Dynamic scoring (or dynamic revenue estimating) for tax legislation has been an issue of interest for at least the past 25 years. House Rule 13 has required, since 2003, that the Joint Committee on Taxation (JCT) provide a macroeconomic impact analysis of legislation to amend the Internal Revenue Code, or a statement explaining why it is not calculable; the first analysis was in 2003. The current Senate Budget Resolution ( S.Con.Res. These analyses are not part of the official score, but rather provide projected feedback effects, although some may argue that feedback effects should be included in revenue estimates. The complexity is expanded in the case of tax reform, because base broadening can also have effects on effective tax rates that could offset part or all of the behavioral effects due to changes in statutory rate reduction. The final section discusses general issues surrounding the use of various models and reviews the empirical evidence on supply side responses (labor supply and savings or investment) and how these effects are incorporated in current models used by JCT, CBO, the Treasury Department, and academic researchers. The main body of the report follows. Three types of effects have been considered in previous studies by the Joint Committee on Taxation and the Congressional Budget Office: (1) the short run stimulus effect where a tax cut increases demand and output in an underemployed economy, while a tax increase reduces output; (2) the effect of deficits or surpluses on crowding out or crowding in investment due to government borrowing; and (3) the supply side effects (increases or decreases in labor supply, domestic savings, and net investment from abroad in response to changes in effective tax rates). More complex intertemporal models can yield similar results with respect to wage tax cuts, if similar elasticities are embedded in the models. An examination of models currently or recently used indicates that many of these models have implicit behavioral responses for labor supply that are much larger than those that are contained in simpler growth models, or that can be supported with empirical evidence. One question is whether the more desirable theoretical structure of these models balances the lack of empirical justification. 8 , CBO is charged with the responsibility for dynamic estimates, assisted by the JCT. Other Models and Researchers

The Solow growth model is the simplest of the models to construct and it has been used primarily by government agencies and think tanks to examine the effects of tax changes, largely in the longer run. A revenue neutral, or largely revenue neutral, tax reform that lowers the rate and broadens the base is unlikely to have a large effect on the economy. For example, if the relative burden shifts to high income individuals there may be a small stimulus because lower income individuals tend to spend more. Should Effects from Short Run Stimulus (Demand Side Effects) Be Considered? In a sense, dynamic estimates are already accounted for when multipliers for different spending and tax cuts are estimated. If dynamic scoring is considered for both spending and tax changes, including crowding out might be more appropriate. In these models, consumers choose consumption and leisure over time. No empirical evidence supports this response, which can dominate the effects when taxes on capital income are cut deeply. A Simple Model of Feedback Effects

Consider a model which incorporates a labor supply based on an estimated elasticity of E. In that case, with L as labor, W as wages and t as the tax rate on wages (denoting a "d" as a change, so that dL is a small change in L and dL/L is a percentage change in L), the labor supply can be defined as:
(1) dL/L = E(dW/W –dt/(1-t))
This model assumes that E is positive, so labor rises with an increase in W and falls with an increase in t. Also note that the response is not to a percentage change in t, but to a percentage change in the after tax share, (1-t).
Dynamic scoring for tax legislation has been discussed for some time. House Rule 13 has required, since 2003, that the Joint Committee on Taxation (JCT) provide a macroeconomic impact analysis of legislation to amend the Internal Revenue Code, or a statement explaining why it is not calculable. The current Senate Budget Resolution (S.Con.Res. 8) includes a similar provision for the Congressional Budget Office (CBO) and JCT. These estimates are not part of the official revenue estimate, but could affect views on legislative proposals.
Official revenue estimates include many behavioral changes, but hold GDP constant. Dynamic scoring allows for changes in GDP. Models for estimating effects on GDP that are used by government agencies and academics are complicated. To those interested in dynamic feedback effects on GDP, these models may appear to be "black boxes." This report, although necessarily technical itself, examines the models used for dynamic scoring, what effects they are reflecting, and how consistent their responses are with empirical evidence. The following points summarize the major findings of the report.
Revenue neutral income tax reform that lowers statutory income tax rates through broadening the base, although assumed by some to spur growth, can potentially contract the economy. The base broadening, by making more income subject to tax, increases effective rates and offsets statutory rate reductions. Models must take these effects into account to appropriately estimate effects of tax reform.
When taxes increase or decrease, some effects that have been estimated may be less appropriate than others to include in the analysis. Some models estimate demand side stimulus effects, which are transitory and can only matter when there is unemployment in the economy. These may not be appropriate to consider in evaluating permanent tax policies. Questions may also be raised about including effects of deficits or surpluses in reducing or increasing investment due to changes in government borrowing. In both cases, these effects apply to spending as well as to tax changes.
Sometimes claims are made that the feedback effects from reducing taxes will largely offset the revenue loss through "supply side" effects that increase GDP and the tax base. No reasonable estimate of the responses of labor supply or savings to tax changes can produce such offsets. The feedback effect from a simple and flexible growth model is less than 10%, given empirical evidence of supply responses, which are small and of uncertain direction.
More complex models for studying supply side effects (intertemporal models), that are based on a more rigid theoretical structure, produce similar results for changes in taxes on wages if the assumptions of the models are consistent with the empirical evidence on labor supply. A review of models currently or recently used by government agencies and academics suggest that is not generally the case (an exception is the JCT's model).
Effects of tax cuts on capital income can be large in these more complex models, reflecting shifting of consumption and leisure to periods far in the future. These shifts, which can induce large short-run increases in labor supply and saving, are generally not supported empirically and may be unlikely. One question is whether the benefits of formal theory in these models outweigh their empirical weaknesses.