Hearing on Dynamic Analysis of the Tax Reform Act of 2014Hearing on Dynamic Analysis of the Tax Reform Act of 2014
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CONTENTS _____________________
WITNESSES Scott Hodge President, Tax Foundation Testimony John Buckley Former Chief Tax Counsel, Committee on Ways and Means, and Former Chief of Staff, Joint Committee on Taxation Testimony J.D. Foster Deputy Chief Economist, U.S. Chamber of Commerce Testimony John Diamond Professor, Rice University Testimony Douglas Holtz-Eakin President, American Action Forum Testimony Curtis Dubay Research Fellow, Heritage Foundation Testimony ____________________________________________
Hearing on Dynamic Analysis of the Tax Reform Act of 2014 Wednesday, July 30, 2014
U.S. House of Representatives, Committee on Ways and Means, Washington, D.C. ____________________
The subcommittee met, pursuant to call, at 10:01 a.m., in Room 1100, Longworth House Office Building, Hon. Pat Tiberi [chairman of the subcommittee] presiding.[The advisory of the hearing follows:] __________________________________________________________________ Chairman Tiberi. The hearing will come to order. Good morning and thank you for joining us with our subcommittee's hearing on dynamic analysis of Chairman Camp tax reform discussion draft, the Tax Reform Act of 2014. Today we examine the discussion draft of the Tax Reform Act of 2014 released by Chairman David Camp in February. The draft attempts to overhaul the Tax Code to create one that is simpler, fairer, and more pro‑growth. I applaud Chairman Camp for his work on the draft and for working to fix our broken Tax Code to strengthen the economy, help employers create more jobs, and increase wages for American families. An important goal for any tax reform plan is economic growth, and the Joint Committee on Taxation for the first time provided a dynamic analysis of the tax legislation where it found the draft will increase GDP by as much as $3.4 trillion and would create nearly 2 million private sector jobs. Chairman Tiberi. Chairman Camp requested feedback on the draft on the JCT analysis on economic modeling generally and how to treat dynamic revenue that results from a macroeconomic analysis of the discussion draft. I am pleased that so many stakeholders and economists have offered feedback thus far, and during the hearing this morning we intend to examine some of the feedback relating to dynamic analysis. The Tax Reform Act is a huge, important step forward in creating a better Tax Code for both individuals and businesses, but that is not to say it can't be improved upon. And that is why Chairman Camp released this as a discussion draft, to gather feedback from stakeholders and experts in a public and transparent manner. I am looking forward to our great bipartisan discussion today. I thank our witnesses for being here and taking the time. I now yield to Ranking Member Neal for his opening statement. Mr. Neal. Thank you, Mr. Chairman. Thanks for calling this important hearing on dynamic scoring. As many of us know, this is an issue that has been around for a considerable period of time. And I would note that, as the chairman described, the response to Mr. Camp's proposal on the Republican side, I think it is fair to say, was more dynamic than the response on the Democratic side. What it does allow is the opportunity to have an open and honest dialogue about dynamic scoring today. The witnesses that the committee has put before us are all distinguished. I have known many of them in different capacities and have great regard for the suggestions that they have made time and again. It is one of the best things about serving on the Ways and Means Committee, you really do hear from good witnesses, and the people that you associate with on this committee I think are superb in their talent. So with the panel that is assembled today we can finally, I hope, put to bed a few widespread and seemingly widely held myths. One of the most dangerous is the notion that tax cuts pay for themselves. As congressional observers can verify, the notion that tax cuts pay for themselves was a rallying cry for the deficit finance tax cuts from the previous decade ‑‑ and, frankly, the issue has been hanging around a lot longer than that ‑‑ tax cuts that failed to produce the job gains and the economic growth that we were promised in the runup to their passage. From my perspective, to date this conversation surrounding dynamic scoring has been a bit intellectually short. During the last two decades, dynamic scoring has been a way to push tax cuts, whether deficit financed or not. Do some tax cuts generate income growth? Yes. But to apply the assessment that all tax cuts pay for themselves, reduce the deficit, or grow the economy really doesn't make sense economically. You should know, I am not categorically opposed to the discussion or the approach to dynamic scoring that will be outlined today. I believe that Congress and the Joint Committee on Taxation and the Congressional Budget Office should all have the best ideas and the opportunity to put those policies forward that will influence the overall economic discussion, but not to miss the point that for the last two decades dynamic scoring has been a euphemism for enacting large tax cuts. The point that is often overlooked with dynamic scoring comes up when there are two sides of the ledger. If we are to consider the positive effects that tax cuts may or may not have on the economy, equally we should consider the positive effects that government spending and investment policies and initiatives would have on the economy as well. Might I suggest that the dust‑up that we are about to have in the next 48 hours over a big infrastructure program, I perhaps would be all in favor of applying dynamic scoring to the idea of what greater efficiencies would be caused by a large infrastructure bill based on the notion that we might not be able to predict everything that would happen tomorrow, but certainly over years to come it may well inure to the benefit of American people. So any time that we are to consider changing how CBO and JCT keeps score, we also should also be mindful that these changes have lasting consequences, and in doing so we may be undermining one of the few remaining nonpartisan and well informed commentators of the Nation's economic health. I understand the short‑term political gains for pushing tax cuts, but again I caution again pursuing this track singularly. Let me conclude by thanking the chairman. It has been a joy to work with him over the years that we have both served on this Select Revenue Subcommittee. And I yield back my time. Chairman Tiberi. Thank you. Chairman Tiberi. Before I introduce today's witnesses, I ask unanimous consent that all members' written statements be included in the record. Without objection, so ordered. Chairman Tiberi. We now turn to our panel of distinguished witnesses, and I would like to welcome all of them. First, Mr. John Diamond, a professor at Rice University in Houston, Texas. Thank you for being here. Second, Mr. Doug Holtz‑Eakin, president of the American Action Forum here in Washington, D.C. Thank you, Doug. Third, Mr. Curtis Dubay, research fellow at The Heritage Foundation here in Washington, D.C. Thank you for being here. Fourth, Mr. Scott Hodge, president of the Tax Foundation, also here in Washington, D.C. Thank you for being here, Scott. Fifth, Mr. John Buckley, former chief tax counsel, Committee on Ways and Means, and former chief of staff for the Joint Committee on Taxation here in Washington, D.C. Thank you, John, for being here. And last but not least, Mr. J.D. Foster, deputy chief economist at the Chamber of Commerce, also here in Washington, D.C. Thank you all for being here and sharing with us your testimony. First we are going to have Mr. Diamond. You are recognized for 5 minutes. Mr. Diamond. Chairman Tiberi, Ranking Member Neal, and distinguished members of the committee, it is a pleasure to present my views on the importance of dynamic analysis. So why is dynamic analysis important? A popular management adage is, if you can't measure it, you can't manage it. Dynamic analysis provides valuable information about the effects of policy proposals on economic growth, and it is important that we use this information to better manage U.S. fiscal policy. Routinely disregarding information on the macroeconomic effects of alternative proposals leads to a budget process that undervalues proposals that increase the size of the economy and overvalues proposals that shrink the size of the economy. We can no longer afford a budget process that fails to maximize economic growth. We can learn several lessons from three dynamic analyses of the Tax Reform Act of 2014, one using the model I developed with my colleague George Zodrow at Rice University, one by the JCT, and one by the Tax Foundation. We find that the Tax Reform Act would increase GDP by 1.2 percent after 5 years, by 2.2 percent after 10 years, and by 3.1 percent in the long run. The analysis using the OLG model by JCT found significantly different results, and there are several explanations for that. One, JCT assumes that the initial level of corporate income tax revenues lost due to income shifting is 20 percent of the corporate income tax base, whereas Dr. Zodrow and I use 24 percent. Also, JCT assumes that excess revenues go to increasing government transfers, rather than further corporate income tax rate reductions, as in our analysis. Further rate reductions enhance growth effects because the associated decline in income shifting allows for further rate reduction that is obtained without the negative effects of base broadening. An additional difference is that we account for the negative impact of base broadening on real wage rates and thus labor supply in the model. The Tax Foundation found much smaller results, with only a 0.2 percent increase in GDP in the long run, as the cost of capital increased under TRA, but the Tax Foundation analysis discusses, but then ignores the benefits of reduced income shifting, the benefits of the reallocation of firm‑specific capital to the United States, and the benefits of moving to a territorial system. We included these important factors. The results indicate that a base‑broadening, rate‑reducing corporate income tax reform is more likely to result in positive macroeconomic effects if the initial amount of income shifting is large and is reduced significantly when the statutory corporate income tax rate in the U.S. declines; if the accelerated depreciation is retained, instead of being used as a base‑broadening provision; and if the base‑broadening, rate‑reducing reform includes a move to a territorial system, including anti‑base‑erosion proposals. In addition, base‑broadening, rate‑reducing individual income tax reform can also increase GDP, depending on the size of the rate reductions, the base broadeners chosen, and the extent to which individual income tax reductions are financed by base broadening in the corporate sector. However, more analysis is needed, and several principles should guide that analysis. First, dynamic analysis should be used to compare the macroeconomic effects of various programs. Second, dynamic analysis should examine and present results of the effects of groups of provisions separately from the entire proposal. For the Tax Reform Act, it would be interesting to see the effects of the individual provisions, the effects of the rate‑reduction and base‑broadening provisions in the corporate sector, and the effects of the territorial provisions separately. This would both increase information and increase the reliability of the analysis. Third, the analysis should be timely and transparent, with enough information released