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Hearing on Economic Models Available to the Joint Committee on Taxation for Analyzing Tax Reform Proposals

September 21, 2006










September 21, 2011

SERIAL 112-116

Printed for the use of the Committee on Ways and Means


DAVE CAMP, Michigan, Chairman

WALLY HERGER, California
PAUL RYAN, Wisconsin
DEVIN NUNES, California
JIM GERLACH, Pennsylvania
TOM PRICE, Georgia
RICK BERG, North Dakota
DIANE BLACK, Tennessee
TOM REED, New York
RICHARD E. NEAL, Massachusetts
JOHN B. LARSON, Connecticut
RON KIND, Wisconsin

JON TRAUB, Staff Director
JANICE MAYS, Minority Staff Director




Mr. Thomas Barthold
Chief of Staff, Joint Committee on Taxation


Mr. Douglas Holtz-Eakin
President, American Action Forum

Mr. John Buckley
Visiting Professor, Georgetown University Law Center


Mr. William Beach
Director, Center for Data Analysis, the Heritage Foundation



Wednesday, September 21, 2011
U.S. House of Representatives,
Committee on Ways and Means,
Washington, D.C.

The committee met, pursuant to call, at 10:06 a.m., in Room 1100, Longworth House Office Building, Hon. Dave Camp [chairman of the committee] presiding.

[The  advisory of the hearing follows:]



Chairman Camp.  Good morning.  Thank you for joining us for the latest in our continued series of hearings on comprehensive tax reform.

Over the last several months, as we discussed the various facets and complexities associated with comprehensive tax reform, a wide array of economists and business leaders have testified before this committee that comprehensive tax reform that lowers rates by broadening the tax base will promote economic health and job creation.  But how much growth and how many jobs is what the American people want to know.  Frankly, it is what I want to know, and I think most Members of Congress want to know as well.

Before we can even determine if a tax reform package is worthy of consideration, let alone be called a success, it is critical to understand the true impact it will have on economic growth, Federal revenues, and, most importantly, job creation; and that brings us to the focus of the hearing today, both the capabilities and limitations of the Joint Committee on Taxation in estimating and analyzing comprehensive tax reform plans.

JCT serves a critical role in the legislative process by providing expert and impartial analysis of potential revenue effects of proposals to change U.S. tax policy.  However, under current practice, the analytical methods used by JCT do not typically take into account the potential effects of statutory tax changes on economic growth.

For most of the proposals analyzed by JCT, this practice is appropriate, because the proposed changes would not be large enough to have a material impact on an economy as large as that of the United States.  However, comprehensive tax reform, by its very nature, constitutes a significant change in U.S. tax policy and has the potential to significantly boost economic growth and job creation.

JCT has developed a suite of macroeconomic models that can be used to estimate the impact of tax policy changes on economic growth.  Today’s hearing will help us better understand which policies and decisions are most relevant to promoting economic growth.  As our economy continues to struggle, this additional analysis and research will serve an important role in helping this committee make the hard decisions that are necessary to craft comprehensive tax reform.

It is my hope that today’s discussion will help to highlight how the work being done by the Joint Tax Committee will help us plan and develop solutions that will help us plan and develop solutions that create a Tax Code that works better for employers and families, instead of one that for far too long has worked against them.

I thank the witnesses for being here today, and I yield to Ranking Member Levin for his opening statement.

Mr. Levin.  Thank you, Mr. Chairman.  Welcome to all of you.

This is a hearing on, and I quote, “The economic models available to the Joint Committee on Taxation for analyzing tax reform proposals.”

Let me first say that I hope that neither this hearing nor anything said here today is construed as a criticism of the Joint Committee, its work, or its staff.  The dedicated team of economists, lawyers, and other professionals of the Joint Committee produce some of the very best economic analysis in the country and do so not in an academic or think‑tank environment, but under the pressures and at the pace of the legislative process.  This committee could not function without them. I thank you, Mr. Barthold, and all your colleagues for your service.

The debate over so‑called dynamic scoring has been going on for years.  During the Bush Administration, the Republican majority and leadership ‑‑ and we remember their statements very well ‑‑ and Ways and Means members on the then‑majority side argued that the Bush tax cuts would pay for themselves and create millions of jobs.  Whether guided by this notion of so‑called dynamic scoring or by none, the majority ruling this committee never paid for anything.  At the end of the Bush Administration, we had a $1.5 deficit and an economy that was losing 700,000 jobs a month.  There were other factors, but there was nothing dynamic about the fiscal irresponsibility of the then Republican majority.

After reviewing today’s testimony and grappling with all of its complexities, I urge that we not become embroiled in a theoretical debate at this particularly challenging time for our Nation’s economy for two reasons.

First, in addition to there being no evidence that tax cuts pay for themselves ‑‑ quite the contrary ‑‑ even most who sound some positive notes about so‑called dynamic scoring acknowledge problems that make such an approach unworkable as we confront today’s challenges.  The reality is that there is
simply no consensus in the economics profession about how businesses and individuals will respond to changes in policy, how foresighted they are in their decision making, or on a host of other questions that would have to be answered to conduct a so‑called dynamic analysis of tax legislation.

Secondly, and most vitally, there is a crisis before us right now, before the Nation, and before the committee; economic growth and jobs.  The committee, our committee should be focused on jobs.  The 14 million Americans who are looking for work need less theoretical discussion of estimating methodology and more practical action on job creation.  One estimate, that of Mark Zandi, is that the President’s proposed American Jobs Act would add 2 percentage points to GDP growth next year and 1.9 million jobs and cut the unemployment rate by a percent point.

The committee Democrats have asked the chairman ‑‑ you, Mr. Chairman ‑‑ to hold hearings on the President’s American Jobs Act.  We have not received an answer, and we renew that request today.

The President’s proposal would jump‑start our economy and create jobs for American workers.  It would put more money in workers’ pockets through a temporary payroll tax cut, saving the average family $1,500 a year.  It would also keep over 6 million workers from losing their unemployment benefits when they continue searching for work and provide new employers incentives to help get them hired.

These proposals ‑‑ these jobs and tax proposals are in the jurisdiction of this proud committee.  It is our responsibility to consider them, and I hope this committee will meet that responsibility here and now.

Thank you, Mr. Chairman.

Chairman Camp.  Thank you, Mr. Levin.

And, without objection, any other member who wishes to have an opening statement included in the formal hearing record may submit one in writing.

Chairman Camp.  We are fortunate to have a panel of witnesses this morning with a wealth of experience.  Let me briefly introduce them.

First, I would like to welcome Tom Barthold, the chief of staff for the Joint Committee on Taxation.  We thank you and your staff for your work and your efforts in preparing for today’s hearing, and we look forward to your presentation.

Second, we will hear from Doug Holtz‑Eakin, who is currently serving as president of the American Action Forum.  Mr. Holtz‑Eakin formerly served as chief economist of the President’s Council of Economic Advisors and later as director for the Congressional Budget Office.

And, third, we will hear from John Buckley, who is well‑known to this committee, who is a visiting professor at the Georgetown University Law Center.  Mr. Buckley formerly served on the staffs of both the Committee on Ways and Means and the Joint Committee on Taxation.

And, finally, we will hear from William Beach, the director of the Heritage Foundation, Center for Data Analysis.  Mr. Beach has been instrumental in developing the economic modeling capacity at the Heritage Foundation.

Thank you all again for being with us today.  The committee has received each of your written statements, and they will be made part of the formal hearing record.

Mr. Barthold you will be recognized for 10 minutes in order to adequately explain JCT’s current modeling practices.  Our other three witnesses will be given the customary 5 minutes to summarize their written testimony.

Mr. Barthold, you are recognized for 10 minutes.  Welcome.

Mr. Barthold.  Thank you very much, Chairman Camp and Mr. Levin.  It is always a pleasure to be before this committee.

Today, I will be describing for you the economic modeling that the Joint Committee staff uses to estimate the effects of Federal revenues from changes in tax policy as well as to provide supplemental economic information for the Members’ consideration.

To make it clear I think perhaps the place to start is to ask the simple question of what is a revenue estimate.  A revenue estimate is an estimate of the change in projected Federal baseline receipts that would result from a change in law.

Now the reference point for a revenue estimate prepared by the Joint Committee staff is the Congressional Budget Office’s 10‑year projection of Federal receipts, which is referred to as the receipts baseline.  The receipts baseline assumes that present law remains unchanged during the 10‑year period and thus asks what receipts will accrue to the Federal Treasury over the next 10‑year period absent any statutory changes.

A common misunderstanding that arises when we report revenue estimates to policymakers is that we are sometimes presenting a receipts forecast.  Generally, when the economy is growing, the Congressional Budget Office forecasts that baseline receipts are growing.  So when the Joint Committee staff reports a revenue estimate with a negative in front of it that does not mean that the Joint Committee staff is predicting that receipts will fall, but rather that baseline receipts will generally grow more slowly if the proposal is enacted than they are projected to grow under present law in the baseline receipts forecast.

Just to emphasize this point, I would like to refer back to some work we did a number of years ago.  Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003, known by its clever acronym of JGTRRA.  In figure 1 before you and on the screen, the red bars show CBO’s January, 2003, forecast of receipts.  The Joint Committee staff estimated that the JGTRRA provisions, at least in the first couple of years, would have negative revenue effects.  Now that did not mean that receipts would fall.  On the figure, when we add the negative revenue effects to the CBO receipts, we get the green bars, which is the combination of baseline receipts plus change in those receipts as estimated by the Joint Committee staff.

The one thing I want to emphasize is that, while lower, the green bars are still growing from year to year.  So it was not a projection that receipts would fall.  They would continue to grow but at a lower rate.  And just to emphasize that point, the blue bars on the figure show the actual Federal receipts for those years.  So, actually, in aggregate, our estimates did quite well that year.  But the point I would like to make here is that the negative revenue estimate was still consistent with receipts growing overtime.

Another frequently expressed misconception about our conventional revenue estimating methodology is the notion that the Joint Committee staff assumes that taxpayers will not change their behavior in any way in response to tax policy changes.  It is true that one of the conventions that is followed by the staff is that we hold fixed a forecast of aggregate economic activity.  However, within that, the Joint Committee estimates are never static in the sense that our estimates always take into account a number of likely behavioral responses by taxpayers, such as shifts in the timing of transactions, changes in the form of income recognition, shifts between taxable and non‑taxable income or more highly taxed to more lightly taxed income, shifts between business sectors in terms of investment and the site of economic activity, changes in consumption behavior, tax planning, and avoidance activities.

Beyond raising funds for the Federal Government, Members often intend that their proposed tax policy changes alter microeconomic behavior or the future growth prospect of the economy.  Our conventional analysis generally addresses only the microeconomic behavior and does not account for possible changes in the underlying Congressional Budget Office macroeconomic assumptions.

Since 2003 and the implementation of House Rule 13, for any legislation that has been reported by the Ways and Means Committee, the Joint Committee staff has prepared a macroeconomic analysis.  To undertake this analysis, the Joint Committee staff has used several different models to simulate macroeconomic effects in order to reflect the sensitivity to different assumptions and to emphasize different aspects of the macroeconomy.

The Joint Committee macroeconomic models that we currently use are the Joint Committee macroeconomic equilibrium growth model, which we cleverly call MEG, an overlapping generations model, and a dynamic stochastic general equilibrium growth model with infinitely lived agents.

I will highlight briefly the MEG model and the OLG model just to provide some distinctions in terms of the types of assumptions that underlie these models, and then I will try and present an example of how we use these models to provide information to the Members of Congress.

In the MEG model, the availability of labor and capital determines total national output.  Prices adjust so that demand equals supply in the long run, but in the short run resources may be temporarily underemployed, or overemployed as people in businesses adjust to outside changes in the economy.

One important feature of the MEG model is that household consumption is determined by what is referred to in economics as the life‑cycle theory.  Labor supply respond to changes in after‑tax wages are separately modeled for four different groups of taxpayers that vary by income and type of worker.  Household saving and consumption respond to the after‑tax return to saving and to after‑tax income.  Business production and the production of housing are modeled in separate sectors with business investment responding to changes in what economists refer to as the user cost of capital. The MEG model is an open economy model.  There are cross‑border capital flows and changes in net exports that can affect the domestic economic outcomes. Another important feature in the MEG model is individuals are myopic. They do not anticipate changes in the economy or in government policy.

By some contrast, the overlapping generations model assumes that prices adjust to any change in economic conditions so that supply always equals demand, period by period, and resources are fully utilized after accounting for adjustment costs that may occur as investment changes.  There is no explicit modeling of international trading goods and services, but international capital flows are modeled through interest rate adjustments.

