to be reasonably thorough. And I have relied, like many others, on the Tax Foundation. The Tax Foundation scores the plans indicating how much federal revenue will increase or decrease over the next decade.
The Tax Foundation gives two scores. The static score, as I understand it, is based on a model that tries to approximate what tax revenue would be if everybody redid their returns on the rules proposed in that particular plan. Then there is the dynamic score. The dynamic score is what this post is about, but I think I’ll tell you a story about what the dynamic score is starting to remind me of.
What The Dynamic Score Reminds Me Of
The Tax Foundation’s dynamic scores have started reminding me of my first managing partner, Herb Cohan of Joseph B Cohan and Associates. Among himself, his brother Paul and his father, the eponymous founder, there was over a century of accounting experience for him to call on. From observing him, I deduced the principles that guided him in managing the firm and summarized them. There were two. – ]Money coming in is good. – Money going out is bad.
There is actually some great wisdom there, but the extremes that Herb carried it to could be disconcerting. I learned this when I was a young manager. One year in February or so I presented him with a check for $50,000 from a new account I had landed. That was good. What I did not realize was what I was setting myself up for. What I had not anticipated was being called into Herb’s office a year after the big check. He had been having a good February up till then as he matched the daily receipts to the prior year. And now the $50,000 check last year had just put him behind. That was bad.
Tax Cuts Good – Tax Increases Bad
As far as the Tax Foundation’s dynamic score goes, you can boil it down to two simple principles. Tax increases are bad. Tax cuts are good. And really big tax cuts like the one proposed by Donald Trump] are – GREAT! Dynamic scoring by the Tax Foundation indicates that Donald Trump’s plan with a static score of $11.98 trillion would increase gross domestc product by 6.5% therefore making for a revenue loss of “only $10.14 trillion”.
Bernie Sanders on the other hand does not looks so good. Taxing capital gains and dividends at ordinary rates raises $1.186 trillion on a static basis but it will according to TF reduce GDP by 2.42%. The thing that I found really odd, even though it was not that dramatic, was the revenue raised in the Sanders plan from the elimination of health care deductions $3.881 trillion was off set by a 0.87% in GDP causing it to net $3.259 trillion. But wait a second? What would be the effect of people not having to pay medical bills anymore? Well, as Kyle Pomerleau explained to me that’s not their department.
At any rate, I assigned myself the task of learning more about the model and getting some comments from other practioners of the dismal science. My report is less than satisfactory, but it is a start.
About The Dynamic Score
The dynamic score, which from its name perhaps, is viewed by many as something of a forecast is not really a forecast. It is more of a counterfactual. TF has this taxes and growth model that predicts how taxes affect the economy. The dynamic score represents, according to the model, what would be collected if the economy were in the predicted shape it would have been, had the existing tax plan been in effect long enough to adjust to equilibium.
Equlibrium in classical economics is the state where supply and demand balance one another out. When something happens that changes the conditions of either supply or demand, things change until a new equilibium is reached.
Stupinomics
Classical econmics is based on this interesting fellow known as homo economicus (HE)
In economics, homo economicus, or economic man, is the concept in many economic theories portraying humans as consistently rational and narrowly self-interested agents who usually pursue their subjectively-defined ends optimally.