so that others can replicate the results. Let me end by noting that JCT has created a great deal of institutional knowledge on microdynamic scoring, and it leads to an immense ability of credibility in those results. I am confident they can do the same for dynamic analysis. Chairman Tiberi. Thank you, Mr. Diamond. [The statement of Mr. Diamond follows:] Chairman Tiberi. Mr. Holtz‑Eakin, you are recognized for 5 minutes. Mr. Holtz‑Eakin. Chairman Tiberi, Ranking Member Neal, members of the committee, it is a great privilege to be here today and to again discuss the important issue of dynamic scoring, which I had first discussed with this committee over a decade ago. It will come as no surprise that I really want to make three points in my remarks. First, to endorse the principle of dynamic scoring and to stress that it can be done in a disciplined fashion to rank all proposals in a fair way. Second is to emphasize that it is perhaps most important in the area of comprehensive tax reform, to look at all the impacts. And then third, to comment briefly on the committee draft proposal itself. So on the principle of dynamic scoring, as the members well know, the idea is to look at the conventional scoring that the CBO and Joint Committee would do, which is to look at all of the revenue and expenditure effects in the Federal budget from enacting legislation, but to then take the further step of looking at the impact of those proposals on macroeconomic performance, the rate of economic growth, the rate of inflation, the rate of unemployment, and the like, and the feedbacks that that economic performance would have on the Federal budget in both the tax and the expenditure sides, so that you incorporate all of the impacts of moving from current law, to the proposal, into the analysis. And as a matter of disciplined budgeting and good economic policy, it is important to recognize all those effects so that two proposals that are the same budgetarily but have very different growth effects are identified as not the same, but in fact one is inferior and the one that produces more growth is superior. And it is important for the committee to have that information, as Mr. Diamond mentioned. There are lots of important issues which I lay out in my written testimony about how you might want to institutionalize this. It is important to have rules, for example, on what monetary policy will be doing during the fiscal policy simulations. It is important to understand how to balance the long‑run budget in the process of analyzing these proposals. But all of these are in fact just rules by which scoring would be done. There are a large set of rules by which conventional scoring is done at the moment. You can develop rules to do dynamic scoring. And I would encourage the committee to move ahead with that so that we have a way to rank all proposals in a fair fashion and to bring the economic policy impacts into the discussion. It is especially important in tax reform. Tax reform, by definition, is lowering marginal rates, broadening the base. And when you do that, two important things can happen. Number one, because tax rates are lower and the base is broader, fewer economic decisions are made on the basis of tax influences and more on fundamental business conditions or fundamental preferences of households and you get rid of a lot of misallocations. You get people working the amount that they want and not hiding out of the labor force, you get capital coming back to the United States from overseas, which is parked there now because of Tax Code reasons, and you in general use the labor, the capital, and the technologies in the economy better. That makes the economy bigger, and you want to recognize that in doing the analysis. The second thing is that you can in fact remove some of the double taxation of saving and investment, and provide better incentives for innovation, for accumulation of human capital and skills, physical capital investment, and that will make the economy grow better. And you want to recognize that in the analysis as well. If you do what you think is a tax reform and those two things aren't happening, you don't have a good tax reform. It is important for the committee to know that the policy can be improved. And so I think, in this setting especially, doing a dynamic score should be part of the process. And lastly, if you look at the committee draft, it has those characteristics. There is a large literature which has looked at the potential benefits of tax reforms, which either push us toward a more comprehensive income tax, or in some cases push us to a more growth‑oriented consumption tax base. The committee proposal is at neither of those extremes, but it is close enough to comprehensive reform that it would in fact generate beneficial growth impacts. Our reading of the literature suggests they could be as much as half a percentage point over the next 10 years. The estimate you have heard before, a little more modest than that. But those are important numbers in an economy that is growing too slowly, generating too few jobs, and generating too little income growth for the American public. So I appreciate the chance to be here today and I look forward to your questions. Chairman Tiberi. Thank you. [The statement of Mr. Holtz‑Eakin follows:] Chairman Tiberi. Mr. Dubay, recognized for 5 minutes. Mr. Dubay. Good morning, Chairman Tiberi, Ranking Member Neal, and distinguished members of the committee. The views I express in this testimony are my own and should not be construed as representing any official position of The Heritage Foundation. Thank you for having me here today to discuss the important issue of dynamic scoring and tax reform. I have been working on tax reform for a decade now, first at the Tax Foundation, then at PricewaterhouseCoopers, and for the last 6 years at Heritage. In that time, I have learned the primary reason we badly need tax reform is to improve the economy's potential and increase incomes and opportunities for all American families. Chairman Camp's recently released tax reform proposal was a big step in the right direction for finally achieving tax reform, in large part because included a dynamic estimate of the plan's income on the economy from the Joint Committee on Taxation. The chairman and staff should be applauded for securing that estimate. Dynamic analysis is the right way to evaluate tax reform because we know that tax reform improves the economy. It does so by increasing incentives for families, businesses, investors, and entrepreneurs to engage in economically productive activities like working, investing, and taking risks, which are the catalyst for economic growth. And we know that they all respond to incentives. Traditional static scoring hampers task reform's progress because it does not measure how it strengthens the economy. It is incomplete. A tax reform plan with only a static score is like a business plan without an estimate of profitability. Now, there is certainly a reasonable disagreement over how responsive families and businesses are when tax rates fall. Those are reasons to present a range of estimates, using various models and an array of elasticities that fall within the mainstream estimates from empirical academic literature, not for shunning dynamic analysis altogether. As my colleagues in The Heritage Foundation's Center for Data Analysis, or CDA, wrote recently, it is better for estimates of tax reform to be approximately right than precisely wrong. Static scoring is precisely wrong. CDA conducted a dynamic estimate of the Camp plan. They found it would increase economic output by $92 billion per year during the 10‑year budget window and it would increase employment by 548,000 jobs per year. CDA found these positive impacts because of the lower rates on families and businesses the plan institutes in its first few years and the move to a territorial system. According to CDA's estimates, the growth effects of the Camp plan taper off the longer it is in place, as policies that increase tax on investment, and therefore increase the cost of capital, have time to go fully into effect. Those include longer depreciation lives for capital and amortization of research and development and advertising expenses. To reverse that downward trend and increase the Camp plan's positive impact on growth, current depreciation schedules at minimum would need to be restored and advertising and R&D returned to fully deductible expenses. Lower rates would also help make the Camp plan more pro‑growth. The top rate under the plan is 38.3 percent. That is only 5 percentage points below where it is today. Chairman Camp understandably chose to adhere to the flawed revenue baseline constructed by the Congressional Budget Office when making his plan revenue neutral. The revenue target that baseline sets is too high, because it assumes that Congress intends for expiring tax policies to expire permanently. Under the reasonable assumption that Congress does not intend to raise taxes by default, Chairman Camp's plan could raise nearly $1 trillion less and still remain revenue neutral. That money could be used to reverse the policies that raise the cost of capital and reduce the plans top rate significantly. Chairman Camp's proposal has given renewed energy to the tax reform debate. A key to maintaining that momentum is to make sure JCT continues offering dynamic estimates of tax reform and other major pieces of tax legislation. The more JCT does dynamic estimates, the better it will become at doing them and the more opportunities outside experts will have to help JCT refine its methodology to improve it analyses even more. Thank you again for having me here today, and I look forward to your questions. Chairman Tiberi. Thank you. [The statement of Mr. Dubay follows:] Chairman Tiberi. Mr. Hodge, you are recognized for 5 minutes. Mr. Hodge. Thank you, Mr. Chairman, Ranking Member Neal, members of the committee. I appreciate the opportunity to be here today. There are many very good reasons to overhaul the Tax Code, simplicity and equity, but really economic growth ought to be the primary objective. And while we all may want a simpler, more equitable Tax Code, if that kind of a tax system actually leads to less economic growth, we ought to think twice about some of those policies. And this is why dynamic analysis must be an essential tool of any effort to reform the Tax Code. There are many base broadeners that may seem like a reasonable tradeoff for a lower rate when measured on a conventional basis, but what we find actually turn out to be antigrowth when measured on a dynamic basis. And let me echo Mr. Diamond that in order to do tax reform right, members should be provided a dynamic analysis of each component of the plan as it is being put together, not just at the end of the process after it is all done. And only then will members know which components maximize growth and which don't. However, economic growth should not be an accidental outcome of tax reform or the process. Before even beginning to think about the process of tax reform, lawmakers ought to set out a goal, an objective for how much economic growth they hope to achieve as a result of their tax reform plan. Any policy that subtracts from that goal ought to be rejected. Any policy that adds to it should be accepted. And let me echo my colleagues that Chairman Camp's plan has many positive features that by themselves would promote economic growth and competitiveness. And chief among those are the lower rates on corporate and individual tax rates and eliminating the AMT. And when we modeled these policies in isolation with no offsets, we found that they would boost GDP growth by nearly 5 percent and create more than 5 million new jobs. And we also found that