Economic decisions are modeled separately for 55 different cohorts.  There are separate production sectors for business and housing.  Again, there are labor supply responses, saving consumption responses, and responses of investment to the user cost of capital.  And the OLG model, unlike the MEG model, is a perfect foresight model.  The individuals in the model figure out what is going on.

Now how do we use these models?  We take the detailed information that we produce in our conventional revenue estimates about how taxes affect individual taxpayers, individual businesses, and investments decisions, and we use those as inputs into the macroeconomic models.

To try and give an example, in December of this past year, the Congress passed the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010; and table 1 in your handout and this figure on the board shows you our conventional revenue estimate.  It produced, by our conventional estimates, substantial revenue losses in the first couple years, followed by very modest revenue increases.  The revenue increases were ‑‑ again, projected relative to baseline receipts.  They are a consequence of substantial timing changes that result from the expensing provisions for capital cost recovery, which were enacted as part of that legislation.

Now concurrent with our conventional analysis, the Joint Committee staff undertook a macroeconomic analysis of the legislation using the MEG model and allowing varying different assumptions about how the Federal Reserve would respond.  Would they aggressively fight future inflation or not? We also varied  consumer and business responses to the tax changes in terms of labor supply response and investment response.

I am going to try and briefly talk about these results to give you an idea of the type of information that is added by our macroeconomic analysis.

What figure 2 shows is that the Joint Committee staff estimated under what we call our neutral Federal Reserve policy response measure ‑‑ that the size of the economy as measured by GDP would increase by 0.6, to 1.7 percent during the extension period, primarily because of the extra demand that would be generated by the tax cuts.

The staff also estimated that lower marginal tax rates on labor and on income from capital would provide an incentive for temporarily increased supplies of labor and accelerated investment.  However, these effects are expected to be reversed by the end of the budget period as the tax decreases expire and increased borrowing by the Federal Government crowds out some of the private investment.  So that in the latter part of the period ‑‑ you can see on the far right the negative bars ‑‑ GDP would decrease by two‑tenths to five‑tenths percent relative to present law.

The second set of bars that I just flipped up shows an alternative Federal Reserve policy response, and it is important in analyzing macroeconomics to think about what else is going on and how the Federal Reserve monetary policy might affect outcomes.

Now the December legislation was not deficit neutral.  To highlight how tax policy changes might have macroeconomic effects, the Joint Committee staff simulated the same policy but assuming that government transfer payments would be reduced by the amount of reduction in the revenues.  We simulated two different time frames for this, either reducing government transfer payments year by year so the revenue and spending changes were in balance every year, on attentively reducing the transfer payments in the second half of the period so that revenue and spending changes were in balance over the 10‑year period.

My written testimony before you today has the details of that.  What I will highlight here in my closing minute, where I have gone into overtime, is the revenue consequences that one might see from this.  Because, remember, the key in macroeconomic analysis is, if the economy grows, there is a bigger taxable base, and so you might expect that there could be some additional revenue.

The first set of charts shows under one set of assumptions just our conventional estimates of the December bill, the second shows what happens when we layer on the macroeconomic effects of that bill, and the third shows projections for when we consider that it could have been done in a deficit neutral fashion and, again, depending upon the Fed response.

My colleagues and I always strive to update our models with the most recent possible data, looking at economic research.  For example, we are currently exploring adding a more detailed international trade sector to the OLG model and additional business investment sectors to the MEG model.  We always try to provide the members with the best information we can.

I appreciate this opportunity to try and give you a very brief walk‑through of some of the work and modeling that we do, and I look forward to answering the committee’s questions.

Thank you, Mr. Chairman.

[The statement of Mr. Barthold follows:  Testimony ]
Chairman Camp.  Thank you very much, Mr. Barthold.

Mr. Holtz‑Eakin, you are recognized for 5 minutes.


Mr. Holtz‑Eakin.  Thank you, Chairman Camp, Ranking Member Levin, and members of the committee for the chance to be here today.  You have my written testimony, and I look forward to the questions.  I will be brief in my opening remarks.

I think there are three major points to be made.  The first is that dynamic scoring is good science, and that is simply the case because the committee should be interested in all of the responses in the economy to changes in tax policy, including the overall level of economic growth, and to exclude that arbitrarily is not good science.  So the principles of dynamic scoring really should not be in debate.

The second point I would like to make is that the committee needs to make some decisions in order for dynamic scoring to become operational and to achieve one of the chief objectives of scoring which is to be able to rank proposals in a consistent fashion, and I think that is where some very tough but not insurmountable decisions would have to be made.

In particular, I have considerable sympathy to the difficulties that Tom Barthold and his staff would have in executing this on a regular basis.  So the committee would have to include in its process enough time to do this analysis on a regular basis.  There is no way around that.

Next is the committee would have to decide on a single approach.  You have seen three alternative macroeconomic approaches to doing the modeling.  In order to get consistent ranking proposals, you are going to have to settle on a single approach so that when you look at two different tax reforms you can compare them in a consistent fashion.  That would require settling at least on a year‑by‑year basis some of the tough questions about how forward looking people are and the degree to which you are going to recognize the business responses.

I think that is especially important in the debate over tax reform.  There is no question that, at the moment, we would benefit from pro‑growth tax reform where we were providing better incentives for the accumulation of human capital, technological skills, and fiscal capital.  But it is also the case that we have woefully underutilized labor and capital resources in the economy right now.  And to adopt good policies that both bring us back to full employment and raise the capacity at full employment to grow more rapidly I think is the objective.  You are going to have to get both into the analysis in one way or another, and deciding the rules for doing that is crucial.

Third point in this regard is this issue of other policies that are going on in the economy.  You will have to simply decide two important rules of thumb by which the committee will operate.  One would be what will you assume on a regular basis about the Federal Reserve so that each and every tax reform is accompanied by a comparable Federal Reserve response and you can get the ranking of them correct?  The second, and I think the harder one, will be deciding how you will provide for budgetary offsets when a tax reform loses money or gains money at certain points in time.

At the moment, we have two difficulties in this modeling.  I want to emphasize this.  The first is actually quite remarkable, and that is for some of these models, particularly for ones where there is tremendous foresight, those models simply cannot be calculated, meaning the computer algorithms will not run if the Federal Government’s budget is on an unsustainable trajectory.

Our Federal budget is on an unsustainable trajectory.  So in order to actually do the analysis you have to make some assumption about how to get the debt stabilized relative to GDP, and that is even before you can do the analysis of the tax reform.

The second piece is that when you do the tax reform analysis you have to have a regular and predictable offset for any budgetary gains or losses.  Will it be spending cuts?  Will it be tax increases out further in the future?  The economy will react very differently depending upon how you do it.  You have to decide upon a set of procedures which may seem arbitrary but which allow you to do the business on a regular fashion.

So the short message is that there will be a whole series of things that the committee will have to decide in order to make this operational.  They may be better or worse from a predictive point of view.  I want to emphasize what Tom said about the difference between the forecast and the scoring.  They may be better or worse from the prediction point of view, but they will allow you to rank things.

I will close with simply the reminder that this will not be a panacea.  You will not find yourself dramatically changing the Federal budgetary outlook over especially the first 5 years on the basis of dynamic scoring.  You will, however, probably adopt better tax policies from the perspective of jobs and growth.  I think that should be the focus of committee’s deliberations.

Thank you.

[The statement of Mr. Holtz‑Eakin follows:  Testimony ]

Chairman Camp.  Thank you very much, Mr. Holtz‑Eakin.

Mr. Buckley, you are recognized for 5 minutes.


Mr. Buckley.  Thank you, Mr. Chairman and Mr. Levin, for the opportunity to speak to you today.

I will echo Mr. Levin’s remarks about the amount of work and the skill that has been brought to this task by the Joint Committee staff.  However, they, like every other economist, are faced with the fact that it is virtually impossible to model ‑‑ for any economic model to accurately reflect our complex economy with global flows of capital goods and services.  Therefore, these models, by necessity, use simplifying assumptions, and those simplifying assumptions often bear little relationship to reality.

They are also, as both Tom and Doug pointed out, very dependent on assumptions of what other governmental agencies will do, including both the Federal Reserve and foreign governments, how will they would respond to the tax policy.

The impact on important sectors like health care, housing, or manufacturing are not measured by these models or measured only in very partial ways.  Tax reform could easily remove long‑standing tax benefits for these important sectors with consequences that this committee needs to understand.  The models do not provide that insight at this time.

I would suggest before this committee places a greater importance on these models, this macroeconomic analysis, there are important questions for which they should seek answers.

The Reagan tax cut in 1981 promised large economic benefits because of its rate reductions.  Why did a study by Martin Feldstein on the impact of the 1981 Tax Act conclude that it had no net impact on economic activity?

The 1986 Tax Reform Act is very similar in structure to what people are talking about today, rate reductions coupled with a broadening of the tax base.  Under standard economic theory, you would have seen a labor response and a capital response.  Yet a study conducted by the University of Michigan found no measurable impacts on the real‑world factors that economists care about.

In 1993, opponents of the Clinton tax increases could rightfully say that virtually every economic model in the country projected that that Act would reduce economic growth and reduce jobs.  The response in the economy was totally different.  The economic projections that accompanied the 2001, the 2003, and for that matter the 2009 tax reductions have not been reflected in the real world.  The job growth and economic growth following those acts was far less than what was predicted.  I would suggest the committee needs to explore why those projections were wrong before they place greater impact on this analysis.

I also agree in many respects with what Doug has said.  The question to me is whether you use these models for analysis or scoring.  They can provide important insights in designing tax policy, and you can fix the assumptions so all tax policies are judged the same.  But the real question is whether they will be used for scoring of {budget estimates}, and that is where I think there is real risk of doing damage.

These are very uncertain economic projections, even the best of the models.  If you base your budget estimates on these models and those budget estimates do not have credibility in the financial markets, you risk serious adverse consequences.  The models have to be both understandable and credible to the financial markets before they can be used in making budget estimates or I think you risk great harm.  They also have to be based on assumptions that the financial markets find credible, and many of the assumptions today do not reflect our economy.

Thank you, Mr. Chairman.

[The statement of Mr. Buckley follows:  Testimony ]

Chairman Camp.  Thank you, Mr. Buckley.

Mr. Beach, you are recognized for 5 minutes.

Mr. Beach.  Thank you very much, Mr. Chairman, Congressman Levin.

It is difficult to find economists who would argue that the Federal Government’s tax and spending policies just make absolutely no difference to U.S. economic performance.  In this age of massive and growing Federal debt, it is even more difficult to find a politically engaged citizen who fails to see the connection between Federal fiscal policy and economic performance.  Indeed, all across the political spectrum and throughout the leading schools of economic thought a broad consensus exists that what governments do with tax dollars and their outlays as well and how they raise revenues matters in the larger dynamic economic world.

Thus, it is crucial that economic models that organize complex theory and data be available and used by policymakers to chart the most beneficial course for the country, given the policy options available to us.  I agree very much analysis is hugely important.  Some observers, however, would warn policymakers away from the use of economic models entirely, even to analyze the likely outcomes of policy change.  But the usefulness of the policy tools far outweighs the known disadvantages.  Indeed, the absence of dynamic economic analysis in major policy debate should be enough to stop such a debate until it is informed by such analysis.

Today’s economic policy models carefully sort through the fundamental requirement that behavioral changes be prominent drivers of economic estimates.  Likewise, today’s complex and nuanced models nevertheless perform with the speed that policymakers require.  It is in fact unacceptable to deliver estimates of how policy change will likely affect economic activity after the policy change has been adopted.

To be frank, there is also the view that dynamic scoring and analysis ‑‑ and those are two different processes ‑‑ is a part of the legislative process advanced by advocates only of tax reductions and limited government.  This misimpression has done much to keep this useful tool out of the policymakers’ hands.  Let me illustrate.

Heritage used a model of the U.S. economy in 2007 to estimate the economic effects of the tax bill advanced by then‑Chairman Charles Rangel ‑‑ Congressman Rangel, who is before us today ‑‑ when he chaired the Ways and Means Committee.  Chairman Rangel’s reduction of the corporate income tax rate from 35 to 33 percent in fact drew Heritage’s praise, and our model indicated that this rate reduction alone would support the creation of as many as 220,000 jobs.  Other provisions of Chairman Rangel’s plan, however, we thought neutralized that very good effect.