The thing is with old HE is that if you pay him less for something, he will give you less of it. And taxing somebody’s income from either working or providing capital is like paying him less. The Tax Foundations model, by all accounts, is a pure supply side model. By laying that tax on HE, the worker, you are going to make him goof off and not work so hard. HE, the capitalist, isn’t going to invest so much anymore, since he is not getting paid as much. Tax cuts make HE work hader and invest his money. Tax increases make him goof off and spend his money on tchothkes or something,
There is a a sub field called behaviorial ecomics, although I call it stupinomics, that examines the ways in which actual people deviate from HE. The reason I call it stupinomics is that it tries to explain and document people doing things that HE knows are stupid, like buying lottery tickets or selling low and buying high. As far as I have been able to tell the insights of behavioral economics have not been incorporated in the Tax Foundation’s model or that of any of its critics that I have been able to track down,
Other Economists On The Tax Foundation
I spoke with Laurence Kotlikoff , a professor at Boston University (and I’ve just noticed also a forbes.com contributor). He told me that he considers the Tax Foundation model simplistic. That was what I also got from other economists, who were only willing to speak on background. Here is the frustrating thing. Nobody else seems to have a dynamic model, because they think it is too hard. (See correction) Professor Kotkikoof indicated that he may be coming out with something soon. Although I’m sure this is a simplistic explanation on my part, he seemed to indicate that you can judge a model as being simplistic if it only has a few equations as opposed to 500 or so.
Professor Kotlikoff gave me an example of a more sophisticated model that is designed to measure the progressivity of our system and work disincentives over a lifetime. One of the things he pointed out is that when you consider not just our tax code but also benefit programs, our overall system is much more progressive than just considering taxes. On the other hand there are these odd places where low income people face very high marginal rates as when a small increase in earnings can throw someone off medicaid or food stamps.
One of the odd things about some of this analysis is that the Earned Income Credit, which is really a transfer payment, is in the tax code, so increases in the credit score as a tax decrease in the Tax Foundation model.
The harshest critique I found of the Tax Foundation was a paper from the Institute on Taxation and Economic Policy titled Tax Foundation Model Seeks to Revive Voodo Economics.
The TAG Model takes an exaggerated view of the impact that taxes have on the economy, while at the same time assuming that the public investments funded through those taxes have no economic value whatsoever.
In the TAG Model, tax cuts are often found to be a “free lunch” or, even more implausibly, a tool for actually boosting overall tax collections. Moreover, these findings are most closely linked to tax cuts for high-income taxpayers, meaning that the model assumes tax policy changes that widen economic inequality are economically beneficial, while those that narrow inequality are often a drag on economic growth.
Ultimately, the TAG Model’s extreme findings strongly suggest that the model is unreliable
When I spoke to Carl Davis at ITEP he indicated that in order for the Tax Foundation model to make sense you have to think that the government is taking resources out of the economy and burning them, rather than producing public goods. Oddly enough, that is probably what a lot of people think. There is this general sense in some quarters that private industry does things better than government in all cases. Personally, based merely on ancecdotal evidence, I’m not persuaded by that view, but that is just me.
From The Tax Foundation
As I was working through all this I circled back to Kyle Pomerleau. He thought the criticism of their model for not having enough equations was not well founded.
The number of equations a model has does not necessarily relate to its quality. When putting a model together there is a trade off between generalizability and accuracy. You could create a model that perfectly predicts the behavior of a single person. However, it would be less generalizable to the population as a whole. You want to balance those things. We believe that we have, but there is always room for improvement. So any comments on the actual equations and assumption would be helpful. Just saying that there are too few equations is, frankly, meaningless.
The Only Game In Town
I will probably continue to cite the Tax Foundation’s estimates in discussing presidential plans. I have not found anybody who questions their static scoring. When it comes to the dynamic scoring, I am going to suspend judgement, because I don’t think there is as much of a consensus among economists as to how taxes afffect the overall economy as there is, for example, among climate scientists on the effect of carbon dioxide on global warming. So I think we may be giving the Tax Foundation’s model just a little more credibility than it deserves. It has a model that allows it to put out results quickly and that matters a lot in the attention that it gets, but it does not make it right.
Correction
It is not that there are not other dynamic models besides the Tax Foundation’s. Professor Kotlikoff has one, as he told me in a subsequent interview. Also the Joint Commitee on Taxation and the Congressional Budget Office have dynamic models, as Kyle Pomerleau as pointed out to me. Nobody other than Tax Foundation, however, seems to be using their dynamic models to score candidate tax plans in close to real time.