on a dynamic basis these rate cuts were much less costly than they appear on a static basis, as much as 60 percent less costly for the corporate rate cut and 20 percent less costly for the individual rate cut. Actually, the corporate rate cut pays for itself beyond the budget window. However, what we found is that many of the offsets that were required to keep the chairman's plan revenue neutral on a static basis had the effect of dampening the growth potential of the plan over the long term. And when we modeled the chairman's plan, we found that the plan would increase GDP by 0.22 percent over the long run. However, we also found that because the plan raised the cost of capital in a number of ways it would reduce the capital stock modestly, which would slightly decrease pretax wages. But because the plan reduces marginal tax rates on labor income, it would raise after‑tax wages slightly, and that in turn would encourage more labor force participation and create as many as 486,000 full‑time jobs. But what these results mean, though, is that people would be working longer, but producing less total output with less capital. However, what we found was that by modifying just a few of the plan's provisions that raise the cost of capital, we can generate even more economic growth. For instance, if we just maintain the current MACRS depreciation system, as opposed to the ADS system that is in the current plan, we could boost GDP growth by 1.3 percent and create as many as 685,000 jobs. In a similar way, we modeled the original Camp plan with 50 percent bonus expensing on a permanent basis, and found that such a plan would increase GDP by nearly 2 percent and create as many at 780,000 new jobs. Well, before I conclude, I do want to say that the Joint Committee on Taxation does deserve credit for doing a dynamic analysis to the chairman's plan. However, the JCT does invite some criticism of its work because of the rather opaque way in which it presents its results, and the lack of transparency in documenting how it produces the results that it does. As my seventh grade math teacher said, show me your work. And that is what we would like to see, because the Joint Committee has made substantial changes to their models over the last decade or so, and it is time they subjected those changes and their core models to review by experts in the field. And if members are going to have any confidence that JCT's estimates are accurate and it is using state‑of‑the‑art tools, then it must allow outside experts to review those on a peer‑reviewed basis. Well, despite all the criticism, dynamic scoring is really about accuracy, credibility, and having the tools to guide us toward tax policies that promote economic growth and steer us away from policies that reduce living standards. And by contrast, the conventional static analysis leaves lawmakers in the dark about the economic consequences of their tax choices, and to me that is economic malpractice. Relying on static scoring turns tax reform into an exercise in arithmetic, rather than an exercise in promoting policies that raise people's living standards and the overall health of the American economy. Thank you, Mr. Chairman. I appreciate any comments you may have. Chairman Tiberi. Thank you, Mr. Hodge. [The statement of Mr. Hodge follows:] Chairman Tiberi. And thank you for endorsing my bonus depreciation bill. Maybe you can work on my colleague from New England. Mr. Hodge. Anything we can do to help. Chairman Tiberi. Mr. Buckley, you are recognized for 5 minutes. Mr. Buckley. Chairman Tiberi, Ranking Member Neal, thank you and the rest of the committee members for the opportunity to speak before you today. I think it is important to understand that all of the models being discussed today are models that are based on what I call supply‑side principles, the notion that increasing the number and supply of people willing to work will automatically translate into greater economic growth. I think that theory is no longer relevant when we have a world economy where there are virtually unlimited supplies of labor overseas and U.S. multinationals responding to market outcomes ‑‑ this is not due to any distortion ‑‑ responding to market outcomes are increasingly accessing those unlimited labor supplies to produce goods and services. I think the question is quite simple when you look at these models: Is the basic economic challenge facing this country a lack of jobs or too few people looking for work? I think we all know what the answer to that question is. Yet, the models that we use today, that are being discussed today, assume that increases in labor supply will automatically translate into increased economic growth. They handle the problem of unemployment in most models by simply assuming it does not exist. I think it is important for the members to realize that the models have been totally erroneous in their projections in the past. They have predicted severe economic issues from the 1993 tax increases that did not occur. Indeed, the period following the 1993 tax increase was one of fairly robust economic growth. They projected large benefits from the 2001 and 2003 tax reductions. Again, that did not occur. I think one reason why those projections have been wrong is that the models in large respect are divorced from reality. And here I want to use Professor Diamond's model as an example. He does not analyze the proposal against today's economy. He assumes we have an economy with no unemployment and an economy where people always act in their best interest, guided by the ability, with perfect foresight, to foresee the future. He does not analyze the actual Camp proposal. He assumes that the Camp proposal will be accompanied by massive reductions in entitlement programs to bring our budget to a sustainable level. The amount of entitlement programs assumed in his model would be at least $2 trillion over the next 10 years, with a lot more to follow. He assumes that the Camp bill will further reduce the corporate rate to 20 percent, which does have the effect of reducing the increase in the cost of capital that the prior witnesses have talked about that would occur under the actual Camp proposal. Mr. Chairman, I think this committee is wise to examine dynamic scoring. I don't think it is wise to get involved in the argument of which model is best and which assumptions are appropriate. I think they should look at the underlying principles that underlie these models and examine why they may no longer be relevant. In the 20‑year period preceding 2008, virtually all employment growth in this country occurred only in the sector of our economy not subject to cross‑border competition, and most of that employment growth occurred in health care, government, and retail. Many believe that we cannot rely on those sectors any longer for increased employment opportunities. Those responses were all due to market forces. A tax reform plan based on the primacy of economic neutrality does nothing to reverse the market forces that have caused a loss of domestic manufacturing employment. Indeed, for reasons that have been expressed before, the Camp bill, because it increases the cost of domestic capital, will reduce incentives to invest in the United States and therefore could be a long‑term drag on economic growth. Chairman Tiberi. Thank you, Mr. Buckley. [The statement of Mr. Buckley follows:] Chairman Tiberi. Mr. Foster, you are recognized for 5 minutes. Mr. Foster. Good morning, Chairman Tiberi, Ranking Member Neal, members of the committee. My name is J.D. Foster, I am the deputy chief economist at the U.S. Chamber of Commerce. Thank you for the opportunity to testify this morning on dynamic analysis of the Tax Reform Act of 2014. I always enjoy when an esteemed tax lawyer pretends he is an economist. I would love to have the opportunity to give a brief before the U.S. Supreme Court. That would be great fun as an economist. I probably wouldn't do very well, but I would enjoy it. Mr. Buckley notes, quite correctly, that the models we tend to use are supply side in nature, and indeed they are, and they do, in fact, assume a certain level of full employment. That is the same assumption, I should point out, that the Congressional Budget Office makes, that despite the poor performance of our economy in recent years, the economy will, in fact, get to full employment. It is, in fact, the forecast of the administration, which forecasts that we will, in fact, get back to full employment. So one can, of course, question whether or not that will ever be the case under current policies, but at least that is the forecast in the basis of the modeling. Returning to Chairman Camp's proposal, many lessons have been drawn from this, and I will summarize them, the five key lessons regarding dynamic analysis, as follows. First, the Joint Tax Committee proved dynamic analysis of tax policy can be done credibly, refuting longstanding assertions to the contrary by some. Second, dynamic analysis remains roughly equal parts art and science. Three, it remains important to consider a variety of models under a variety of assumptions. As they gain experience, analysts should be able to settle on a single primary model and assumption set. But the tools are not there yet. Consequently, it remains important at this stage to give heed to each models results under a variety of assumptions. And with respect to the tax reform process itself, the most important lesson of all by far, the amount of additional growth required from tax reform should be made explicit and specific at the outset. Comprehensive tax reform offers a unique opportunity to strengthen the U.S. economy substantially compared to what it otherwise would be, but there is a lot of work, as evidenced by the tremendous effort that went into the Camp plan, and it would ultimately engage the whole Nation. The expected results should justify the effort. Proponents of pro‑growth tax reform long been handicapped at the outset, but in a manner only now apparent. Tax reform is typically required to meet a variety of ex ante, identified, and precisely quantified design criteria. One such criteria is revenue neutrality. A second is distributional neutrality. Each of these can be justified as necessary to reform, but each is likely to limit the ability of tax reform to improve the economy. In addition, many tax provisions of little or no overall economic consequence hover over tax reform. It is likely some would be preserved, further reducing the extent of other changes that would be expected to benefit the overall economy. In contrast, the most important criterion of all, a stronger economy, has been left generic and loose, and thus repeatedly suffered at the expense of the other criteria. Tax reform's chief objective is a stronger economy. Yet, according to the body of analysis available to date, an honest appraisal must conclude the Camp proposal shows a fairly modest improvement in economic performance, likely much less than intended. How did this come about? What constrained the effort so that it was unable to produce the kind of game‑changing economic gain intended and what should be expected? Perhaps the models used for data economic analysis are yet too rudimentary to capture properly the full magnitude of growth effects from tax reform. Perhaps. Much of the answer is certainly that while a significantly stronger economy was the goal, the size of required gain was not specified. As has been common in the past, whatever additional growth was anticipated, the result was accepted as the best one could do, even if it meant the best was not very much. In contrast, major design criteria such as revenue and distributional neutrality were met with fair precision. Put simply, in a contest of competing requirements, this