It may surprise some on this committee to learn that Heritage’s Center for Data Analysis has published the only dynamic analysis and score of the justly famous tax reform proposal of Senators Ron Wyden and Dan Coats, which previously that bill was cosponsored, as you know, by Senator Judd Gregg.  Our analysis showed policymakers that this bipartisan reform effort could potentially mean that the Federal deficit would be $61 billion lower per year; the Nation’s debt‑to‑GDP ratio would be 3.9 percentage points lower in 2020; there would be 2.3 million more jobs created on average in each of the years in which the tax reform had full effect.

No one knows, of course, what policymakers will do, even when they possess the very best analytical tools.  This we do know, however:  The standard conventional or static tax models used today by the official revenue estimators at the Joint Committee in the absence of their dynamic analysis could produce highly inaccurate revenue estimates and estimates of economic effects.  It is this record of inaccuracy and, thus, of bad policy advice that has fueled the interest in dynamic analysis over the past 20 years in which I have been working on this issue.

In the real world, we know that businesses and consumers will respond to both tax cuts and tax hikes, and they will do so in fairly predictable fashions.  Tax cuts often, but not always, spur investment, which spurs hiring and increases payroll taxes; and they lead to a positive feedback effect for government treasuries.  Yet it is exactly this kind of feedback effect that static analysis misses.

Advocates of dynamic scoring must be careful not to oversell its capabilities or benefits.  There are legitimate disagreements about which economic model best captures the economic effects of tax policy changes.  Even so, we get better, more transparent government by encouraging the introduction of more economics into the evaluation of tax policy choices and the occasional use of dynamic scoring models to advise policymakers on really big tax bills.  Better government and better tax policy is, I believe, a winning combination of benefits that assures the widespread adoption of dynamic analysis in the process of creating tax policy.

Thank you very much.

[The statement of Mr. Beach follows:  Testimony ]

Chairman Camp.  Thank you very much.

Thank you all for your testimony.

Mr. Holtz‑Eakin, the committee has heard from a number of witnesses this year that comprehensive tax reform that broadens the base and lowers rates will help spur economic growth and job creation.  Can you walk us through the economics of why this is the case and how that might manifest itself in economic models that analyze any proposal. And what is it about that type of reform that would promote growth?

Mr. Holtz‑Eakin.  Economies grow in two ways.  The first is by increasing their capacity to produce; and that comes from giving up something in the present and investing in either physical capital, factories, equipment; skills and human capital, better, more productive workers; or new technologies and a higher level of innovation.

The tax system influences that in deep and fundamental ways because individuals have to give up something now for a return in the future, and taxes affect those returns.  As a result, a tax system that is fundamentally reformed to lower marginal tax rates and take less of that return will incentivize people to undertake those activities.  If it is a reform that is durable and predictable, it will also give them greater confidence in those future returns and, by removing that uncertainty, incentivize activities.  So it is not really complicated.  It is at the core of the nature of economic growth.

It is also true at the moment that the economy can grow by utilizing the existing resources.  We have millions of workers out of work, we have lots of factories not in use, and if we were to undertake fundamental tax reform right now we could spur immediate activity on top of these long‑run impacts.

I think, for example, a corporate rate cut would right now change the valuation of our existing capital.  So we would see equity values go up.  That would make household balance sheets better.  They would spend more.  It would change the incentives for business to invest right now and thus lead to the kinds of feedbacks on to hiring and payroll taxes that Bill Beach mentioned.  It would also change international location decisions, which happen quickly, where you could get capital flows into the economy.

So, in both ways, fundamental tax reform can spur immediate growth and long‑run growth.

Chairman Camp.  Thank you.

Both for you and Mr. Barthold, as Mr. Holt‑Eakin just said in sort of response to this question, I understand a dynamic analysis would analyze the impact that reform could have on the supply of labor and capital.  As he mentioned, idle factories, workers out of work.  So, given our current economic conditions, with high unemployment and large amounts of capital sitting on the sidelines, do you think the benefits of reform could be even larger than historical assumptions?  Or put another way, do the current group of economic models sufficiently recognize the excess capacity that I have just mentioned?

And if each of you would like to respond or, Mr. Barthold, if you would like to go first.

Mr. Barthold.  As Doug noted, macroeconomic growth occurs both from increases in aggregate demand and increases in aggregate supply.  Generally, people tend to think of the aggregate demand effect as more of a short‑term effect.  The point that you were just raising, Mr. Chairman, with the excess capacity means if there were an increase in demand then we could put resources to work even without expanding the economy’s future capacity.

In terms of models and what they show, actually, our MEG model is structured to attempt to analyze what economists would generally think of as disequilibrium outcomes.  In other words, our current relatively high unemployment can be reflected in short periods of time in our MEG model while over the long run it provides more equilibrium outcomes.  Is that model perfect?  No.

Another factor that I think your question also raised is are we reflecting the range of outcomes you could see.  One thing that I tried to emphasize a little bit was the difference between ‑‑ and Doug mentioned this, also ‑‑ the difference in Fed responses.  You would expect with current high unemployment that the Fed would be more neutral and would let the aggregate demand incentives, the improved cash flow aspects of the tax reduction, for example, flow through to consumers without trying to fight inflation by raising interest rates in the short term, with interest rates being increased.  So that would provide some short‑run and some of the longer‑run crowding‑out effects.

As whether there are facets that the models try to capture perfectly and across all sectors obviously, I have to say the answer to that is no and we are still working on it.

Mr. Holtz‑Eakin.  So I thing the key for this committee is that if you were to go forward with an approach that encompassed, as the MEG model does, both the near‑term business cycle impacts and the longer‑term supply side growth you could do that in a way that was rigorously comparable both over time and at any point in time across proposals.  You would always be starting from a baseline.

That baseline at the moment reveals enormous unemployment ‑‑ we are starting from a very low level of economic activity ‑‑ and, as a result, could show quite potentially large business cycle gains.  At other points in time, the baseline perhaps right at full employment the same modeling approach would not give you any business cycle gains because you are already at full employment.  It would only have the supply side approaches.

So I don’t think there is any disqualifying problem with having that kind of approach.  The baseline would capture the starting point and the degree to which you could get the near‑term gains.

In the same way, having a consistent rule for how the Fed reacts, the Fed is unlikely with large amounts of unemployment to be raising rates at a rapid rate, and a rule for how the Fed behaves would capture that.  So I don’t see any overwhelming obstacle to instituting a set of procedures that were consistent at any point in time and captured what is going on in the economy over time.

Chairman Camp.  All right.  Thank you.

Mr. Levin is recognized.

Mr. Levin.  Mr. Chairman, I want to state clearly why I think this hearing is perplexing and potentially counterproductive.  We need analysis.  We also have a crisis facing this country and its families. A jobs crisis. A growth crisis.  We have proposals presented by the President of the United States relating to economic growth and jobs.  Most of those proposals are in the jurisdiction of this committee.  We should have an analysis of those.  We should have hearings on those.

We have one analysis ‑‑ I don’t know if you call it dynamic, but let it not misshape what the challenge is before us.  So one analysis, as I mentioned in my opening statement, Mark Zandi’s, is that the President’s Jobs Act would add 2 percentage points to GDP growth next year and 1.9 million jobs.

Mr. Holtz‑Eakin, you say in your testimony we should not overestimate, that we should have little reason to believe tax cuts, even the best, will pay for themselves, and that over 10 years, no matter what scoring, it is unlikely that there will be a major impact, whatever model you use.  And here we have a jobs crisis, and we need to hold hearings on that.

So, look, I remember the fight over the proposal in 1993.  There was some macroanalysis that said, as mentioned here in the testimony, it would lose jobs, et cetera.  It would ruin the economy.  And it helped lead to a major series of years characterized by economic growth and jobs.  So that is why it is perplexing.

So let me just ask Mr. Buckley a question, if I might, because the chairman asked about tax reform. Lowering the rate and widening the base theoretically has something going for it.  But you have to discuss what it takes to do that.  You have to discuss that.  I took economics 101 at Columbia.  My professor later won a Nobel prize for economics.  I don’t think that helped me very much.  I tried.

So I want to ask you, Mr. Buckley, if as part of widening the base and lowering the rate, you eliminate all of the deduction for mortgage interest, the deduction for State and local income tax, if you include in income the cost of employer‑provided health care, if you eliminate the charitable deduction and the exclusion of interest paid on State and local bonds, if all those are eliminated, what is the analysis?

Mr. Buckley.  Mr. Levin ‑‑

Mr. Levin.  Macro or micro?

Mr. Buckley.  However you do it, I do believe that the details of a tax reform matter dramatically.  The economists who claim there are large economic efficiency benefits from tax reform are modeling a specific proposal.  Essentially, their vision of what should be an ideal tax system, probably not a vision that this committee would adopt.  They cannot analyze tax reform without a specific proposal.  This committee cannot, either.  Some types of tax reform could result in a net tax increase on U.S. manufacturing by repealing large benefits for the manufacturing sector.

Mr. Levin.  Is it your proposal today to pay for ‑‑

Mr. Buckley.  For the rate reduction.

Mr. Levin.  ‑‑ by eliminating the remaining money in 136, which I think is mindless.

Chairman Camp.  It does not eliminate the remaining money in 136.  There is a reduction in the 136 dollars.  It does not eliminate.

Mr. Levin.  The remaining money.

Chairman Camp.  It is a big distinction.  It is 1.5.  I think there is 7 billion left.

Mr. Levin.  But that is all spoken for.  That is all spoken for.  If you look at what is in the hopper now, it eliminates what isn’t spoken for.

Mr. Buckley.  That is what I think ‑‑ the one thing the models do not do very well is analyze the impact on sectors.  If you repeal current law benefits for owner‑occupied housing, I believe you will see a reduction in home prices.  I believe that those benefits are capitalized in the current value of our homes.

Now that may be desirable economic policy, but you need to know what impact that would have on the economy and whether can you mitigate those effects through transition rules.  Until you have those details ‑‑ and that is really what this debate is lacking, is a detailed proposal ‑‑ you do not know what the consequences of the tax reform will be.

Chairman Camp.  All right, thank you.

Mr. Herger is recognized.

Mr. Herger.  Thank you, Chairman Camp.

I would like to ask Mr. Barthold about how the scoring process considers administrative and compliance costs.  In 2006, Congress passed a 3 percent withholding tax on government agencies’ payments for goods and services.  Joint tax scored this provision as raising Federal revenues by $7 billion.  Subsequently, however, the Department of Defense released a study finding that, for DOD alone, the cost to implement this new tax would be over $17 billion.  This means the government would be spending far more to collect this tax than it raises in revenue.

Another independent study estimated that the cost of businesses to comply with this withholding requirement could be over $40 billion.  In general, the high cost of tax compliance means less money is available for small business to invest in job creation, and many of us are hopeful that simplifying the Tax Code would reduce this burden and thus spur economic growth.

Mr. Barthold, does the current scoring process incorporate the cost to the IRS and other Federal agencies to administer specific tax provisions?

Mr. Barthold.  Thank you, Mr. Herger.

What we are estimating for the committee members are the receipts’ effect to the IRS.  We try to bring into the process at the staff level issues of what it will take for different agencies or different taxpayers to comply.  But the estimates themselves do not include direct estimates of compliance costs except to the effect that compliance and complexity affect taxpayer behavior.

If I could ‑‑ I know I am on your time, but if I could make one note about the $7 billion estimate that was done for the 3 percent withholding at the time that TIPRA was enacted, I think it is important for the members to recognize that estimate has two components.  Because it is a withholding provision, it has the effect of accelerating tax payments within the fiscal budget period.  And that was the bulk of the $7 billion estimate, was an acceleration of payments into the Treasury.

There was a second component which was smaller, but not insignificant, of ongoing compliance gains.  Because as I know the committee was aware because they had heard testimony, there was some substantial noncompliance by government contractors in terms of paying their legally due income and payroll tax liabilities, and that is what had motivated the enactment of that proposal.

I hope that addresses your question, Mr. Herger.

Mr. Herger.  Well, Mr. Barthold, it would seem to me again where just one department, the Department of Defense, estimated that its costs would be more than double the revenues coming in, it would seem that we are getting an incomplete picture of how tax changes affect a budget.  And if tax policy creates new administrative costs for the government, then we have to either increase total appropriations or agencies have to sacrifice other priorities.  Conversely, if tax reform reduces administrative costs, that should generate savings in the discretionary budget.

Mr. Holtz‑Eakin, from your experience at CBO, do you have any thoughts on this topic?

Mr. Holtz‑Eakin.  I am certainly not familiar with the specifics of that proposal.  I do know that when CBO undertakes to score proposals it has to make some judgement about the likely implementation of the rulemaking, the time it will take for that rulemaking, and, as a result, when the Federal budget is affected.  And it also has to make some judgment about overall discretionary funds that will be necessary to implement it.  So I think this is part and parcel of doing estimates ‑‑ impacts on the Federal budget.

