Why Economic Policy Isn't Dynamic
Samuel Johnson, the 18th-century English writer, once declared that “patriotism is the last refuge of a scoundrel.” But that was before there was such a thing as an economic model. And so, it seems, scoundrels have found a new refuge.
In the past, Republicans would argue for tax cuts using simple arguments. By increasing the incentive to work, cutting income taxes would boost gross domestic product. It might even increase tax revenue -- if you believe Arthur Laffer and the famous curve he drew on the back of a napkin. These arguments became known as supply-side economics -- or, in the words of former President George H.W. Bush, “voodoo economics.”
Repeated rounds of Republican tax cuts failed to pay for themselves, and failed to noticeably boost growth. All we got was a big overhang of national debt. But reality has never been a particularly strong deterrent to congressional Republicans, and supply-side economics is back with a vengeance. In January the new Republican congressional majority wrote it into law, under the euphemistic name of dynamic scoring. They have now hired a new director for the Congressional Budget Office: Keith Hall, a veteran of the George W. Bush administration. He will be charged with implementing dynamic scoring -- in other words, coming up with models that say that tax cuts are awesome.
To get some perspective on this move, we should turn to Harvard economist N. Gregory Mankiw. Mankiw, who also served in the administration of George W. Bush, really, really, really doesn’t like taxes. So when Mankiw is suspicious of a policy designed to sell tax cuts, you know something is fishy:
[T]hree problems make the task [of dynamic scoring] difficult in practice...
First, any attempt to estimate the impact of a policy change on G.D.P. requires an economic model. Because reasonable people can disagree about what model, and what parameters of that model, are best, the results from dynamic scoring will always be controversial...
[T]here are good reasons for the economists hired by Congress to pursue dynamic scoring. But there are also good reasons to be wary of the endeavor.
Mankiw, of course, is being his typical urbane, reserved self. I will be meaner, and say what needs to be said. Frankly, the models the CBO will use for dynamic scoring probably will be bad ones.
In order to do dynamic scoring, you need a dynamic model -- a model that represents how the economy behaves over time. Modern macroeconomics is chock full of such models. There are as many of them as there are grains of sand on a beach. You can have your pick, since macroeconomic data is typically too weak and uninformative to rule in favor of one or the other. Furthermore, each of these models has a number of parameters that represent how the economy responds to things. The range of parameter values used in models is enormous, since no one knows what the right model is in the first place.
Here’s a famous example. In 2004, Nobel Prize-winning macroeconomist Edward Prescott wrote a paper saying that high taxes caused Europeans to work much less than Americans. He justified this claim with a macroeconomic model -- the same one, basically, that had won him the Nobel. To explain the reduced work hours of Europeans, the model had to assume a very large value for a certain parameter, called the Frisch elasticity of labor supply, which basically measures how much people’s choice of work hours depends on their wages.
Prescott’s finding contradicted the evidence that the value of the Frisch elasticity is an order of magnitude smaller than what he claimed. The resulting controversy still hasn't been resolved. But it goes to show that if you can pick your model and pick your parameters, there are few if any limits on the results you can get. And that means that if you’re politically biased, you can always show that your least favorite policy is wrecking the economy -- or that your favorite policy will work miracles.
The CBO, with the Republican Congress breathing down its neck, seems less likely than academics to make a neutral choice of models and parameters. It’s almost certain that it will choose models and parameters that make tax cuts look amazing. On that basis, the Republicans will push for more and more tax cuts.
When it turns out that the models are wrong, we’ll probably just end up with a bigger national debt and not much of a growth boost to show for it -- just like we did with the original incarnation of supply-side economics. But if that didn’t faze Republicans 15 years ago, it seems unlikely to bother them now.
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