In Washington's fiscal Wonderland, where things are rarely as they seem, a nasty battle is brewing over budget estimating. And arcane as the dispute may appear, it could well decide the fate of ambitious Republican proposals to cut taxes for businesses and families.
The budget forecasters are fighting over the proposed tax cuts in the GOP's Contract With America. Using traditional estimating methods, the White House insists the cuts would cost $300 billion over the next five years and must be paid for with offsetting revenue increases or spending cuts. Anything less, the Clintonites insist, would be a return to defi- cit-boosting voodoo economics.
But Republicans say the tax cuts can pay for themselves. They believe the longtime "static" system for scoring tax cuts is wrong, and they're promoting "dynamic" revenue estimating. According to this approach, new tax breaks generate so much economic activity that instead of cutting into government revenues, they produce a windfall for the Treasury. To prove it, the GOP wants to try to move to a two-track system, where congressional estimates of the impact of proposed tax changes are scored by both methods.
MIGHTY EYESHADES. Republicans are eager to change forecasting models because they know the power of budget estimates on policy. For instance, President Bush's capital-gains tax cut vanished in 1989 when congressional green eyeshades concluded the cut would cost $2 billion a year. The drain--just 0.2% of the $1 trillion the Treasury collects annually--gave Democrats enough ammunition to sink the plan.
This time, the stakes are much higher. According to Fiscal Associates Inc. President Gary Robbins, who advises House Republicans and is a leading proponent of dynamic estimating, the GOP tax agenda would increase the U.S. gross domestic product by a staggering $2.7 trillion over the next five years. Robbins, a former Reagan Treasury official, argues that the GOP capital-gains tax proposal would generate $126 billion in new revenues by spurring massive economic growth. The provision would cut the top capital-gains rate in half, to 14%, and adjust gains for inflation.
Sound like a lot? A proposal for far more generous business depreciation write-offs for capital investments would have an even greater effect, Robbins reckons. Such a change would boost the economy's annual growth rate from 2.5% to 4.5% over five years and generate a mind-numbing $420 billion in new tax revenue. The twin moves, Robbins says, would more than pay for GOP revenue-draining tax breaks, such as a $500-per-child credit for families, a phaseout of the "marriage penalty," and a bigger inheritance-tax exemption.
BIG-BANG THEORY. Robbins was able to produce the eye-popping numbers by making some fairly ambitious assumptions. For instance, his model figures that the depreciation change would cut the cost of capital in the U.S. by a huge 16%. And like most economists, he reckons that investment-driven changes produce far more bang for the buck than, say, the child credit, which would do little more than spur consumption--much of it for products produced overseas.
But Robbins' analysis does not just take into account the way people adjust their behavior in response to a tax change. It also measures the effects of tax policy on the overall economy. His method is, to say the least, controversial. "Robbins' numbers are absolutely preposterous," huffs Joel L. Prakken, an economist with the St. Louis consulting firm Laurence Meyer & Associates. Even some supporters of Reagan's tax cuts have doubts. Economist Michael K. Evans, for one, calls Robbins' estimates of the benefits of the depreciation changes "wishful thinking."
Critics of the dynamic model itself contend that the effects of tax changes are usually relatively small. "It's impossible to measure with any precision what the effects are going to be," says Alan J. Auerbach, an economist at the University of California-Berkeley. Indeed, the effects of even huge changes in tax law may be impossible to measure accurately. For instance, economists are still squabbling over the impact of the Reagan Administration's 1981 tax cuts.
That's one reason official revenue estimators at the Treasury Dept. and on Capitol Hill take a more conservative approach. They look only at the impact of a change on taxpayers' behavior. For instance, if the government raises the gasoline tax, fuel consumption may drop.
But government estimators have shied away from figuring the macroeconomic impact of these changes. That's because traditional forecasters insist they can't quantify the impact of a tax cut on employment, lower interest rates, and faster growth. With deficits already high, they fear a wrong guess would give lawmakers the leeway to bust the budget with more tax breaks. Notes Treasury Dept. economist J. Bradford DeLong: "Any time the amount of technical knowledge is small and the ideological content is extremely high, you're asking for danger if you include it in the budget process."
In the dynamic-vs.-static estimating debate, the Clinton Administration may have a surprising ally--Wall Street. Traders would love a capital-gains tax cut, but they're already worrying that a shift to dynamic estimating would wipe out the budget discipline needed to prevent budget-busting tax giveaways. Says Allen L. Sinai, chief economist at Lehman Brothers Global Economic Advisors Inc.: "There's no tax cut that pays for itself. It's a fiction." And John G. Lonski, senior economist at Moody's Investors Service, frets that tax-policy fears already "may have pushed bond yields up and stirred new worries in the stock market."
"MAGIC POTION." Senate GOP deficit hawks, including incoming Budget Committee Chairman Pete V. Domenici (R-N.M.), are also wary of the dynamic school. But House Republicans hope to replace Congress' top revenue estimators--Congressional Budget Office Director Robert D. Reischauer and Joint Tax Committee Staff Director John L. Buckley--with dynamic scorers. The current pair "are mixing this magic potion somewhere up in the dome of the Capitol," says incoming House Budget Committee Chairman John R. Kasich (R-Ohio). "And it isn't working very well."
To avoid spooking the markets, Republicans figure they must initially prepare both a traditional and dynamic estimate for their tax proposals. Should revenues exceed the official forecast, the GOP would be able to make a strong case for further tax cuts and a switch in methodology. Until then, though, they'll likely have to finance tax cuts the tough way: with hard cash.
A TALE OF TWO BUDGETS Will proposed tax cuts in the GOP's Contract With America cost the Treasury billions or generate vast new revenues? Here's how various estimates stack up over five years: IN BILLIONS OF DOLLARS DYNAMIC MODEL STATIC MODEL CAPITAL-GAINS TAX CUT +$126 -$56 INCREASED DEPRECIATION FOR +420 +5 CAPITAL EQUIPMENT EXPANSION OF IRAs +10 -18 DATA: JOINT COMMITTEE ON TAXATION, FISCAL ASSOCIATES INC. DENNIS BRACK/BLACK STAR