Mr. Herger.  Thank you, Mr. Chairman.

Chairman Camp.  Thank you.

Mr. Johnson is recognized.

Mr. Johnson.  Thank you, Mr. Chairman.

I am asking that ‑‑ Mr. Barthold, I want to ask you about the revenue impact analysis for the 2003 tax cuts and in particular the capital gains tax cut.  I am sure you’re familiar with the July 24th Wall Street Journal edition on tax oracles.  This is it.

Mr. Chairman, I would like to get this introduced into the record, if I could.

Chairman Camp.  Without objection.

[The information follows: The Honorable Sam Johnson ]

Mr. Johnson.  Thank you.

The editorial points out there was a surge in tax revenue following the 2003 tax cuts.  The surge simply was missed by the budget scorekeepers.  In particular with respect to the capital gains tax cut the Wall Street Journal points out the behavioral model that Mr. Barthold celebrates predicted that the capital gains cuts would cost the government just under $10 billion dollars from 2003 to 2007 when the actual capital gains revenues over 5 years were $221 billion higher than JCT predicted.

Mr. Chairman, I think I would like to ask Mr. Barthold, why was the analysis so wrong with respect to the revenue impact of the capital gains tax cut?

Mr. Barthold.  Thank you, Mr. Johnson. As our staff pointed out in some of the background material that we prepared in our overview, we tried to account for taxpayer behavioral responses, including capital gains realizations. Because it is entirely discretionary, it is a very difficult area. In the document that we published in advance of this hearing, JCX 46-11, we noted in particular that compared to baseline projections of capital gains and a simple static sort of analysis of saying if you change the rate of tax on those gains, what would happen to receipts, that our modeling at the time of 2003 had over 70 percent of the static effect offset by behavioral change.  So we had a substantial behavioral component to that particular estimate.

The Wall Street Journal’s discussion I think makes some ‑‑ without knowing completely what they are trying to compare ‑‑ I think they have some confusion in what they take as the baseline projections for capital gains as opposed to overall receipts.  In part of this particular editorial and the editorial that they had prior to this editorial, they seem to display some confusion about the point I made earlier regarding whether our estimates are about receipts or a change from the baseline of receipts.

But that said, as I noted in my testimony, we always strive to try to update and present to the committee information based on the best estimates possible.  Because of the importance of the capital gains in the tax policy debate, it is one area that we are reviewing.  We have a research project underway right now.  In fact, we have just submitted to a small professional conference of academic economists a proposal to present some preliminary results from this research that we would use to change our modeling.

So all I can say is we do our best overall on ‑‑

Mr. Johnson.  Well, I recognize it is not a simple thing.  But in light of the revenue figures, do you not believe that cutting the capital gains tax rate, as Congress did in 2003, can have a positive macroeconomic impact?  In other words, do you not believe a tax cut such as the 2003 capital gains tax cut can lead to greater investment, job growth, and perhaps higher tax revenues?

Mr. Barthold.  Mr. Johnson, on that point you actually enter sort of a different realm about what is the macroeconomic transmission mechanism of particular policy changes.  Reducing the tax on capital gains increases after‑tax returns to individuals’ savings, particularly in the form of equity investment.  The way we would analyze that is that is one component of how people save.  Other considerations:  Do we shift out of dividend‑paying stocks into stocks that accrue more gains; do we alter portfolios that have less debt, more equity?  That all goes into the type of analysis that I tried to present to you briefly this morning.

So by increasing the after‑tax return to savings, there should be some positive effects on savings.

Mr. Johnson.  Thank you, Mr. Chairman.

Chairman Camp.  Mr. Rangel is recognized.

Mr. Rangel.  Thank you, Mr. Chairman.  Thank you for this enlightening hearing that we are having.  I gather from the joint committee that the purpose that this panel is here is to share with us the resources that you have available to us as tax writers, if and when we move forward with tax reform.  And my question to you:  Does anyone here have any reason to believe that we will be using this information in order to reform the tax system?

I guess not.

I guess not.

Mr. Beach.  The answer is yes.

Mr. Rangel.  Then could you share with me what allows you to believe that this Congress will be reforming the tax system?  What have you heard; what indications?  Because I have been on this committee longer than anyone else and I received no signal that my committee will be moving into tax reform in this session.  Because as you pointed out, I have been a strong advocate of tax reform, I think it increases revenue.  It is fair.  It is more equitable.  So share it with me, Mr. Beach.

Mr. Beach.  I don’t know what the committee will do, obviously.  I am not sitting where you are sitting.  And I hope that you do tax reform, and do it very soon, and you follow some of the principles that you laid out when you were chairman of this committee.

I will tell you that as a long‑time person whose group helps Members of Congress shape their bills and does some analysis of their bills to help them understand better, I am getting a lot of business.  I think as a market indication, there is a strong interest among members of this committee and Members outside of this committee in reforming the taxes.  But I think also a lot of Members understand that there is a dance that has to be held here.  And one partner is tax reform and the other partner is overall fiscal reform.  And it is the difficulty of finding how you in fact dance with those two partners.

Mr. Rangel.  What you are saying, Mr. Beach, is that it is a complex and sensitive subject politically.  I don’t see how you think we can overcome that problem this year.  And I know you are not talking about having this committee move into a tax reform mode next year.

I guess my real question to you, based on your experience, when the President has a tax proposal of any kind, as he recently reported, you don’t believe that you can really be for or against it until the committee of jurisdiction reviews it and has hearings on it.  Would you agree with that statement?

Mr. Beach.  That is a matter for the committee to take up.  I know there is tremendous interest in this outside.

Mr. Rangel.  You pay taxes.  You are going to be affected by what happens here.  Now, you have got a 12‑member committee.  You know what the Ways and Means and the Finance Committee’s responsibility is.  You know about deadlines that we have.  I hope you are not suggesting that you think that we can do tax reform between now within the deadlines that the Congress has.  Is that what you are telling me?

Mr. Beach.  You shouldn’t do it.  If you are not started right now ‑‑ you should take your time to do tax reform.

Mr. Rangel.  That means that you agree with me.  You don’t think it is the right thing to do to start tax reform now, with all of the congressional restrictions that we have on timetable.

Mr. Beach.  You have already started tax reform.  There are so many discussions going on.  But this committee and the Congress has a duty which is even greater than that, and that is to plot a course through the most difficult financial challenge that this country has faced perhaps in the last 100 years.  And tax reform is part of that.  But also major changes to our spending priorities is part of that as well.

Mr. Rangel.  Thank you, Mr. Chairman.

I assume that means that you don’t expect us to do tax reform this session.

Chairman Camp.  All right.  Mr. Tiberi is recognized for 5 minutes.

Mr. Tiberi.  Thank you, Mr. Chairman.  Mr. Barthold, I want to follow up on the line of questioning from Mr. Levin regarding the President’s Jobs Act and how you model that Jobs Act.

Let me give you a real‑life example and tell me how your process applies to this.  I had a discussion Monday with a constituent who is part of a family‑owned business.  They are an S Corp.  He and his wife were looking at making an investment decision, and they were down the road of making this decision.  The President’s proposal has an impact on that investment decision, and thus he and his wife now have put a hold on that investment decision and ‑‑ an investment decision that theoretically would create jobs and opportunity.  And so based upon the President’s proposal, that is stopped.  And it is going to stop for maybe forever, based upon the President’s proposal and what happens to it.

How do you and your folks at Joint Tax figure that out and apply it to real life?

Mr. Barthold.  Mr. Tiberi, you raised a really important issue in economic modeling, and that is how to account for individuals’ or businesses’ expectations.  As you have described your constituents, they apparently feel pretty strongly about the uncertainty that is created by introduced legislation.  We try to account for, as I noted, taxpayer behavior in all the estimates that we do.  What is particularly difficult, I think, in what you proposed is what does that do to the baseline?  We make these estimates relative to baseline receipts.  And the baseline receipts projections aren’t assuming that there is any change in law.  So our baseline receipts projections assume that a lot of investments would have gone on as projected under the macroeconomic projections of the Congressional Budget Office.

The situation you posed is you think that legislative uncertainty may change the course or timing of those investments.  Now, when that gets picked up is when the Congressional Budget Office redoes its macroeconomic forecast.  If they redo the macroeconomic forecast, that will then be reflected in what we think about the course of the economy, the course of receipts from business income. But as you posited this particular situation, that is sort of missed in the economic modeling right now because your constituents had something they were thinking of doing in, let’s say, the next 6 months, and now they are not because of legislative uncertainty.

We have recently had a revision in the CBO macro forecast.  We are not picking up in anything that we are doing on Capitol Hill, in our modeling, really, that reflects that kind of uncertainty and changed decision because of current legislative uncertainty.

Mr. Tiberi.  Since CBO is mentioned, Mr. Holtz Eakin, can you comment from your perspective when you sat at CBO?

Mr. Holtz‑Eakin.  I would concur that incorporating explicitly policy uncertainty is one of the real weak points of the current state of economic science.  In that regard, if I could, I think it is important to distinguish between scoring and forecasting.  Think about football.  For reasons that I don’t know, if you get a touchdown, you get six points.  If you kick the extra point, you get one.  If you run or throw it across, you get two.  I have no idea why.  Because those scoring rules allow you to compare two teams, they allow you to compare games across the country and over time.

And that is what you want out of good rules to evaluation legislation.  You want to be able to score them consistently.  You would also like to be right.  But the committee operates in areas where, quite frankly, often it is impossible to be sure you are right.  We passed the Medicare Modernization Act when I was at CBO.  There had never before been a product which was insurance for the cost of
outpatient prescription drugs offered by the Federal Government.  We developed scoring rules so that there are more and less expensive ones.  We had no idea if we were right.  It turned out we were way too high.  Probably 30, 40 percent too high.  Over time now, I think scores of prescription drug estimates will get better.

I think the same will be true for the Joint Committee.  If you go down this route, you will bring into the scoring additional information ‑‑ growth consequences ‑‑ and they won’t be right the first time.  But they will get better and better.  And at every point in time, you will be playing fair across the proposals.  That is the key.

Mr. Tiberi.  My time is expired.  Thank you, Mr. Chairman.

Chairman Camp.  Mr. Davis is recognized.

Mr. Davis.  Thank you, Mr. Chairman.  I would like to continue in that line of questioning, Mr. Eakin.

In your testimony you suggested coming up with a new single approach to estimating that provides uniformity of scoring while taking aspects of both static and dynamic scoring into account.  How does the current regime produce scoring estimates that result in qualitative differences, in your opinion?

Following on that, how do you think a new system would treat, comparatively, a reduction in marginal rates versus, say, the credit from State and local sales taxes?  I am not looking so much for a specific answer on the second, but trying to get to a more realistic aspect.

Mr. Holtz‑Eakin.  I think that it is important if you are worried about economic growth, particularly over the long term, longer horizons, you want to have a system that reflects the fact that there is a big difference between a revenue‑neutral tax reform that cuts marginal rates, broadens the base, and one that might, say, jack rates up on every taxpayer in America and then provide a refundable credit to exactly the same people.  It would be revenue neutral.  Some people might take that cash and spend it.  It might look like a good idea in the near term.  But over the long term, those are terrible incentives for labor and capital and growth.  And you want the process to reflect those incentives.  Static models will not capture the longer‑term index.

Mr. Davis.  Anybody else like to comment on that?  Mr. Buckley.

Mr. Buckley.  The only thing I would say is, there is a sharp difference between analysis and scoring. I think a lot of these models may be useful in analyzing different proposals and the comparative benefits.  When you are doing that, the committee can specify assumptions that they want the Joint Committee to follow.  I don’t think you can do that for the actual scoring of the legislation. Do exactly what Doug has suggested.  Put the assumptions in there and you can compare different proposals across the board.  But if you use that for determining the budget score, what you reflect as the budget cost of the bill, the perception of political interference, if this committee sets the assumptions ‑‑ and somebody has to do that ‑‑ those estimates then have no credibility.  And I think you run a real risk in the financial markets if you use that type of estimate in determining the ultimate cost of the bill.

I think that is the real question here for the committee. Analysis is fine and good.  You want more information.  But you should be very careful before you take that final step and say that the actual official score of the legislation is determined with regard to these models and with regard to the assumptions that the committee specifies.

Mr. Davis.  Thank you.  Mr. Eakin, you wanted to add an additional point.

