What is Dynamic Scoring
A measure of the impact that proposed tax budgets would have on the budget deficit and the overall economy over time. Dynamic scoring is one of two models used by the Tax Foundation that accounts for how fiscal policy changes indirectly affect macroeconomic measures like GDP and employment in the long term.
The second model, static scoring, measures the immediate and direct change to spending, revenue and the deficit due to new fiscal policies.
BREAKING DOWN Dynamic Scoring
Dynamic scoring follows supply-side economics, which states that supply is the primary driving force behind an economy’s growth. When capital and labor are supplied, demand is created. Tax increases on a worker’s wage affects the amount of labor that he provides. The worker will work less, save less, and invest less. On the other hand, tax cuts mean more disposable income for the worker who would in turn work longer and harder, and save and invest more money, thereby stimulating economy growth. The effects on costs of labor and capital due to a tax change are calculated using the dynamic model, after which the effect on other economic factors like GDP, employment, and federal revenues are taken into account.
The Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) work closely with Congress to forecast the country’s surplus or deficit due to fiscal changes in a proposed budget. These offices historically used static scores to outline the direct effect of new tax laws on spending, revenue, and the budget. In 2015, House Republicans passed a law that required the CBO and JCT to use dynamic scoring for major legislation. For example, the CBO evaluated President Barack Obama’s budget for fiscal year 2013 by calculating where the deficit would be after its impact on GDP is factored in. The dynamic score showed that the GDP, due to the proposed budget, will change between 1.4% and -0.2% from 2013 to 2017, boosting demand, and between -0.5% and -2.2% from 2018 to 2022, hurting private investments.
While republicans believe that tax cuts will contribute largely to the growth of the economy and use dynamic scoring to support their claims, liberals and opponents argue that dynamic scoring is a biased measure and will only encourage tax cuts and increase the country’s deficit in the long run. In 2003, President George W. Bush cut taxes on salaries and investment income but still maintained a huge deficit. So while the supply side benefit of tax reduction increased the amount of labor, savings, and investments, the high deficit increased interest rates in the economy. The Tax Policy Center’s dynamic analysis on President Donald Trump’s 2016 plan to cut taxes for businesses and individuals showed that the increase in supply of labor and capital that ensues will eventually be offset by the reduced investments from a higher budget deficit.
Example of dynamic scoring
The following is a very basic example of how dynamic and static scoring are interpreted. If income tax for a certain worker was cut from 30% to 25% and she earns $100,000 per annum, federal revenue produced is reduced to $25,000 from $30,000. Because the lower tax rate cost the government $5,000 in lost revenue, static analysis states that the tax cut will have no impact or change in how the worker behaves. Dynamic scoring assumes that the lower tax rate will lead to higher disposable income which creates an incentive for the individual to work, save, and invest more money. The increase in the worker’s financial activity will create additional income for her of say, $100,000, which is also taxed at 25%. The government receives an inflow of $25,000 which fully or partially offsets the initial cost.
Although dynamic scoring is in its infant stages where there are no set processes on the assumptions used in creating the dynamic model, it is still considered a valuable tool for policy makers to evaluate the trade-offs in tax changes and policies that would achieve their goal better.