was not a fair fight. Substantially stronger growth never had a chance. Fortunately, the problem being clear, the solution is equally clear. Tax reform should proceed with a definite, specific, realistic, and quantified goal for a stronger economy. Deciding tax reform's goal for economic improvement is a debate unto itself. To advance the debate one could contemplate an economic growth budget. How much economic growth is lost to current policy and how much economic growth are we willing to spend through the Tax Code? The analogy to tax expenditure analysis is obvious. Here we are not talking about the revenue effects of individual provisions, but rather the aggregate economic effects of tax policy overall. Among competing goals, economic growth should be treated as first among equals in the formulation of comprehensive tax reform. As we have learned, this requires the goal to be explicit, not merely a stronger economy, but how much. Such an explicit goal also means we will have a clearer understanding of the economy budget, how much economic growth we are willing to give up through the Tax Code to achieve noneconomic goals. Such a goal and such a debate is only possible because of the progress to date in dynamic analysis. This progress must continue for the analysis to be credible, and reliable, thus for the projected economic improvement to be credible, and thus for the comprehensive tax reform to be surely successful. Thank you, Mr. Chairman. Chairman Tiberi. Thank you, Mr. Foster. [The statement of Mr. Foster follows:] Chairman Tiberi. Before I ask a question, Mr. Buckley, you took issue with a portion of Mr. Diamond's written testimony. I would like to comment on a data point in your testimony ‑‑ in your written testimony ‑‑ that I believe is incorrect, in your main thesis about the effects of the Camp draft on business investments. You rest this claim that the Camp proposal, and I am going to quote from your written testimony, "would result in a net $590 billion tax increase on corporate income and business income of individuals," end of quote. So you cite the JCT macroeconomic analysis for this quote, but I think you forget a huge caveat that JCT included in their analysis. In fact, the $590 billion claim includes revenue raisers on pass‑through businesses, but ignores the benefits of actual cuts in the individual rate on those same businesses and completely ignores the AMT repeal on those same pass‑through businesses. And while we don't have exact numbers, the business tax cuts amount to hundreds of billions of dollars, wiping out a large portion of those tax increases that you cite. So I just wanted to make that point. Mr. Buckley. Mr. Chairman, may I respond? Chairman Tiberi. At the end of my questions, you may. So going to my question, and I would like to ask Mr. Hodge this first, a number of you, including you, Mr. Hodge, recommended changes to the discussion draft and argued that the tradeoff between tax reduction and cost recovery is particularly difficult. There are several temporary tax policies, as you know, that are designed to speed up cost recovery, but which Congress only extends on a temporary basis, many times retroactively. We have had this debate. I have introduced, as you know, a couple of those that have both passed the House. One, bonus depreciation, which you mentioned. Another, section 179 small business expensing. Permanent on both without offsetting them with raising taxes elsewhere. So, first, do you think that we should assume these policies are permanent for purposes of defining tax revenue neutrality and distribution neutrality? That would be one question. And second, how do you believe including permanent versions of both of these policies as part of the Tax Reform Act of 2014, without the need to offset them with higher taxes elsewhere, would increase economic growth through tax reform? Mr. Hodge. As I mentioned, Mr. Chairman, we modeled the Camp proposal with 50 percent bonus expensing on a permanent basis and found that it significantly increased the growth potential of the plan. And we have actually modeled your proposal on its own and found that it would achieve quite considerable economic growth, create jobs, and more importantly, lower the cost of capital, which would be a great benefit to workers, it would provide them with better tools. And we found that generally when it comes to expensing provisions or provisions that allow full cost recovery, that in the long run cost recovery or full expensing ends up paying for itself. In fact, our model shows that it has greater economic benefits than simply lowering the corporate tax rate. We think both should be done, and they should be done at the same time, and then you will get even greater economic growth. But certainly I think those are the kind of provisions that, unfortunately, because of the static requirements that Chairman Camp was working under, required this tradeoff. And we really don't think it was necessary. You could have done both. You could have lowered the rate and moved toward expensing, and that would have boosted tremendously the growth potential of the plan. Chairman Tiberi. Mr. Holtz‑Eakin, your thoughts on that? Mr. Holtz‑Eakin. The issue of the baseline is an important one. And right now the baseline has this tremendous asymmetry where if a spending program exceeds $50 million it is extended indefinitely regardless of whether it has been reauthorized by Congress or not, but a comparable provision on the tax side is assumed to expire, and it leads to an imbalance, in my view, in the way policies are evaluated. The top criteria should be to treat proposals in a fair fashion, and that is a fundamental asymmetry that is built into it. I would treat them both the same, thus the bonus depreciation would be extended. That has been the practice of the Congress, that would be the baseline if we had symmetry between the tax and the expenditure side. And so, I think you should do that, and you would get better information about the real budget outlook, and if you do the dynamic analysis you get better information about the economic policy. Chairman Tiberi. Mr. Diamond. Mr. Diamond. I agree with their analysis. I think it would be interesting. I think the JCT has actually looked at this in a dynamic analysis and I think that was very useful. I do take and actually used a version of an OLG model, and I take issue with four of the five points that Mr. Buckley raised. Chairman Tiberi. I thought you would. Mr. Diamond. He was correct on one. But he said it is only supply‑side effects, but the 2003 act used my model and we found negative effects in the out years, so that is directly contrary to your testimony. You dis the idea of perfect foresight, but two very prominent economists in 1987, in a book called "Dynamic Fiscal Policy," on page 10, give this reasoning for perfect foresight: Perfect foresight may seem extreme, but it is actually very useful. Actual deviations in individual behavior are both likely to understate and overstate. So one household may overstate wages and one household may understate wages. So perfect foresight is kind of the perfect average. But he argues for using a myopic model. A myopic model systematically gets the wrong answer, so you assume everybody makes the same mistake every period. How can we possibly want that type of model over an OLG model, which has a much more reasonable side. So again, that is Auerbach, Kotlikoff page 10. Supply and demand analysis, it is only supply side. That is false. My model includes both a labor supply and a labor demand. Firms have a derived labor demand. So we have both demand and supply effects. If only supply were to increase, what you would get is you would get an increase in labor supply, but you would also get a reduction in the wage rate. And I would expect any of my Econ 201 students to be able to point that out on a test question. Finally, this issue of, what do you do with these huge projected budget deficits? And his response is that the model is totally unrealistic because we don't deal with it. We don't actually assume there is a massive reduction in transfer payments. I just assume not to look at it, because I can't tell you how you all are going to solve that problem. But I can tell you this: If I assumed that the problem was solved by tax increases, then that implies that tax rates would be higher and economic distortions would be larger, and thus the positive effects of tax reform would be bigger, not smaller. So if I am wrong anywhere, I am wrong for underestimating the size of the effects. Chairman Tiberi. Mr. Buckley. Mr. Buckley. Thank you, Mr. Chairman, for the opportunity to respond. First of all, my numbers come out of the Joint Committee analysis. What is indisputable from the Joint Committee analysis, and from some of the prior witnesses, is that the Camp draft will increase the cost of domestic capital, leading to projected reductions in business investment. That is the result of the Joint Committee analysis using their own derived model. The point I am trying to make about the economic assumptions is that they are quite unrealistic. It is not ultimate full employment that is assumed in some of these models, it is that we have a full employment economy today and at all times. Increases in labor supply can automatically translate into increased economic growth only an economy of full employment, otherwise they just add to the current surplus of unused labor supply. These are I think important issues. Now let me apologize if Professor's Diamond's model got it right in 2003. Then Representative John Kasich stood on the floor of the House of Representatives and said every economic model in this country projects that this bill is a job killer. And they were wrong. These models I think are very imperfect guides to policy. We have a world with unlimited labor supply overseas. If we do not enact policies to increase the competitiveness of U.S. businesses in the world economy, the increased labor supply will not be utilized. Chairman Tiberi. Okay, thank you. We could have a good debate here. I am going to ask Mr. Foster to comment on my question. Mr. Foster. Thank you, sir. I think this might be time to refer to something I wrote in my testimony regarding the process with which one would use dynamic analysis in practice. And it starts with how CBO does its beginning forecast. First, we get some sense of where the economy is today. That in itself is difficult. Then CBO has a projection for potential output. That shows we are at full employment whenever we get there, where we would be, and how that trajectory goes over time. And then the forecaster has to figure out some way to draw the line so that we go from where we are to the potential. What dynamic analysis really does, done properly, is to shift that potential, hopefully up. And then we figure out how does that change the trajectory from where we are to the new potential in going forward. It doesn't assume in practice that we are instantly at full employment. We use that for modeling exercises now because we are still learning how the models work, but in practice one would never do that, any more than CBO today in doing an economic forecast, or the administration, would say, okay, we think instantly we are at full employment. Now, if we are at full employment, that is fine, today we are not there. So one would not use that sort of methodology. We are still learning the models, and so we go to the abstraction of assuming we are at potential output today. That is not how dynamic analysis would ever be used in practice. Chairman Tiberi. Thank you. Mr. Dubay, do you want to add anything to that? Mr. Dubay. That is exactly what I was going to say, that tax reform is about increasing the economy's potential. So