Mr. Holtz‑Eakin.  I think this is the right discussion.  I think I come down at a different place.  Point number one is that I see no qualitative difference between the kinds of uncertainty that surround these growth effects and the different models that capture them and the kinds of uncertainty that surround the conventional micro uncertainty around a lot of scores.  We did scores for terrorism risk insurance.  I hope we never find out how accurate they are.  There are fundamental questions of uncertainty that pervade the scoring process.  There is nothing new about that here.

I also come down on a different place on the financial markets.  They use these models every day in order to evaluate exactly what you are doing.  So I don’t think they are going to be at all phased by the fact that you use them to make your decisions better.  They are using them right now.

The third thing I would say is there will be some arbitrary decisions.  And the goal to make them appear to be done in an evenhanded, nonpolitical fashion is an important one.  Transparency would do a lot to solve that.

So I think there is a route forward.

Mr. Davis.  Mr. Beach.

Mr. Beach.  There is one thing I would want to remind the committee, is that when they take a score of an important bill from the good people at the Joint Committee on Taxation, it is not based on an economic model.  Be under no
misimpression.  You have used an economic model to get to that score.  What you are assuming is the economy does not have an effect.  So any way, shape, or form, when your scores come in there is an economic set of assumptions behind that.

What we are saying on this panel ‑‑ I think we are all agreed ‑‑ is that you need to have the best information, the best advice possible to plot that good course to a better economy.  And that is why dynamic analysis is so crucial and it should be part of the routine pieces of information that come to this committee.

So when you get a static score, the assumption is the economy is not working there.  There might be microeconomic behavioral assumptions built in, but the general economy is not responding.  That is the assumption made by the static score.

Mr. Davis.  Thank you, Mr. Chairman.  I yield back.

Chairman Camp.  Mr. McDermott is recognized.

Mr. McDermott.  Thank you, Mr. Chairman.  Mr. Chairman, I have spent 40 years sitting in Ways and Means Committee, 17 years in the State legislature, and 23 years here.  And these mind‑numbing discussions always remind me of Henry Jackson, our Senator, who once said what he was looking for was a one‑armed economist so he wouldn’t hear any more of this “on the one hand this” and “on the other hand that.”

And in the State of Washington I hired a guy in 1979, after we lost our bond rating and whatnot, to do our revenue estimates, because we always had a fight between the Governor’s office and the legislature as to what the revenue was going to be.  We finally said, let’s get one guy and he would give us a high, a medium, and a low, and then we would pick one, and the Governor had to live with it and we had to live with.

Now, up here we keep playing this game of OMB and CBO and the Joint Committee on Tax and everybody else.  It is all for political reasons.  Groucho Marx probably said it best when he said, “When you go into politics, the first thing you have to learn to do is to have a straight face.”  And we sit here and have these sober‑faced discussions.  But we know that we are never going to get a balanced budget because one group is going to say, if we do this, if we cut taxes, the revenue will go up.  And another group will say, no, if you cut taxes, the revenue will go down.  And we never agree on the baseline.  And we fight.  And we are going to come to a showdown here on the weekend, because people say we are in so much debt that we can’t ‑‑ what can we do?  Well, it depends.

But we don’t have one definition of being in debt because we don’t talk about the investment in infrastructure.  We don’t talk about a lot of things in some kind of unified system.

My belief is that these discussions ‑‑ the majority will decide what they think the estimate is.  I think this hearing is probably about let’s use some dynamic scoring so we can make things look better going into some kind of a tax reform discussion.

I read, Mr. Buckley, your statement that if we accept some of these assumptions, we may have a negative effect on the market.  Could you expand on that?  We are sitting here today with the Republican leadership saying that we don’t want Bernanke fiddling with the interest rates because it is going to ‑‑ they don’t want things to get better, that is pretty clear.

Mr. Buckley.  Let me slightly respond to what Doug said.  Businesses do use macroeconomic models in making business decisions.  And that is exactly what I think this committee should do.  That is perfectly appropriate.  But when they report to their shareholders, they record the cost without reduction for the potential gains that may result from the investment.  If any business reflected in its current statements the prospective but uncertain benefits from its current investments, it would probably violate every securities law.

So to say that business used these assumptions, that is correct, they do, in making business decisions.  They do not use these assumptions when they report to shareholders.  If the profits from the investment actually are realized, the business takes those profits and they will count in the year which they are realized.  If you score using these estimates, you are saying that the Federal Government will take into account uncertain benefits before they are realized.  I think that is pretty dangerous.  I think it is dangerous as far as the acceptance of the market for cost assumptions.

Mr. McDermott.  What difference would it make to the market if you started taking those ‑‑

Mr. Buckley.  If the markets suggested that you could pass big tax reductions and pretend that they had no cost because of uncertain projections of future macroeconomic benefits, they would not respect those decisions.  There is a point where you need credibility in your budget assumptions.  Those budget assumptions have credibility now because they are consistent with the cost accounting standards that businesses have to follow in their everyday life.

Mr. McDermott.  Can we have that as long as we have OMB and CBO fighting?

Mr. Buckley.  But they are not making assumptions about the wisdom of the change in law.  They are making
microeconomic decisions about the effects on revenues.

Chairman Camp.  The time is expired.  Mr. Buchanan is recognized for 5 minutes.

Mr. Buchanan.  Thank you, Mr. Chairman, for holding this important hearing.  I also want to thank all of our witnesses today.

Mr. Eakin, I was curious.  I want to talk about taxes and small business in a minute, but I was very interested to read your comment the other day on the Federal Reserve.  I believe we need to audit the Fed.  I have talked to a lot of people in Florida who are concerned about the Fed and their active involvement.  What are your thoughts on whether the Fed should be more active or less active in terms of our policies?

Mr. Holtz‑Eakin.  I have no idea what I said.  I talk too much, evidently.

Mr. Buchanan.  I heard your comments.  I think it was along the lines that the Fed was too active.  I just hear that comment a lot.

Mr. Holtz‑Eakin.  I don’t think ‑‑ there are multiple discussions about the Fed.  Number one, I do not believe that there is much the Fed can do to enhance near‑term economic growth at this point in time, and that doing nothing is essentially the right near‑term situation in my view.  They still have capacity to help us if, God forbid, European financial shocks or something get transmitted to the U.S.  They can step in and help us on the downside.  And I believe that I would prefer to have the Congress of the United States do appropriate oversight in hearing settings and make sure that the books are square.  But I do not want the Congress of the United States running U.S. monetary policy.  I have seen how the Congress produced fiscal policy, and I am not overwhelmed.

Mr. Buchanan.  The other thing I wanted to get on is small business.  I know we all believe it is the backbone of our economy.  It creates 70 percent of the jobs.  And I see it in our communities that are concerned about taxes and where that is going.  There is also the lack of credit out there.

Mr. Barthold, in terms of your modeling, what have you taken into account in terms of pass‑through entities?  How do you look at that in terms of your modeling?

Mr. Barthold.  Pass‑through entities are part of our conventional modeling.  And to the extent that the conventional modeling feeds into the macroeconomic analysis that we provide from time to time, pass throughs are included.  On the macro side, as I noted in the testimony and overview document, we don’t divide the business sector into small businesses, medium businesses, and large businesses.  We use a much more crude aggregation.  Most of the time we are looking just at business investment and investment in housing.

But in our conventional modeling, as I know you know from some material that we went through earlier in the year, we have a substantial amount of background data on the types and numbers and distribution of different entities ‑‑ sole proprietorships, S Corporations, partnerships ‑‑ by industry.  And we use that data to analyze all the different proposals that members such as yourself bring to us.

Mr. Buchanan.  A lot gets thrown around.  I have been in business for myself for 30 years and been active with a lot of small businesses.  I am concerned because a lot of times it gets thrown around about the idea that only 2 percent of small businesses are affected by the tax increases.  But yet when you look at the income of these pass‑through entities, 50 percent of the income is impacted.

And when you look at the environment, especially in Florida, but I am sure other States, where you have a lack of credit, the growth and whatever success I had because I had strong banks that were able to back cheap capital, but when you take into account a lot of pass‑through entities looking at their taxes are going to go up, along with a lack of capital, then we try to figure out why we don’t have the job creation.  That is what I am getting feedback on every day back in Florida.  Do you have any thoughts about that?

Mr. Barthold.  I think the issue that you are raising is very similar to the issue that Mr. Tiberi raised earlier, and that is; to what extent does current legislative uncertainty affect current business decisions, and then how is that reflected in the modeling?  I noted that short‑term uncertainty that is not picked up in the periodic updates of baseline projections of investment,  macroeconomic activity, on business income, is missed in the process.

Mr. Buchanan.  Mr. Beach, do you have anything you want to add to that?

Mr. Beach.  It is very important to do the pass‑through entities correctly.  In models that we use, we take a lot of time to take a look at which ones are most likely to be benefited by drops in capital cost because of the capital‑intensive nature of some of those pass‑throughs, labor costs, because of that, and so forth.  You need to have very detailed information.

Fortunately, I can tell you that the Joint Committee does a pretty good job of sorting through that.  I will also tell you that I think the Joint Committee would benefit tremendously by having more active participation of advisory panels, outside groups, that would come in and not oversee their work, but be at a place where they could try out new ideas and get suggestions.  There are a lot of people in this town and around the country that are handling questions just like you have asked that are outside the Joint Committee.

Mr. Buchanan.  Thank you, Mr. Beach.

I yield back.

Chairman Camp.  Mr. Smith is recognized.

Mr. Smith.  Thank you, Mr. Chairman, and thank you to the experts on the panel here today.  I certainly want to be sensitive to the fact that there are a lot of moving parts in the economy.  And I think I hear you saying that it is hard to predict everything.  I am certainly sensitive to that.  We are forced to ‑‑ and I think it is healthy ‑‑ to look even beyond the 10‑year window.

Mr. Holtz‑Eakin, do you think that we could use dynamic analysis perhaps to even look beyond the 10‑year window?

Mr. Holtz‑Eakin.  I think it would be incredibly desirable to do that.  You certainly want to always use all the information you can about the long‑run consequences of both the tax and the spending policies of the government, there is no question.  We have enormous long‑run problems that the 10‑year window doesn’t capture right now.  The only real issue is the degree to which you bring those into the formal scoring process.  And that is the place where the Holtz‑Eakin‑Buckley feud shall continue.

Can I respond to what he said?  I think what he said is wrong.  Can I respond?

Under current procedures, the CBO and the OMB will put out a baseline projection in January.  And those will be budget projections for the U.S.  This committee could then in the middle of the year pass a tax reform, under current procedures.  When the next January came around, CBO and OMB would have to create new budget projections and they would have to look at the new current law and decide whether that tax reform helped growth or didn’t.

All we are talking about is whether during the year you actually use that information to decide among tax reforms.  It is not going to change the integrity of the budget projections.  The financial markets are not even going to notice.

Mr. Smith.  Thank you.

Mr. Buckley.  If I could have an opportunity.  I am sorry; on your time, too.

You are right, you keep doing changes in estimates.  There is no way that the CBO estimate next year is going to be dramatically different by reason of a tax reform enacted this year.  I don’t think it is going to change the projections all that much.  The real question is how you score it.  If you score it in a way that hides the budget cost, I think you run into trouble.  And particularly if you score it under assumptions that this committee selects ‑‑ and that is what Doug says you have to do ‑‑ then I think you have real problems.

I think it is different if CBO has a new baseline.  I think it is a quite different thing from this committee saying we shall assume that the Federal Reserve is going to accommodate this in this way; we shall assume this and we shall assume that.  And therefore you would determine the score by the actions of this committee.  That is a political judgment that I think you are perfectly appropriate to make.  I don’t think it should affect the budget score.

Mr. Smith.  Pardon me while I shift gears a little bit.  I know that tax policy does have consequences in the economy.  And I know that different States have different tax policies among themselves.  And so I have seen where tax policy affects behavior.  I think we can all agree on that to a certain point.

Take, for example, section 1031 exchange policies that oftentimes encourage some behavior that impact market values.  And then a high property tax State like Nebraska sets property taxes according to market value, and all of a sudden tax policy can effectively influence and affect local tax policy ‑‑ even the most local of taxes, being property tax.  Is that taken into account in an analysis of any form right now?

Mr. Barthold.

Mr. Barthold.  Yes, Mr. Smith.  There are a couple different avenues in which some of the State and local effects are taken into account.  What we don’t do is we don’t project that there will be a change in the budgetary receipts in the State of Nebraska or in the State of Missouri.  But we do as part of our individual modeling, for example, assign individuals to States.  We have upgraded from time to time ‑‑ in fact, just this last year, we added a State tax calculator ‑‑ so that when we look at behavioral effects, we will be able to take into account the combined marginal tax rates of the Federal and State level.  We also use that State tax calculator to look at possible itemized deductions for real estate property taxes and State and local income and/or sales taxes.

