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Hayek Scores Over Keynes April 8, 2013 5:00 PM | Tagged as dynamic, scoring, static
WSJ April 1, 2013 (page A12): “The Senate Gets Dynamic” (editorial)
No, the above title is not a news flash from March Madness.
For decades, Congress has used Keynesian models for scoring proposed tax policy changes. This is also called “static” scoring, which is based on the false assumption that increasing tax rates will always increase tax revenues. (Search for past Biz Bucks Blogs on macroeconomics, Laffer, and Keynesian for more information.) These static models assume that with ever increasing tax rates, there is no effect on economic output. The businesses, entrepreneurs, and venture capitalists of our country will just keep investing and making more jobs, more products, and more money, and paying more taxes, regardless of tax policy. That is ridiculous.
The Net Present Value of a business decision is fundamentally based on future, AFTER TAX cash flows. When taxes are raised, proposed ventures have a smaller NPV and, thus, many become unwise risks. Economic activity is reduced by increasing taxes from the levels we now have. This, in turn, reduces tax revenues. This is a classical economic principle. The economist Frederick Hayek who wrote about this would be proud to know that finally some members of Congress are starting to “get it”.
As noted in the referenced editorial, a recent vote in the Senate has brought hope to the current legislative insanity. Recently, they voted 51-48 in a non-binding resolution to require CBO to include dynamic scoring in all proposed tax changes. This, unfortunately, means the current models would not be retired and replaced, but at least a second opinion would be available that reflects the reality that tax rates affect economic decision making.
While no model will accurately predict the effect of tax policy changes on the economy, dynamic scoring comes much closer that static scoring. As my USC Econ prof, Dr. Alan Shapiro, taught us, “It is better to be vaguely right, the precisely wrong.”
No, this editorial wasn’t an April Fool’s joke. Hope now springs eternal that a “binding” resolution for dynamic scoring will pass and change the culture, the capability, and the competence of our national legislative branch.
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