when you go back to, say, the 1993 tax hikes, it would be more accurate to say that the economy won't be as strong because of them. We probably would have had stronger job growth had we not raised taxes in the early 1990s, during that decade. Same thing goes for the tax cuts in the early 2000s, the economy wouldn't have grown as strongly as it did had we not cut taxes at that point. On the issue of the extenders, I think it does hinder tax reform, because think about it, according to Chairman Camp they had to replace a trillion dollars of revenue they wouldn't otherwise had to had you had an equal treatment between tax policy and spending policy under the CBO baseline. So that means that Chairman Camp was forced into even more difficult choices, which included having to extend depreciation lives, which cut down on the growth potential. So I think it is important to equalize the treatment so that we can get better tax policy going forward. Chairman Tiberi. Thank you. Mr. Neal is recognized. Mr. Neal. Thank you very much, Mr. Chairman. I would like to submit for the record a series of posts from Bruce Bartlett, who served in the Reagan and Bush senior administrations, as well as working on the staff of Representative Kemp and Ron Paul. Chairman Tiberi. Without objection. Mr. Neal. Thank you. I don't think as we pursue this discussion that the argument should come to one side favoring tax increases. We are trying to figure out the manifestation of sound policy that will promote economic growth. I think we can all agree upon that. And at the same time, I must tell you, as you practice economics, you can see how that doesn't always translate into the certainty of the speeches on the House floor or the meetings in the Oval Office, as I heard Vice President Cheney when I was invited, it was just a handful of us, to the Oval Office within days of Bush junior becoming President, and we went back and forth on tax policy as the President laid out his proposal. And the President asked me what I thought, and I thought it was a very honest opportunity for the conversation. And I suggested, Mr. President, why don't we do some modest tax cuts for middle‑income Americans and continue to pay down the debt? The rejection didn't come from the President, it came from Vice President Cheney, who had served with me in the House in a prior life. And I call that to your attention, because even though you give us speculation, which I think is very important as to what outcomes might occur based on what policies, that is not the way it is translated in the course of a campaign. And that is part of the difficulty with the soundness of what has been offered here today in terms of discussion. Now, Mr. Buckley also referenced a key point. I remember that discussion as we closed the debate on Clinton's budget in 1993. And the principal architect in the House at the time of dynamic scoring was the majority leader, Dick Armey. He argued, juxtaposed with the position of now Governor Kasich, two points. One, if we embraced that budget that Clinton offered in 1993 ‑‑ and by the way, credit to Bush senior for the courage that he demonstrated ‑‑ but if we embraced that Clinton budget in 1993, one of them said, it will take us to fiscal Armageddon. The other said as the debate closed with the lights dimming, and I recall it vividly, we would head toward the greatest depression since the depression of the 1930s by endorsing and embracing that budget. Instead, two budgets from Clinton and one from Bush senior took us to the greatest spurt of economic growth in the history of the company. Mr. Eakin, appreciating the honesty that you frequently bring to these discussions, could you see a path of using dynamic scoring to bring about a sound infrastructure investment proposal for the country, trying to measure those outcomes? Mr. Holtz‑Eakin. I think there is no reason to restrict insights into economic policy to just the tax side of the budget, there is no question about that. I think, if I could ‑‑ I don't want to take too much time ‑‑ Mr. Neal. No, please. Mr. Holtz‑Eakin. ‑‑ it is important to recognize that this is a scoring issue and that most of scoring is about ranking alternative proposals. There are a lot of claims about accuracy. There will always be inaccuracies in this process, static, dynamic, whatever you want to liable it. The future is a very difficult thing to predict, period. But you should do your very best, as CBO does now and the Joint Committee does now, to sort of put yourself in the middle of the range of outcomes, it could be higher, it could be lower, try to get it right in the middle, and systematically rank things in the right order. And that is the most important thing that you would do if you brought dynamic scoring into the process, is get the rankings right, reflecting the best of our ability to model the economics. The second thing I would say is, these are models. There is a lot of criticism about how they are not reality. They are not supposed to be reality. The whole point of a model is to extract from reality key features you care about. What are the key features for economic growth, put those in a model, see the growth impacts. And for that reason you shouldn't say, this is what is going to happen. You should say, this is what is going to be improved by this proposal, although the future may happen however it may be. And so I don't think it does any good to say, well, there was a claim about a model and then we end up having rapid growth or a claim about a model and we had bad growth. Those are two different thanks. Mr. Neal. Thank you. Mr. Buckley, one of challenges that is facing us is this notion of the worker participation rate. Today's announcement that the economy grew by 4 percent ‑‑ and we still note there are too many people working part time and who are underemployed ‑‑ and would you finish the position that you were offering earlier with Mr. Tiberi? Mr. Buckley. Well, my view is that what you need for long‑term economic growth is for the United States to be competitive in the world economy. And that requires incentives for domestic investment, whether it is bonus depreciation or current law, you need investments in human capital so our workers are more productive in the world economy. We have a world economy now. Our companies are very good at accessing this vast supply of labor overseas. And again, let me repeat, all because of market outcomes. This is not a distortion in economic. They are going overseas because the market tells them to do it. We need to have policies to encourage them to stay here with investments in physical capital and human resources that will make our economy more productive in the long term. You should note some of these projections of economic growth assume that people work longer at lower wages because of the decline in capital investment. That is not my vision of how to improve our long‑term economic situation. Chairman Tiberi. Thank you, Mr. Neal. Having worked for John Kasich for 8 years, he certainly doesn't need to be defended here. But what I think he would say, which I have heard him say a whole lot of times, is that maybe the trajectory changed because of the 1994 election, where the House was taken by Republicans and the Senate was taken by Republicans and the trajectory of spending and the regulatory environment changed. That is what he would say. Again, he doesn't need defending, but since he is not here, he would take issue with a couple of those statements. I recognize Mr. Paulsen for 5 minutes. Mr. Paulsen. Thank you, Mr. Chairman. And we appreciate all the testimony from the witnesses. I am going to start out more specifically, then expand a little bit more broadly, and I am going to reference a specific tax that was included actually in ‑‑ repealing a specific tax that was included in the Camp draft. It has had a very negative impact on companies in Minnesota, in my State and around the country. It is the medical device excise tax. And studies have shown that this excise tax has led to job reductions, hiring freezes, reduced investments in research and development and capital infrastructure in the medtech industry. Mr. Holtz‑Eakin, I will just start with you. Can you please describe maybe how repealing this tax and potentially reversing some of these trends could generate economic activity that could be incorporated into a dynamic analysis, and what would the overall effect be of repealing the medical device tax under a dynamic analysis look like? Mr. Holtz‑Eakin. Well, as you know, the American Action Forum has actually done some work on the medical device tax and found that it does have negative impacts on employment in that sector, on investment and innovation in that sector. Those are analyses that one can capture under conventional scoring and should, but the conventional scoring would then have to take those employees and put them somewhere else in the economy, take the income that is lost there and have it generated somewhere else in the economy. Putting that into the dynamic analysis, along with the other features, gives you a better trajectory of long‑run investment, innovation, and growth. I would say that as a matter of practice you don't want to have to do full‑blown dynamic analysis on every proposal. Only large ones merit that kind of treatment. Mr. Paulsen. And then I will just expand a little more broadly then. One of the most important parts of developing tax reform legislation is analyzing the tradeoffs between lower rates and then those provisions that narrow the tax base. And, Mr. Hodge, you mentioned earlier that dynamic scoring is really about accuracy, credibility, having the tools that guide us toward tax policies that promote growth. Now, some of the provisions are of little economic benefit that are in the code right now and clearly should be eliminated to help lower rates, but other provisions have significant economic effects that must be weighed very carefully against the benefit of lower rates. In the various models that all of you have looked at or used to estimate the economic effects of the discussion draft, which revenue raisers, other than general depreciation rules, have a material impact on the economy? I can just start with Mr. Diamond, and we can just kind of go down. Mr. Diamond. Well, any of the revenue raisers that affect the cost of capital would have had the largest impact on the growth effects. So accelerated appreciation, the research and investment credit, other things like that. In addition, revenue raisers on the individual side, you would want to get the revenue raisers that promote the most efficiency in the economy. So maybe reforming the mortgage interest deduction would have increased growth because it would have reduced the difference in the tax treatment of business capital and housing capital. And so some reform on that front, which I have written on previously, would also help to alter the proposal to get bigger growth effects. Mr. Paulsen. Mr. Dubay maybe. Mr. Dubay. Yeah, I agree. I agree. Anything that increases the cost of capital has depressing growth effects. One thing, I look at the 10 percent surtax as a pay‑for, so that raises that top rate up to 38.3 percent, so I look at that as an opportunity to increase growth by getting that further down. Mr. Paulsen. Good point. Mr. Hodge. Mr. Hodge. Yeah, I would echo all of those, and I would also throw into the mix the capital gains treatment. And while the chairman's proposal doesn't really increase the effective capital gains rate that much, we think it would have some material effect. And I think, if anything, we should be reducing the capital gains rate back to where it was prior to 2 years ago when it was raised to 20 percent, or now it is 23.8 percent. So all of those