So we do try to account for some of the interaction that is in the Federal system.  But it doesn’t go down to projecting budgetary outcomes for specific States.

Mr. Smith.  And then how that might come back around and affect tax.

Chairman Camp.  The time has expired.  Mr. Neal is recognized for 5 minutes.

Mr. Neal.  Mr. Chairman, thanks for holding this hearing.  I often think that this is a part of congressional life that the public does not get to see, where there really is an exchange, and you listen to people who do this every day and there is good give‑and‑take, and the people that are at the witness table are not only seasoned but, just as importantly, I think, pretty honest about the arithmetic that is put in front of them.  I appreciate it very much.

I tortured Mr. Holtz‑Eakin over the year with this question.  And I see no reason that I should leave him alone today, on that basis.  He knows where I am going with this.  He already knows the answer and I know the answer to the question that I am going to raise with him.  But I appreciated his candor.

I was driving along one night listening to a lengthy NPR piece, and Mr. Holtz‑Eakin was the subject of the interview.  I thought the candor he expressed on the campaign trail was very helpful to the dialogue as well.

Do you think tax cuts pay for themselves?

Mr. Holtz‑Eakin.  On average, no.

Mr. Neal.  Thank you.  Now I am going to come back to you for a second here, because I also want to question Mr. Buckley for a moment here.

You were around during the Tax Reform Act of 1986.  How do you realistically think that we can get to that 25 percent rate that is being shopped by many in this town at the moment?

I want to give Mr. Holtz‑Eakin a chance to speak to that as well.

Mr. Buckley.  Unless you are willing to sustain a large net tax reduction ‑‑ and that is clearly a question here ‑‑ I doubt that you can get to 25 percent if you follow your normal practice of providing transition relief for people who have made investment decisions based on current law.  For example, you can raise a lot of money by repealing the mortgage interest deduction.  However, if you decide it is unfair to raise that ‑‑ repeal that deduction for people with existing mortgages, the amount of money you raise disappears rapidly.

A lot of the numbers that are being used for tax reform debates so far are not revenue estimates.  They are static tax expenditure estimates.  If we are talking about purely static, tax expenditures estimates are static.  So a lot of the estimates that people are using are static estimates.  It will be estimated with behavioral responses; not macroeconomic responses, but behavioral responses.

So I think it is very difficult to do, without being pretty rough, and not properly taking into account the investment decisions that people have made based on current law.

Mr. Neal.  Mr. Holtz‑Eakin.

Mr. Holtz‑Eakin.  I think qualitatively the key is that the Tax Code now subsidizes to a tremendous extent consumption items.  The mortgage interest deduction is the consumption of debt to finance owner‑occupied housing.  The
employer‑sponsored insurance exclusion is the subsidization of the consumption of insurance and health products that it pays for.  If you go through the list, by and large what we do with the Tax Code are things that subsidize what is the opposite to growth policy.  It is consume now, forget about the future.  So if you want to get rates down and you are serious about growth effects, you have to reform the Tax Code to reward saving and investment and to stop subsidizing consumption.  And that is the only way you will get rates down.  That points to the reason why it is very often the case that tax cuts don’t pay for themselves and that analyses of tax policies don’t show big growth effects, is because often it is not very good growth policy.  Because a lot of tax policy simply is not.

Mr. Neal.  Mr. Barthold, he just teed‑up the question that I want to raise with you.  Mr. Beach disagrees with the economic models you use as it relates to static estimates.  Would you like to expound upon the testimony you offered based upon the models that you have offered today?

Mr. Barthold.  Well, I just wanted to take issue with the word “static,” as I noted in my testimony and we noted in our background material, and as came up in the discussion of capital gains tax policy changes.  We incorporate at the microeconomic level a substantial amount of behavioral response.  We try to account for compliance behavior, portfolio changes, shifts between investment sectors, all in response to tax proposals that the Members offer to us for economic analysis.

What we pointed out some today is that in macroeconomic work that we have tried to do for the committee, we are presenting further economic analysis on how some policies might have broad effects on the economy in terms of labor supply and capital investment how they could matter to future economic growth.

Chairman Camp.  Thank you.  Mr. Schock is recognized.

Mr. Schock.  Thank you, Mr. Chairman.  First, I would like your permission to submit questions in writing to these panelists so that they can respond in writing if I run out of time.

Chairman Camp.  Without objection.

Mr. Schock.  First, Mr. Holtz‑Eakin, your response to tax cuts don’t pay for themselves.  I am curious, by my friends on the other side who keep pointing this out, I am wondering whether or not government spending to spur economic growth pays for itself.

Mr. Holtz‑Eakin.  Not in my view, no.

Mr. Schock.  So when you said earlier that oftentimes cutting taxes is not an effective way of spurring economic growth, obviously we have tried to spend a lot of money here in Washington, D.C. to spur economic growth.  Which of those two paths do you think is a better one to spur economic growth, if you can; and if not one of those two paths is better, is there a third that we are not seeing?

Mr. Holtz‑Eakin.  I think if you look at long‑run growth, ignoring business cycles, unquestionably the preferred package, pro‑growth tax reform, has the bigger impacts.  I have little doubt about that.  The debate over what happens in the short run ‑‑ throw money at the economy, get Keynesian effects; cut taxes, get Keynesian effects ‑‑ I think both have proven to be relatively inefficient and not something that we ought to get too high hopes of.

I guess the biggest thing is have a discussion where how you cut taxes matters, not just do you cut taxes.  How you spend money matters, not just do you spend money.  There is a big difference between providing high‑quality infrastructure over the long term and passing out cash benefits to American citizens.

Mr. Schock.  Do you think that infrastructure spending matters if it is more long term and sustained?  For example, a highway bill over 6 years versus a 1‑ or 2‑year stimulus bill?

Mr. Holtz‑Eakin.  I have little faith in so‑called infrastructure stimulus spending.  This for decades has been a phantom that Congresses have tasted.  It never arrives in time.  It is often spent on bad projects.  It is not good policy.  There is no question that we need better infrastructure programs where we spend the money wisely.  And I recommend to you a private sector commission report that I can get to you on reforming transportation infrastructure programs.

Mr. Schock.  I would like that.  Thank you.

Mr. Barthold, we had a panel of company CEOs and CFOs before us on the issue of tax reform and I specifically asked them ‑‑ many of them received different types of credits, deductions in our current Tax Code ‑‑ whether or not, in fact, eliminating all those tax deductions and going to a straight, for example, 25 percent rate would be better for them.  They unequivocally ‑‑ all of them said yes.  I then asked them whether or not, in fact, their business models would stay static or whether or not they would in fact invest more money in the United States.  Most of these were multinational companies.  Again, went down the line, Republican and Democrat witnesses alike, all uniformly said they would in fact invest more in the United States if we got rid of deductions and could get the rate close to 25 percent.

That leads me to ask you specifically a question.  And I will put it in writing so you can respond in writing, but maybe you can take a jab at it with the time that you have got:

First, whether the Joint Committee revenue estimating methodology would assume one or more of the following:  First, that U.S. multinational would increase the amount of their U.S. domestic investing by investing capital inside the U.S. that, under current law, would have been invested outside the U.S.

Second, that the amount of foreign investment inside the U.S. would increase above what is expected under current law.

Third, that less earnings stripping would occur with respect to foreign investment in the U.S. than occurs under current law.

And fourth, would U.S. companies engage in less income shifting than occurs under current law?

Mr. Barthold.  Well, I think I can take at least a short answer on that and I will be happy to give you more detailed response in writing.

You asked really about both sides of U.S. domestic investment in response to a corporate rate.  First of all, we think, off course, it depends on what other tax policy changes are made. But if we are just saying lower corporate rate, that gives incentives for corporations to expand their business activities in the United States.  So, yes, part of our modeling would show ‑‑ particularly if we are talking about macroeconomic effects ‑‑ we would show that U.S. investment by U.S.‑based multinationals should increase.

Similarly, it does make any investment by anyone in the United States more attractive.  So we should expect also that the incentives would be for foreign‑based multinational corporations also to expand their business activities in the United States.

You asked about two aspects of income shifting for inbound investment by foreign persons.  There is some evidence ‑‑ it is mixed ‑‑ of what is called earnings stripping.  That is because of the ability to deduct at a relatively high statutory tax rate against the U.S. base and report that income abroad with a lower statutory tax rate.  Again, the incentive would be for less earnings stripping.

On the flip side, for outbound investment or activities to try to locate U.S. multinational income abroad rather than in the United States, the incentive would also be to retain more of that income in the United States.

Chairman Camp.  Thank you.  Mr. Becerra is recognized.

Mr. Becerra.  Thank you, Mr. Chairman.  Thank you, gentlemen, for your testimony.

Mr. Barthold, from what I can gather, trying to work through all the economic‑speak, this is like trying to ride a bucking bronco when you are trying to come up with a good score.  In the modeling that is done and that has been traditionally done, have you all developed a sense of the variables that you can include in this equation to give you your score that you have the most confidence in helping you come out with a result that reflects reality?

Mr. Barthold.  Mr. Becerra, the interesting question that you raise, it is really about the level of uncertainty that there would be to different aspects of our modeling ‑‑ different aspects in proposals that Members might create for us to think about.  As Doug had mentioned before, there are some areas that are well known and well tried and relatively well understood.  There are other areas also where there is lots of good data and the outcomes seem quite clear.  And then there are some where we are really in very much the realm of the brand new and the unknown.

As an example of something that is well known, well understood, good data, one policy that has been changed from time to time by this, committee has been to adjust the value of the standard deduction and the personal exemption.  We feel really, really good about our estimates on that; one, because there are not huge behavioral responses from those sorts of changes.  The numbers are quite clear.  It is a well‑understood area, with lots of good data.

Mr. Becerra.  So have you a higher degree of confidence with some of the variables that you have in this equation than others?

Mr. Barthold.  That is definitely the case.

Mr. Becerra.  I assume as we move forward, the more data you collect, the greater your ability to know if you you feel confident about tweaking a particular variable or adding or subtracting a variable.

Mr. Barthold.  I will just leave it as that is so.

Mr. Becerra.  To the degree that economics is a science and to the degree that your modeling and CBO’s modeling to come up with a score, an assessment, can be characterized as a science, we are essentially making some very good educated guesses about what we think the very fluid and dynamic economy will do if we tweak it here or there, based on a policy change in law.

Mr. Barthold.  To the extent that estimates are guesses, what you say is correct.  Our models are empirically‑based models.  So where there is better data, where there has been more testing of the data, more similar sorts of policy changes in the past, we have better confidence about the estimates that we make for those policies than when we are starting with something brand new and where there is limited data.

Mr. Becerra.  Let’s put aside for a moment this unresolved question of whether tax changes can produce measurable macroeconomic effects.

Mr. Buckley, let me ask you a question.  Is there a constant relationship between GDP growth and jobs?

Mr. Buckley.  You probably are asking the wrong person on the panel.  My guess is there is; that the greater economic growth, the greater job growth, since labor is such a large part of our economy.

Mr. Becerra.  And, Tom, maybe that should have been directed first to you, and then let me go back to Mr. Buckley, because I wanted to ask Mr. Buckley a question.  But to the degree you think there is an answer, is there a constant relationship between GDP growth and jobs?

Mr. Barthold.  There is a positive relationship.  If you mean constant, if I could say for every $50,000 increase in GDP, that that represents half of a job or one job, there is going to be variability because it depends on what sector is growing and what sector is producing the GDP.  But as a general matter, real economic growth means greater job opportunities.  In particular, it means greater income for individuals.

Mr. Becerra.  And different economic growth policies could have different job consequences.

Mr. Barthold.  That is certainly the case.

Mr. Becerra.  So, Mr. Buckley, looking at it from the other end, would a budget score in and of itself tell policymakers about the loss of jobs?

Chairman Camp.  I am afraid time is expired, Mr. Buckley.  If you want to respond in writing, that would be fine.

**Information not provided**

Chairman Camp.  Ms. Jenkins is recognized.

Ms. Jenkins.  Thank you, Mr. Chairman.  Thank you all for being here.

I would like to follow up where Congressman Schock left off on the international front, maybe for each of you to comment, because we all know the U.S. economy is a whole lot more global today and many experts tell us that our Tax Code hasn’t kept pace with the globalization.  And one option would be to move American companies toward a more territorial style tax system.

