Undynamic Analysis

Tuesday, February 21, 2006

"THE EVIDENCE is in, it's time for everyone to admit that sensible tax cuts increase economic growth, and add to the federal treasury." That was Vice President Cheney the other day, speaking to a conservative gathering here. But Mr. Cheney is the one who needs to reexamine his evidence. Yes, tax policies can help promote economic growth. But no matter how many times the vice president and his tax-cutting allies proclaim their belief in the tax-cut fairy, she doesn't exist. Tax cuts do not magically pay for themselves, bringing in more revenue than they deplete from the treasury.

Proponents of the magic tax cut have long argued that, if only the growth-enhancing effects of cuts were accounted for in the budgetary equation, this cost-free boon would become clear. Trouble is, responsible economists who have attempted to engage in this kind of "dynamic analysis" haven't come up with the unalloyed positive conclusion the administration wants -- much less the proof of pay-for-themselves tax cuts.

The Congressional Budget Office -- during the tenure of a fan of dynamic analysis, former White House economist Douglas Holtz-Eakin -- used a variety of different dynamic models and found only small economic effects from the president's tax cuts, a majority of them negative.

That's not terribly surprising: Tax cuts don't operate in a fiscal vacuum. As Eugene Steuerle, a Treasury Department tax official during the Reagan administration, explained in a paper on the topic, "Few economists, conservative or liberal, are comfortable with the claims made by more radical advocates of dynamic scoring that a tax cut operates independently from government's corresponding need over time to cover the cost of a tax cut by paying more in interest, collecting more later in taxes, or reducing spending."

Historical analysis hasn't been any more helpful. Indeed, consider a new assessment by N. Gregory Mankiw, who served as head of the Bush administration's Council of Economic Advisers and is a proponent of dynamic scoring. Writing with Matthew Weinzierl, Mr. Mankiw found what he considered to be a "surprisingly large" feedback effect from cutting capital gains rates: that half of the tax cut is self-financing. Which leads to the question: Who pays for the other half? And, Mr. Mankiw concluded, other kinds of tax cuts are less dynamic.

Now the administration is moving to commission its own evidence, creating a "Division on Dynamic Analysis" in the Treasury Department. As Mr. Cheney explained, "It's time to reexamine our assumptions and to consider using more dynamic analysis to measure the true impact of tax cuts on the American economy."

This measly budget item -- $513,000 -- may be just a sop to conservatives; after all, though Mr. Cheney may not know it, Treasury professionals have been doing dynamic analysis for some time. But it could be something more pernicious: an office set up in pursuit of a particular result. After all, Mr. Cheney says the evidence is in.

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