things can materially affect the growth potential of these plans, and really, it is the cost of capital, I will just echo everyone else's sentiment on this, that is the driving force here. Mr. Paulsen. Mr. Foster, just from the chamber perspective, just the cost of capital. Any other observation? Mr. Foster. Well, the general rule is that the Tax Code inherently distorts economic activity, and so any movement in tax reform towards reducing those distortions, any at all, is beneficial. What we are not always very good at in economics is determining which ones are most harmful to economic growth and which are not. But the cost of capital, I think we all agree on this panel, is certainly very, very important. Mr. Paulsen. Mr. Chairman, I see my time is almost expired. I yield back. Chairman Tiberi. Mr. Larson is recognized for 5 minutes minutes. Mr. Larson. Thank you, Mr. Chairman. And let me reiterate what my distinguished colleague, Richie Neal, had to say before about the importance of these hearings and our distinguished panelists and commend the chairman for providing us the opportunity to learn from sources, exceptional sources, and people that have a great deal to say and have a vast amount of knowledge as well. And this comes at a critical time in our economy and a critical time when people are thinking through going through a decision‑making process. It also comes at a time when Congress, I believe, is at a 7 percent approval rating with the American people. And part of the reason that Congress is at that juncture is because people have a hard time seeing any action or believing what they are saying. So what I always like to do is to try to apply what I call the Augie & Ray's test to this. Now, I am not an economist, nor am I an attorney, and so these are not pure, econometrics are not going to be applied here. But what you do get at Augie & Ray's is an unfiltered view of the world. So, for example, listening here today, I am impressed with the varying ways that you can look at the impact of the GDP. But at Augie & Ray's, they would say, don't talk to me about the GDP, talk to me about the JOB. And it is the JOB that the American people are concerned about. So it is great that we have this discussion, but how would you ‑‑ and I am going to start with Mr. Buckley ‑‑ how would you translate this? Because I think it is the responsibility of Congress to demystify these things for the American people so we can build the trust amongst them that policy and decisions like this are important. But how is it that this is going to impact my local manufacturers and those guys that stop by Augie & Ray's, how is a family household impacted by this? What kind of metrics? Or, I forget who used a term, I thought it was very good, what kind of measurements do we have with respect to that impact on those individuals that we can translate into meaningful policy? And I will start with Mr. Buckley. Mr. Buckley. Well, I think the first thing you want is a positive business environment in the United States and positive incentives for investment in the United States. I think one agreement, if you are looking for a bipartisan agreement on this panel, is that the Camp bill increases the cost of domestic business, capital, and in the long run it is a negative for investment in the United States. Now, it has a particularly large impact on capital‑intensive industries, largely manufacturing. When people on this panel say it increases the cost of capital, they are talking about the average cost of capital. It doesn't increase the cost of capital much for financial services businesses because they do not utilize research and development expensing or accelerated depreciation. It will have a particularly adverse impact on those segments of our economy that utilize those incentives. They will see the biggest increase after cost of capital. And it is those types of jobs that I believe are necessary for middle‑class growth and income. And it is those types of investments, and I would say investments in human capital as well, that are necessary for the United States to be productive or competitive in an economy that has worldwide flows of capital. Mr. Larson. Isn't this the same problem that we are faced with and other cognizance that the full committee has with trade over this same issue? It is a global economy, and yet this distrust at home amongst individuals over the fact that it is easier for jobs to go overseas, and we get left out in the process. And manufacturing seems to be depart and goes where the lowest common denominator, in this case labor is, so for reasons of profitability. You suggested earlier that we need to have incentives to be here. Do the rest of the panelists agree with that, do you think? Mr. Diamond. I agree that we need to have incentives. I agree with most of what Mr. Buckley just said. On the topic of dynamic analysis, I think there are measures in the models that would be useful, and we need to look beyond strictly looking at GDP. And Mr. Hodge referenced this earlier, is you can have a positive GDP response when capital is declining, and so the GDP response is purely showing that people are working harder. But people like to consume both goods and leisure, so if increases in GDP come only from increased hours at work and possibly lower wages as demand and supply in the models equilibrate, that would be a bad thing. In my model, I mean, you can look at employment, at wages, you can actually look at welfare, so you could see, and welfare would be a measure that is based on how much consumption do you have both in terms of consumption goods and in leisure time, and then we can measure this theoretical version of welfare. And going back to Dr. Holtz‑Eakin's point, this is isn't a projection that is meant to say this is exactly the right number. These are meant to compare alternative proposals so that we can reach and manage the U.S. economy to the highest potential growth path. Chairman Tiberi. The gentleman's time has expired, but anyone else want to comment? Mr. Hodge, you want to comment? Mr. Hodge. Just very quickly. I think getting to your point on how tax reform can benefit the average person, you can see that in dynamic analysis. For instance, when we analyzed on a dynamic basis bonus expensing, if you look at that, the distributional effects on a static basis, it shows that average people don't benefit at all. But when you look at it on a dynamic basis, after those economic effects have flowed through to pretax incomes, you see that the incomes of everybody have grown by about 2 percent. That is the real benefit of a dynamic analysis, especially on a distributional basis. You get to see the effects on real people after the economic consequences have flowed through to their wages. Chairman Tiberi. Mr. Holtz‑Eakin. Mr. Holtz‑Eakin. I think if you are talking to your constituents, you can say, look, we have three problems that we know about. We have too few people working. The people who have jobs are not getting raises, income is not going up. And we are at a disadvantage in the global economy, our competition is not fair. So you could fix some of that with trade, but if you are just talking on tax policy, you can say, look, here is a proposal that the dynamic analysis says improves GDP growth. What does that mean? That means initially more people are working. You can produce more because more people work. That is a jobs problem. Eventually, everyone who wants to work is back at work, and GDP can only go up by making them more productive and generating more income. That means they are getting raises. That is good. And some of these proposals would actually level the playing field between U.S. and international global competitors. That would be great for purposes of the location of activity in the United States. So this is about getting jobs, getting raises, and keeping our companies here, and that is what it is about. Chairman Tiberi. Very good. Thank you. The gentleman's time has expired. Mr. Marchant is recognized for 5 minutes. Mr. Marchant. Thank you, Mr. Chairman. Several of you have recommended changes to the discussion draft, and in each case you have argued that the tradeoff between rate reduction and cost recovery is difficult. There are several temporary tax policies that are designed to speed up cost recovery, but which Congress only extends for short periods of times and often retroactively. The House has recently voted to make two of these, bonus depreciation and section 179 small business expensing, permanent without offsetting them with higher taxes elsewhere. First, do you think we should assume these policies are permanent for purposes of defining revenue neutral and distributionality neutral tax reform? Mr. Diamond. Mr. Diamond. I actually find that a hard question to answer, so I will speak specifically to bonus depreciation. The effects of bonus depreciation are much different whether it is passed on a permanent basis or a temporary basis. If people think bonus depreciation is going to be temporary, it could cause firms to invest in the window and then would lead to decreased investment outside of the window; whereas, if bonus depreciation is permanent, you would have a more constant rising up of investment. And so over a time path, we get very different effects. So I am not sure how we should make that assumption. I think it is going to be proposal by proposal we would have to think about that differently. But for bonus depreciation, I think it is a pretty complex proposal to look at. Mr. Holtz‑Eakin. I will just repeat what I said earlier, which is for constructing baselines I think you should have equal treatment, and the current treatment is unequal. You could fix that by having the tax law sunset and the spending program sunset, or you could fix that by having current policy extended on both sides. It is my judgment that again and again we have done section 179, we have done bonus depreciation, it is a sensible assumption to treat those as permanent in the baseline until the Congress behaves differently. Mr. Dubay. I agree with Mr. Holtz‑Eakin. I think we should be looking at these as permanent policy. There is a question at some point. At some point, all these policies were put into place with an expiration, so they were temporary at one time or another, but once Congress extends them one or two times, it is subjective as to what criteria you use, but once you have extended them a couple of times, at that point you should assume that they are permanent. It has a great benefit to having a consistent baseline everyone can agree on. So one of the silver linings from the fiscal cliff tax hikes from last year, we have a much closer current law and current policy baseline. And I think we should be looking at the current policy baseline for revenue to continue that process of getting all on the same page. Mr. Marchant. Let me ask a follow‑up question on this before I hear from the rest of you. How would including these permanent versions of these policies as part of the Tax Reform Act of 2014, without the need to offset them with higher taxes elsewhere, increase the magnitude of economic growth inside of that reform? Mr. Diamond. So for bonus depreciation, JCT actually provided a dynamic analysis in a committee hearing, and so they found that bonus depreciation would increase GDP by two‑tenths of a percent. So that would be double the ‑‑ Mr. Hodge. I think they also found that it raised revenue. Mr. Diamond. It raised revenue. Yeah, it increased the capital stock by 0.6 to 1 percent. Mr. Hodge. Paid for itself. Mr. Diamond. So, I mean, it would be substantial, especially considering the size of the policy, when you are talking a 0.2 percent increase in GDP for a policy that has a relatively small revenue