So, a couple of questions.  If we would make that change, are the models available and capable of accurately estimating the impact of this change on economic growth and investment decisions?  If not, do they need to be updated to estimate the impact on the economy of bringing our international rules more in line with that of the rest of the world?

Mr. Barthold.  Thank you, Ms. Jenkins.  Within our conventional estimates I had noted in my testimony that we use a fixed GNP as opposed to GDP as the baseline assumption, GNP being the measure of income which can be earned by U.S. people either abroad or in the United States.  So within our conventional estimates we model some cross‑border investment  flows of U.S. taxpayers.

Now, what we don’t do in the conventional estimates is then incorporate possible effects from those flows on domestic productivity and ultimately domestic employment and second‑round macroeconomic income growth.  I pointed out in my testimony that our MEG, model actually does incorporate cross‑border flows from foreign and U.S. investors, and that as investment flows, that has effects on productivity, and ultimately increased employment. The MEG model assumes that domestic and foreign investment responds to after‑tax returns.  So in assessing a proposal that might involve territorial concepts ‑‑ more territorial concepts as opposed to worldwide concepts, that would be part of how we analyze that for macroeconomic purposes.

Some things that are not in our modeling, one feature that would be important ultimately, is if the United States does something, what does the rest of the world do?  We do not model what the rest of the world does.  That is a hard one to guess in any event.

And I should note that ‑‑ one of the work projects that I noted is we are trying to upgrade our overlapping generations model, which gives some alternative sensitivity for Members.  We are trying to upgrade that to more explicitly model cross‑border flows.  Right now the cross‑border features are only reflected in net interest rate changes.

Ms. Jenkins.  Okay.  Thank you.

Any thoughts, comments?

Mr. Holtz‑Eakin.  I would defer to Mr. Beach, who actually has a model, and ask how he does it.

Mr. Beach.  Congresswoman, thanks for that question.  I would refer you and the members of the committee to the analysis that we did of the Wyden‑Gregg/Coats bill, where a much lower corporate rate was introduced, down to 25 percent.  We had territoriality.  We had major economic effects coming from the rest of the world.  You can look at that.  I am very impressed.  I was part of the team that helped build the MEG model.  The MEG model has great capabilities for doing these things.  The research program you just heard of was very good.

With respect to how we handle the rest of the world, when our tax rate goes down, as you well know, the rest of the world tries to follow.  And we use Ray Fair’s model out of Yale University, which is available at no cost on the Internet.  It is a very fine model.  And it has a well‑articulated set of 57 countries that interact with whatever policy changes you introduce.

Ms. Jenkins.  Thank you all.  I yield back.

Chairman Camp.  Thank you.  Mr. Paulsen is recognized.

Mr. Paulsen.  Thank you, Mr. Chairman.

Let me just start out, because several of you have commented or made comments regarding how the economic models handle budget deficits and how that debt is a very important factor in determining or understanding the model’s result.  If the committee really wants to get an accurate picture, an accurate understanding of the potential benefits of tax reform, as accurate a picture as possible, how do you recommend that we address this issue overall?

Mr. Barthold.

Mr. Barthold.  I think that is probably more of a question for my colleagues on the panel.  Our modeling does reflect the fact that increased budget deficits can crowd out private capital formation.  But how to address the policy issues are the Members’ call.

Mr. Paulsen.  Mr. Holtz‑Eakin.

Mr. Holtz‑Eakin.  Mechanically, what I would do is isolate the impact of current tax policy versus the reform policy.  And to do that, first go to the spending side and at least in a computer, if not in the real world, fix Social Security, fix Medicare, fix Medicaid.  Do the big transfer programs on the spending side that are the budget problem, so that over the long term the debt to GDP ration is stabilized, not exploding.  Now you have got a stable spending policy, and enact a tax reform and look at the difference between those two scenarios.  That is the benefits of tax reform, isolated.

Mr. Buckley.  I would slightly disagree.  We have increasing debt not just simply because of the spending side.  We have one of the lowest tax burdens of any developed country in the world.  Our taxes now are approximately 15 percent of GDP ‑‑ our Federal taxes ‑‑ which are really very low, historically.  It is hard to run a government with a large defense budget and other needs like with a revenue base that low. Sustained deficits do affect, I believe, long‑term economic growth.  And they have to be handled.  I do think you can’t get there only on the spending side.  You have to adjust revenues as well.

Mr. Beach.  The first thing I would do is avail yourself of the good work that the CBO and Congressional Research Service is saying in illustrating how crowding out works.  Crowding out is kind of a ham‑fisted approach to understanding the deficit, because ultimately it is the composition of the deficit and the drivers that you need to understand best.  Many of you probably sit on the subcommittee dealing with health care, and of course health care is driving so much of this deficit.  So ask for analysis that decomposes the drivers of the deficit.  And then as we reform those drivers, you will see that that has a positive effect on the economy through prices and through competition and through the better allocation of resources, particularly capital resources.

And in our modeling ‑‑ and I would be happy to share this with you ‑‑ we have done that kind of work, got in, looked at the compositional things, reformed those; and then from the spending side, absent a tax change, we see greater efficiencies in the economy just because resources are better used.

Mr. Paulsen.  I think one thing that is very interesting is I talked to several corporations ‑‑ and this has not been in testimony here ‑‑ but how do you use your own projections for your own company and allocation of capital?  And a good number of them use dynamic scoring or macroeconomic policy as well themselves as they look moving forward.

Let me just ask this, Mr. Beach.  I will just start with you.  When choosing between different tax reform options ‑‑ we kind of laid into this a little bit ‑‑ which types of policies are going to be the most effective or the most likely to produce the dynamic long‑term growth that everyone is sort of looking for or hungering for or wanting right now?  Are they the policies that kind of give the one‑term benefit for a jump start, or is it more the policies that provide the long‑term sustainable low tax rates, rates for taxpayers for a long time?

Mr. Beach.  Well, as fiduciaries of the revenues of the fiscal situation of the United States, you are going to want to look at the long term.  And that also is the right answer for the economy as well.  So keeping tax rates low, low relative to other countries, making sure that you are raising enough revenue for your needed services or government, that is the basic thing, make sure there are as little as possible expenditures, subsidies, going through the Tax Code.  That is better done on the spending side.  And then that just releases the private sector to lead the economy to higher levels of growth.

Mr. Paulsen.  Thank you, Mr. Chair, I yield back.

Chairman Camp.  Thank you.  Mr. Stark is recognized,.

Mr. Stark.  Thank you, Mr. Chairman.  Thank you for your  patience.

We will hear from our colleagues across the aisle that cutting taxes and cutting spending and shrinking the role of government leads to growth.  I guess that leads to the conclusion that our economy would be better off if we eliminated all regulation, and the safety nets, and the military, and sort of end up looking like Somalia.

But assuming that we won’t go that far, I wonder, Mr. Buckley, if you could tell me ‑‑ and I am somewhat confused by this issue of dynamic analysis and static analysis.  If the Republicans were successful in following their plan to eliminate Social Security and eliminate Medicare, what would be the difference if you scored that dynamically or statically?

Mr. Buckley.  Well, if you eliminated those programs, you would see large nominal reductions in spending.

Mr. Stark.  Nominal.

Mr. Buckley.  Nominal.  I would guess that dislocations would be so severe that you would see real economic effects that would be negative.  Medicare is a large part of the health care sector in the economy.  Social Security is the primary income support for the elderly.  Eliminating those two things, which I am fairly confident nobody is talking about ‑‑

Mr. Stark.  Oh, yes, they are.

Mr. Buckley.  Well, let me put it this way, I would hope no one is talking about it, because it would have very serious consequences, put the economy in the safety net back to pre‑ Depression times where things were not as good as they are today.

Mr. Stark.  Wouldn’t make a difference if you scored that dynamically or statically, we would still be in deep trouble?

Mr. Buckley. This is where I don’t think the models are very good ‑‑ they would probably treat that as positive because it removes these government distortions from the economy.  It would create really serious economic consequences.  I mean, homelessness and hunger are pretty stark economic incentives. I am not so certain if you follow some of these models you wouldn’t get a projection of a positive impact here.  And that is why I think so many of these models are just at their base wrong, and they have not proved to be very accurate.

Mr. Stark.  Thank you very much.  I yield back, Mr. Chairman.

Chairman Camp.  All right.  Mr. Marchant is recognized,.

Mr. Marchant.  Thank you, Mr. Chairman.

So far we have heard from you how macroeconomic models have seen some limited use by the Joint Committee on Taxation and CBO.  I am interested in hearing from you about the extent to which other Federal Government agencies, or even other governments such as the States, have used dynamic models to evaluate policy options.

Mr. Holtz‑Eakin and Mr. Beach, how have they overcome some of the concerns that we have heard about today about dynamic scoring?

Mr. Holtz‑Eakin.  Well, I know from personal experience that the U.S. Treasury and the White House Council of Economic Advisors have at times used these kinds of modeling efforts to understand the impacts of policies and ultimately the budgetary impacts.  Some of those are in the public domain and you could look at them.

When I was at Syracuse University, I was on the Tax Study Commission for the State of New York, and I was on the Ways and Means Advisory Board for revenue forecasting purposes.  And we regularly used models of this sort which at the State level included a fairly serious scrub of cross‑State influences; could New York State influence what was then largely the outbound exodus of businesses, slow it down?  And also these tough issues on capital gains and bonuses, because an enormous part of the New York State revenue was driven by the taxation of Wall Street incomes.

So I think there is a wealth of experience.  I couldn’t pretend to summarize all the other States, but this is not new territory.  There are places that have undertaken to do this both for purposes of accuracy and because their revenue streams sort of demand that they understand it better.

Mr. Marchant.  Mr. Beach.

Mr. Beach.  Yes, it is the case that macroeconomic models play a prominent role in many of the Federal agencies as matter of their routine work.  For example, the Energy Department, through the Energy Information Agency, on a quarterly basis runs the global insight macroeconomic model, which is the big one, that is the one Heritage uses and the one most of the Fortune 500 companies use to develop their quarterly forecast of energy use in this country, and also it is important for the budgeting of the Energy Department and  a lot of the programs that you run through the Tax Code.  The Treasury does that.  Doug has mentioned it.

I also mention the CBO, under Doug Hotlz‑Eakin, has vastly increased the number of models which were used.  They use eight, nine models right now, and that is wonderful.

The Agriculture Department is famous for its use of macro modeling and has been using those models now for almost 30 years to look at ag programs at the local level.

I wrote an article not too long ago in which I called every State in the country to find out what their modeling practices were, and found 11 States ‑‑ the big ones, California, New York, and others ‑‑ using macroeconomic models to advise the legislature on spending programs and on tax policy changes.  And in the case of about half of those States required when doing the revenue estimate ‑‑ I was chief economist for the Sprint Corporation, and I would like to echo, just to say we used macroeconomic models all the time to look at the various ways in which public policy would affect our company.  And we were a large enough company that sometimes we would actually affect the outcomes for certain parts of the economy.

So it is in widespread use.  I tell you, I will say this in just a second or two, I have been working, giving dynamic modeling up here at the Federal level for a long time, and you folks are moving way closer to the goal than you may even sense.  Since it is now in such widespread use, we need to get the Joint Committee actively engaged in it to the extent that these other agencies are as well.

Mr. Marchant.  I have one more question to Mr. Barthold.  Are there studies that the Joint Committee on Taxation have on hand that show what effect a consumption tax versus an income tax would have on the gross domestic product?

Mr. Barthold.  In the mid‑1990s we started doing some macroeconomic analysis and studying how to incorporate our detailed conventional modeling, the results of that that I described, into larger macroeconomics models.  The first part of that was to look at broad tax reform of replacing income taxes with consumption taxes.

So one place to look is on our Web site.  There are the results of the symposium that we held with a number of outside modelers who looked precisely as replacing income tax with a consumption tax.  But more generally, there are a large number of academics who have published work on that subject.

Chairman Camp.  Mr. Berg is recognized.

Mr. Berg.  Thank you, Mr. Chairman.  I really enjoy this hearing.  And in North Dakota, we have dynamic analysis but we call it something different in our tax policy; we call it common sense.  We have lowered our income tax, our corporate income tax and property tax this last year.  Some of those, it is the third time we have lowered them in the last 10 years.  We have seen the exact reality of that.  We have a little over 3 percent unemployment rate, we have a substantial amount of our State’s budget in cash, we are short on workers, we have a lot of jobs that are unfilled.

When I was back home on Sunday, there were eight pages in our local newspaper of employers looking for employees.  So again, I just think when we talk about the dynamic analysis, the more information that we can have, I mean just the better decisions it will make.