impact. Mr. Marchant. Mr. Chairman, one last question. In countries such as Canada that over the years have lowered their corporate tax rate, and other countries that have, have they used a dynamic score, have they used a static score, or have they used projected surpluses in revenue to use up to pay for those? Mr. Hodge. Every country has done it a little differently, Congressman. Canada has been just cutting their corporate tax rate with hardly any offsets against those rate cuts. In fact, they have seen corporate tax revenue stay very steady throughout the entire period of time, even during some of the recessionary period, and largely because of income shifting. They are benefitting from income shifting in propping up their corporate tax collections. A country like Slovakia is a very interesting case. When they passed a flat tax more than a decade ago, they sought analysis, dynamic analysis, from about seven several different parties, including like the IMF, World Bank, local universities, and then their own treasury. And then they found one that they felt was probably more realistic, somewhere in the middle. I think that is a pretty good model. Let's look at outside, have Mr. Diamond, have Tax Foundation, have others do an analysis and then compare them. I think that is a fairly reasonable way of looking at what the economics profession is doing. The British Treasury just did a dynamic analysis of their corporate tax rate cuts and found that it produced substantial benefits and increased revenues as a result. So I think this is where the economics profession is moving, and I think it is time that we did the same. Chairman Tiberi. The gentleman's time has expired. Ms. Sanchez is recognized for 5 minutes. Ms. Sanchez. Thank you, Mr. Chairman. And thank you to all of our witnesses for joining us today. Before I get into my questions, I have to say that I am a bit disappointed by the fact that JCT, who are the people who did the official nonpartisan dynamic scoring for the Republican tax draft, were not invited to be here on the panel today to discuss their work. And I also hope that this is not the last of our discussions about the desperate need for tax reform at the Federal level, because every day that the Congress waits to do tax reform is another day that we are falling further and further behind other jurisdictions who understand the need to reform. I certainly don't purport to agree with all of the provisions in the Republican tax reform draft, and that is a draft that has not gotten a lot of warm embrace from its own caucus, but I do believe that that discussion draft deserves some discussion, and very thoughtful and deliberative discussion, about the substance of the bill itself because we have really not had that in this committee. Today we are here to talk about economic modeling. So because we are here today to talk about the economic modeling, Mr. Buckley, I am hoping that you can explore some of the assumptions that go into this model. For example, some of the models that have been discussed assume that the permanent debt‑to‑GDP ratio is flat or that consumers make the perfect economic decision they ever will encounter in their lives, or that every person who wants a job can have a job. And what do you think the possible effects of making those assumptions that exist in these modelings, what do you think the effects of that are ultimately? Mr. Buckley. Well, I think the effects are that the model results are not necessarily very predictive of what would occur in the real world, but I think it is important to understand on the assumption of GDP, stability of debt to GDP, these models, most of the models simply will not project a result unless you fix the long‑term budget situation in the United States. There is no positive impact from these policies unless you do that. And the modelers' choice of assumption makes a very big difference in the models' results, assuming reductions in entitlement benefits give you the biggest long‑term growth. Ms. Sanchez. It was stated earlier that the models are not supposed to reflect reality, but why can we not inject a little bit of reality into some of these models? Mr. Buckley. Well, let me take this opportunity to praise what the Joint Committee staff did in its model, because it did model reality. It modeled the existing economy with temporary substantial unemployment. It did model the current unstable long‑term budget situation. It didn't assume that we did it. It modeled a situation where it has been criticized that people are myopic. I think it is fairly reflective of our ability to predict the future. So it did make a very good faith effort to model. I may disagree with the underlying theory of it, but it did, and it showed very modest increases in growth. And the modest increases in growth all come because of the individual tax reductions. The net effect of the business changes is negative. Ms. Sanchez. Thank you. I am sure that all our panelists today, the tax analysis departments of all your organizations probably did dynamic analysis of the 2001 and 2003 tax cuts. Is that correct? And a simple yes‑or‑no answer will suffice. No? Mr. Holtz, no. Mr. Diamond. I was at the Joint Committee on Taxation at the time. Ms. Sanchez. Okay. Mr. Diamond. Yes, we did. Mr. Holtz‑Eakin. My experience with that was at the CBO. We did a macroeconomic analysis of the President's budget, which included the 2003 tax provisions. Mr. Dubay. I was not at the organization then. Ms. Sanchez. Okay. Mr. Hodge. No, the Tax Foundation didn't do that at that time. Ms. Sanchez. Mr. Foster? Mr. Foster. I was not with the chamber at the time. Ms. Sanchez. Okay. Mr. Buckley, do you think that dynamic growth projections that were done for the 2001 tax cuts would have likely shown a tremendous amount of growth potential like the analysis that we see today? Mr. Buckley. I think if you used the conventional supply‑side models, you would have seen a much larger growth response because they were net reductions in tax. The Camp bill is revenue neutral, so these models can't show a big increase in long‑term growth because you are just moving liability around. In 2001, those were substantial tax cuts, and the way these models work, it would show big economic growth. Ms. Sanchez. It would show big economic growth, but how does that compare to the actual economic state of the U.S. in the 2000s, which, I might add, were a result of two unfunded wars, an economic crisis in our financial sector, a tanking housing sector, trillions more in debt from an unpaid Medicare Part D program, and of course, over a trillion in un‑offset tax cuts? Chairman Tiberi. The gentlelady's time has expired. You may answer quickly. We could have a debate. Mr. Buckley. Her question answered itself. The results were not positive. Chairman Tiberi. Thank you, Mr. Buckley. Ms. Sanchez. Thank you very much. Chairman Tiberi. Mr. Young is recognized for 5 minutes. Mr. Young. Thank you, Mr. Chairman, for holding this hearing. I think this has been quite instructive. I think it is very important. I would like to recognize my colleague, Dr. Price, who has introduced some legislation in support of dynamic scoring and his leadership in this area. I cosponsored that legislation as well. All of you have done dynamic analysis of the Camp draft. I certainly appreciate that and your efforts here. I actually think this should be a bipartisan effort. I mean, this is about evidence‑based policymaking. And I have actually discovered, outside of the klieg lights and C‑SPAN coverage and so forth, that it is a bipartisan initiative to dynamically score a range of different policies, from immigration reform bills to transportation bills to tax bills. I am a member of the No Labels Group, a group of conservatives, liberals, and everything in between where we periodically convene and talk about issues of the day and try and find some common ground. In our last meeting, over coffee, roughly a dozen Republican and Democrat Members came together, and I think on that day there were eight Democrats, four Republicans, there was nearly universal agreement in the need to dynamically score all our legislation moving forward. Now, we can quibble over the details, but as I see dynamic scoring, let me sort of recharacterize this issue very similar to the way Mr. Dubay did. We can either be wrong all of the time by adopting this artificial static model, and it indeed is a model as well, or we can be right some of the time through dynamic analysis, and through an iterative process learn from our suboptimal models and make all of our assumptions very clear to the public and to the best minds in the country and the policymakers alike and improve upon those models. I would add that we could do static analysis along with dynamic analysis and use the static analysis as a baseline and then compare which models perform better over a period of years, and ultimately perhaps transition into what I suspect would be a strictly dynamic analysis environment. I think that is the way to go. With respect to tax reform specifically, if we consider the baseline under a dynamic analysis, fewer offsets would be needed to reach budget neutrality. And I think we therefore can work in a bipartisan fashion to do things under a dynamically analyzed tax reform model. We can extend the R&D credit, section 179, the Earned Income Tax Credit, LIFO, accelerated depreciation. We can eliminate regressive taxes like the medical device tax. Now, do you agree ‑‑ I will ask Mr. Dubay ‑‑ if the committee were to consider dynamic growth as part of its budget‑neutral analysis, that the risks of a dynamic score being wrong are outweighed, perhaps significantly outweighed, by having extra revenue to use on keeping provisions intact, like section 179 at the $500,000 level, that inarguably encourage growth? Yes or no, if possible. Mr. Dubay. Yes. I look at dynamic scoring as a more accurate answer than static scoring. It is not that it is right or wrong. It is certainly more accurate. Because as I said in my testimony, we know that tax reform will improve economic growth. Static scoring doesn't take into account those impacts. So we know that it is wrong and we know it is wrong in which direction. So we know that dynamic scoring gets us closer to the right answer. Mr. Young. Right. So progress occurs in all realms, science, any area of academia, in our economy, in policymaking, through an iterative process, or it out to occur through an iterative process, through trial and error and improving upon suboptimal results. Same think should apply with respect to tax policymaking. Same thing should apply with respect to our analysis. I so was encouraged to hear of this notion of microdynamic analysis. We need to look at specific provisions of our Tax Code and other areas of policy, major ones, as Mr. Holtz‑Eakin emphasized, in a dynamic way as well. Now, if that requires additional staffing at Joint Tax, this is an area where I am willing to invest in a few more staffers to ensure that we have more optimal growth‑oriented policy that will increase the number of jobs, increase personal income, and so forth. The last thing I would add is just emphasize that this doesn't have to, at least initially, be an either/or sort of question. We could have both and then transition into the one that is proven to work best over a period of years. I would start with dynamic analysis for PAYGO purposes. But thank you so much for being here. I yield back. Chairman Tiberi. Ms. Schwartz is recognized for 5 minutes. Ms. Schwartz. Thank you, Mr. Chairman. I appreciate the time and the conversation this morning. Just a couple of points and then a couple of questions, if I may. One is that in this whole discussion about the use of dynamic scoring and economic growth, it does seem that ‑‑ two particular points ‑‑ suggesting that cutting taxes is always good for economic growth is kind of the suggestion here a bit. I think many of us who do actually think that there is an opportunity for us, Republicans and Democrats, to work together to lower rates, broaden the base, to really look at tax deductions in the way as to what works and what doesn't and what stimulates the economy and what doesn't is very real. But the notion that tax cuts alone lead to economic growth is one that has been disproven time and time again, obviously tax cuts for the wealthiest and tax cuts for the wealthiest people and the wealthiest corporations. We have been promised that. If it worked, we would maybe not be in some of the situations we have been in, in the past. So it makes many of us very skeptical that that itself is not enough for us to build a basis for tax reform. It just isn't. The second point is that economic growth really may mean different things to different people, and we sort of use that terminology as though it is the same thing. Does economic growth only mean growth in the GDP, which of course it has to be accounted for, but is it just an increase, the wealthy get much wealthier, which is kind of where we have been in the last decade, or does it also mean that the middle class gets wealthier? And does that matter to anybody on the panel, is kind of the question. Should it matter to us? It is actually what has made this country great, by the way, is not just entrepreneurs and great corporations, but it is also people with the skills and the ability to take these jobs and be paid a fair wage and buy products. So I think that what we have to look at is to understand that we should take into account, and I think Mr. Young said this, take into account some of the dynamic scoring you are talking about, but it is not the only rationale for what we do. We have to look at our ability to meet our obligations in this Nation. We have to look at our ability to have the revenues we need to educate our people, to be able to compete economically in this world, to be able to grow that middle class. And then we have to be able to make some of that infrastructure transportation investment so in fact we can also compete in the global marketplace. If we can't do those things, then just creating more wealth in this Nation will change who we are in this country, and that is one of the questions we need to actually say, are we are comfortable with that and really a great disparity between the very rich and everybody else? So here is my question really. As we look at the use of dynamic scoring, if we look at economic growth, I was going to ask Mr. Buckley, you touched on this, could you speak to how that incorporates in any way, if it does, the income inequality that has been happening in this country for the last decade, in particular, the issue you raised of wages and the competition from overseas? If we are really going to be a low‑wage country with high wealth and low‑wage workers, what does that mean to our competition overseas? Could you speak to what in some ways, I might understand, the narrow definition of economic growth without looking at that? And my second question, if you would speak to what would be the impact on the economy if we actually do not have the dollars to make the investments in education, in workforce training, and in infrastructure that has been so key to making our country such a great economic powerhouse that it might be and helps businesses to grow and to locate and to stay here. Mr. Buckley. Well, first thing, when you look at the models, labor elasticity is higher at upper‑income levels, so that upper‑income individuals have the luxury of working or not working, and therefore these models have supported rate reductions that are disproportionately at the top. I think that is unwise for many reasons. Now, the other thing, and here I may differ a little bit, or differ a lot, with my other people here. Dynamic scoring is, what you are essentially saying, we want to take into account the positive impacts of our policy decisions today. That is a luxury that we do not permit our corporations to make. They make investments, and they make investments with the expectation that the return in the future is going to be far in excess of the cost of the investment. But they cannot say, our investment we are making today is less costly because we anticipate income. I believe you have to have kind of objective rules for budgeting. If the policy choices are wise, the positive impacts of those policy choices will flow right into future budget projections. Chairman Tiberi. The gentlelady's time has expired. Ms. Schwartz. Thank you. Chairman Tiberi. Mr. Reed is recognized for 5 minutes. Mr. Reed. Thank you, Mr. Chairman. Mr. Hodge, you said something in your testimony, and believe it or not, we do listen to the testimony, and I was listening to your verbal testimony. Mr. Hodge. Well, thank you. Mr. Reed. And I found it very intriguing. You said something about peer review, transparency, making the scoring process much more open to review by the public as well as people in positions that could comment on that process. I wholeheartedly agree. This is a conversation, coming to Congress in 2010, I have had repeatedly with different individuals in the position that do the scoring. And one of the things that was brought back to me and that we had a conversation with in response to my request to get the black box, to get the magic assumptions, to get the calculations was, well, if we give you that information and we tell you how we do this, people may manipulate, work around, abuse, whatever term you want to use, their proposals, their legislation, to get the score that they want. And I was actually kind of amazed by that because I am a firm believer in transparency and I am a firm believer, if people are going to do that, that will stick out as you go through the process. Have you ever heard that response from any of the folks, be it at the CBO or JCT, in regards to the pushback on disclosing these assumptions? Mr. Hodge. Well, I will say somewhat cynically that I guess it shows that the Joint Committee really does believe tax policy changes behavior, that people will work around these things. And they are doing it now. I mean, the 10‑year budget window used to be 5 years, and if you made it 15 years, then people would work around that. No, transparency is the key here because it is the only way of understanding whether or not the tools that the committee is using are meeting current standards within the economic community. There has to be transparency. I would volunteer to come in and demonstrate our model to any one of you. It sits on a laptop. We can come in. I will show you what is behind the curtain. I will show you all the assumptions. I will show you the data that is behind it. I will show you the equations. You can pick them apart. Mr. Reed. The algorithms and everything else. Mr. Hodge. We are happy to come in and demonstrate it for you. In fact, the committee ought to have that in front of you so that during a hearing you can do macroeconomic analysis, dynamic analysis during a markup. Mr. Reed. Now, just so we are clear, Mr. Hodge, I mean, the bulk of my conversation generally was not with JCT. It was with CBO and CBO representatives on the budget side. And they have got the same type of process of assumptions and algorithms and things over there. Doug, have you ever dealt with that issue? And I think we have talked about this before. Mr. Holtz‑Eakin. Well, I am handicapped by having actually done the job. Mr. Reed. Yeah. Mr. Holtz‑Eakin. And it is important to recognize that scoring is not a model. Scoring is a judgment exercise. I scored the Terrorism Risk Insurance Act, first time it was passed. There is no model for that. I had to score a death benefit for people killed prior to the invasion of Iraq. There is no model for that. And so while it is useful to have models that incorporate the impact of beneficial and bad policy so that you know what is going on, in the end this will always be at the CBO and at the Joint Committee an act of judgment. Now, CBO has in its cost estimates something called basis of estimate. It has an obligation to be transparent about how it came to its conclusions and to lay out the judgments it made. But I think it is a fool's errand to pretend that somehow this is a machine and that you can change parameters or inspect parameters and know exactly what is going on. You should get good staff, respect their judgment. It is important to the integrity of the Joint Committee that you not micromanage it. And there is a big difference between transparency, saying this is the conclusion to which I have come, and scientific replicability, and you will never get the latter and should not get the latter. At CBO, I used proprietary data from large pharmaceutical companies to do the Medicare Modernization Act. There is no way that should be disclosed to anybody. So that estimate could not be replicated. And so it is important to think about this not as if it is scientific replicability of an experiment, but instead building an institutional culture for good judgments informed by all the information that is relevant. Those are two very different things. Mr. Reed. But would you not agree that if the institution assumed the wrong assumption or exercised the wrong judgment, that would be a problem, that we would not be able to see whether or not that was erroneously achieved? Mr. Holtz‑Eakin. It has to explain how it came to its conclusions. I think that is an obligation of both the CBO and the Joint Committee. It is in the statute now. They may or may not be meeting that obligation successfully. I think that is a fair complaint. At that point, if you look at how they did it and say, no, wait, there is a lot of evidence that the judgment you drew here is just incorrect, we have tons of data, they should be updating constantly their ability to do that estimate well. I have no quibble with that. And I believe that the CBO, while not perfect, has tried to do that. If you go to the CBO with additional data, if you go to them with additional research, they will incorporate that into their view of the scoring process. Mr. Reed. I appreciate it. Thank you for the input. Thank you, Mr. Chairman. I yield back. Chairman Tiberi. Thank you. Mr. Neal, would you like to be recognized? Mr. Neal. Thank you, Mr. Chairman. I thought this was very helpful. I thought the panel was very informed. And I hope that you might consider down the road scheduling Joint Tax to come in and talk about the proposal as well. Chairman Tiberi. Certainly will consider it. Speaking of Joint Tax, sitting behind Mr. Gerlach the entire hearing has been the head of Joint Tax, professionally, Tom Barthold. Thank you so much for being here. And I particularly want to thank you and your macroeconomic team and staff for the analysis and all the hard work that you put into the Camp draft. We do very much appreciate it. And Mr. Neal and I were talking about the witnesses today, and I think we both agree, topnotch panel, excellent testimony from all of you. It has been a real educational, informative discussion. Important to understand the importance of dynamic scoring, the limitations of dynamic scoring, and modeling in general. I think it always is helpful to help committee members as we continue to try to develop tax reform legislation that will help increase wages, help create jobs, and help grow our economy. So it has been a real pleasure to have you all here. We do appreciate the time that you took today. And that concludes today's panel. [Whereupon, at 11:40 a.m., the subcommittee was adjourned.] |
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