So as I was sitting here I was thinking, looking back ‑‑ maybe this was for the Joint Tax, Mr. Barthold ‑‑ were there some periods in the last 20 years that we just looked at tax policy totally statically, and even though we knew it would have different effects we didn’t put that into the scoring.  Is there a thing we can look at, again in the past, that says if we used dynamic modeling we would have been much more accurate than we were?  Any examples that stand out?

Mr. Barthold.  Let me try and answer that in a slightly different direction, Mr. Berg.  I hope this is responsive.  We reevaluate estimates in our models all the time in the course of upgrading to try to improve the information that we provide to the Members.  And so as the models incorporate empirically‑based outcomes from the 1990s, we use that as information for how we analyze things now ‑‑ recognizing that the 1990s were a different time from now.  But in terms of looking at a behavioral response by taxpayers, looking at shifting of investments across sectors and responsiveness by businesses, that is important data for us.

If you are asking are there important big estimates that we got wrong, I am sure there are.  But I would like to think about them and maybe respond at another time.  I don’t want to admit to any, offhand in a public hearing, if that is fair.

Mr. Berg.  That is very fair.  In fact, we may follow up on that in writing.

Mr. Barthold.  I would be happy to, Mr. Berg.

Mr. Holtz‑Eakin.  Briefly, I think there are some lessons, and I want to first of all emphasize there has never been static analysis, not at the Joint Committee, not at the CBO.  The question is whether you take macrogrowth effects into account or not.  There are all sorts of behavioral responses that are modeled.

In 2003 when I was at CBO, we did an analysis of the President’s budget proposals, a comprehensive macroeconomic impact, and that included the 2003 tax cuts, the JGTRRA that came up earlier, and it also included the Medicare Modernization Act, $400 billion of subsidized consumption.  And when we did the analysis, what we saw was overall modest impacts of both those things.

My conclusion was that if you undertake a radical policy of subsidized consumption, it offsets the beneficial growth effects of tax policy, and that is the lesson.  Everyone else’s conclusion was I did the analysis wrong.

The point of this is that we would have been wrong if we just looked at the tax cuts in isolation, because other policy negated the impact.  That happens a lot with the Joint Committee.  There is a lot going on out there.  It is not just macroeconomic uncertainty in other countries.  There are also other policies that go on that impact ultimately receipts.  And getting it wrong isn’t really the metric of whether the analysis was done right.  There is a lot going on that makes these estimates uncertain.

Mr. Berg.  Thank you.  As long as you are all here, one last question I had is on the capital gains tax.  It seems like that is getting a lot of press today at 15 percent.  Just quickly:  Will increasing that capital gains tax ‑‑ again it is on capital that already in my opinion has been taxed once ‑‑ is there any model that would show that that would encourage growth if that number goes up?

Mr. Barthold.  Well, Mr. Berg, I think we touched upon this a little bit before.  As you know under the baseline, the maximum rate on capital gains will increase to 20 percent after 2012.  That is already accounted for in terms of baseline receipts.

Your question about growth is what is the overall effect of taxing the return to saving and of the increased rate on capital gains and changes in tax rate on dividends, other ‑‑ the ordinary tax rates on interest income all go into our modeling when we do macroanalysis of what would be the effect on the macroeconomy.

Mr. Berg.  I yield back, Mr. Chairman.

Chairman Camp.  Mr. Pascrell is recognized.

Mr. Pascrell.  Thank you, Mr. Chairman, and to our distinguished panelists.  I am very, very hesitant to listen to people who were part of waltzing us through the last 10 years or economic issues.  Mort Kondracke, certainly no liberal by any extent, said in discussing the tax cuts in February 2003, after the tax cut in 2001, that this is a wild ride Mr. Bush has set in motion.  When it is over, we will know a lot, a lot about economics.  We will either be a lot richer as a country, or in disastrous shape.  The credit or blame will belong to the President.  Now that is what he said in 2003.

Followed by what Mr. Tom DeLay said:  The jobs and growth package will not only grow the national economy ‑‑ whatever models we are talking about, Mr. Chairman ‑‑ but through that growth, it will help us support and fund the war on terror and other priorities for years to come.  The American people understand the relationship between the war on terror and economic recovery, et cetera, et cetera.  And here we are.

Now in the last 18 months, we have seen the addition of about 2.2, 2.4 million private jobs that have been added to the economy.  Yet we go back over the 8 years, and this is not pointing blame, because both parties ‑‑ neither party is privy to virtue on the subject of where we are economically.  So please know where I am coming from.

It seems to me we need a more eclectic view when we talk about models, that no one model suits this, particularly because of what you said, Mr. Eakin, there are other factors involved.  You cannot just cut taxes and think jobs are going to be created.  That certainly did not happen in the 2001 and 2003 tax cut, until 2005 when we had a little bit more private sector jobs.  There are a lot of factors involved.

So people who say all we need to do is cut taxes or all you need to do is cut social programs and we will have Nirvana, that is certainly no model that we could adhere to at this particular point.  I don’t think anybody on the panel would support that.

So these are a lot more complex than we think, and you folks have been pointing that out very nicely.

I have a question for you, Mr. Eakin, and then I would like to turn to Mr. Buckley on the same question.  In your opinion, how does a statutory rate influence ‑‑ because we have been talking a lot about this ‑‑ influence a company’s decision to create jobs versus an effective tax rate?

Mr. Holtz‑Eakin.  Well, certainly companies are going to operate on effective marginal tax rates at the margin.  They are going to look at the overall consequences of the Tax Code for their net gain from adding a worker.  That is the key.  Statutory will be embedded in there, but it might not summarize it entirely.

Mr. Pascrell.  Will they think of other things besides the tax rate that would go into their decision in determining how they would grow, how they would hire people, how they would not hire people?

Mr. Holtz‑Eakin.  Certainly.  As this committee is well aware, the Tax Code is an exceedingly complex animal with statutory rates, all sorts of deviations from the base ‑‑

Mr. Pascrell.  Mr. Beach.

Mr. Holtz‑Eakin.  Deductions, depreciation the whole thing.

Mr. Pascrell.  Thank you.  Mr. Beach.

Mr. Beach.  Yes.  The marginal tax rate is one of a spectrum of issues which go into determining the hurdle rate.  Every chief financial officer has a hurdle rate in place in their mind, the committee does as well, for making an investment.  So you have a lot of things that go into that.

I will point out that the marginal tax rate, the effective marginal tax rate is one of the major ones because it varies, it goes up and down and it is very large.  So doing that is important.

Mr. Pascrell.  Mr. Buckley?

Mr. Buckley.  I believe it is the effective corporate tax rate that is important.  Our statutory rates are relatively high compared to other countries.  Our effective tax rates are not, because we provide more generous depreciation benefits.

Mr. Pascrell.  It has to be part of the discussion.

Mr. Buckley.  That is correct.  That is one of the real questions on tax reform.  If you do eliminate accelerated depreciation, you do kind of shift the tax burden onto those sectors that rely on that for their major incentive.

Mr. Pascrell.  That is absolutely true.

Chairman Camp.  Mr. Reed is recognized.

Mr. Pascrell.  Is that it?

Chairman Camp.  Time is expired, yes.  Mr. Reed.

Mr. Reed.  Thank you, Mr. Chairman.  I enjoyed the testimony today, it is very enlightening trying to get an understanding, not being familiar with the world that you live in in macroeconomic forecasting.

From a historical point of view in judging it from forecast and then as a result of actual numbers that were produced, is there any one model that stands out as one that has been very ‑‑ more accurate than other ones?  If anyone would care to ‑‑ you have got a slew of them here in your testimony as different models.  Is there one that stands out amongst you as scholars in this area?

Mr. Beach.  Let me take a quick stab at that, because the field of models that are commercially provided is a good field to look at.  After all, the Fortune 500 companies are kind of picky, they want to make sure the models they pick are the ones that are the most accurate and have been over the course of time.

And without doing an advertisement for my company, I very much like the global insight model.  It is a combination of all of the old models put back together into one.  It is the one that is sitting out there in almost everybody’s portfolio of models.  Ad then I must say, then you must go on to develop the models that are best suited for your companies, a standard off‑the‑shelf one.  That is why the MEG model was such a breakthrough for the Joint Committee on Taxation because it is a great model.  John Diamond’s overlapping generations model that you heard about today ‑‑ you haven’t heard John’s name, but it is in widespread use throughout this town.  It is getting a lot of attention and a lot of auditing.  That is another one that is rising to the the top as one of the best models.  It isn’t rocket science to pick these models.  There are only a few out there that are any good.

Mr. Reed.  Okay.  Mr. Barthold, anything you want to add on that from your opinion?

Mr. Barthold.  I just wanted to make one point. The Joint Committee staff does not make macroeconomic forecasts per se.  We do modeling to provide information to the Members about possible outcomes from the policies that they are exploring.  I wouldn’t really be in a good position to endorse private sector enterprises.

Mr. Beach.  One other thing, Mr. Reed, I forgot to the mention this.  The macroeconomic advisor’s model out of Saint Louis is also an extraordinarily good model, and it was that model that was the basis for the MEG model.  So you already have a well‑respected commercial model.  It is not identical to MEG by any means, but it is kind of the architecture.

Mr. Reed.  A good source, okay.

And then other countries that are dealing with these issues and trying to forecast out their tax policy implications, is there any one country we could look to in our office as kind of a benchmark to identify and maybe learn something from what they do differently from what we do?

Mr. Beach.

Mr. Beach.  Good science being done by the OECD more and more.  You can go down the block to the World Bank and they are making significant advances in here.  A lot of countries have very poor practices actually with respect to modeling.  And so there aren’t a lot that you can look to.  The Germans have done a decent job, but I would look rather to the international organizations and to practices of the States that we have mentioned here today.

Mr. Reed.  That we talked about earlier.

Thank you, Mr. Chairman, I don’t have anything further.

Chairman Camp.  Thank you.  Dr. Boustany is recognized.

Mr. Boustany.  Thank you, Mr. Chairman.  I would like to explore the limitations of models using a specific example.  Over the past 3 years and now in the President’s current proposal, he has repeal of certain expensing measures for oil and gas companies that would hit predominantly independent companies, smaller companies, not the integrated, large ExxonMobils or Chevrons or those types of companies.

The most prominent of these is the repeal of the intangible drilling costs.  And again, these are measures in a capital‑intensive endeavor where you can expense where the return ‑‑ if you get a return, it is on the back end.  And in talking to a lot of companies they are telling me that if these things are repealed, we will end up seeing a lot less of this type of activity by these companies.  Consistently, the scoring of these measures as a package yields about 45 billion in revenue.

I want to question that figure based on the modeling, and here is why.  If you reduce independent companies’ production of oil and gas, you are going to ‑‑ it seems to me you are actually going to lead to a decrease ‑‑ well, certainly a decrease in activity and decrease in revenue emanating from it.

And so I guess my question is:  How did that $45 billion come into ‑‑ how was it derived?  Were certain behavioral considerations taken into effect based on interviews or discussion from what would really happen here?  And was there  a consideration that we now have a delinkage between the price of oil and the price of natural gas in this country ‑‑ well globally, for that matter, but predominantly in this country because it is more pronounced here than it is globally?

Given the natural gas production, 97 percent of it is done domestically.  It is done by small, independent companies.  I have heard anecdotal information that suggested a company that might drill 15 wells perhaps would only drill two, or one, if the expensing provisions were repealed.  So I want to explore some of these aspects and how they fit into the limitations that these models predict.

Mr. Barthold, if you would start.

Mr. Barthold.  Thank you, Mr. Boustany.  The question that rises is obviously an important one to that particular sector of the economy.  The oil and gas industry is a big component of the economy, and that is the main factor behind the scale of the estimate that we produced.

But as I noted in my testimony we assume  ‑‑ we take into account ‑‑ I shouldn’t say we assume ‑‑ we take into account that if we change the tax treatment of one sector, that there will be less economic activity in that sector.  Now that economic activity, though, isn’t necessarily lost to the economy as a whole.

Now, unfortunately, I assume there are some of your constituents that you have talked to, the independent drillers of gas, they would go out and seek their funding from Doug Holtz‑Eakin or John Buckley.  And a Doug and a John would look and say, “Gee, because of this tax change, the returns don’t look so good; I don’t want to finance your gas venture.”  They may turn to the film industry or they may turn to the micro‑processor industry and invest their funds there.

So the investment isn’t necessarily a loss to the economy.  And our conventional modeling always tries to account for some shifting across sectors.  So the model, yes, does recognize there will be less investment in oil and gas.  We have done work to recognize the point that you made that oil and gas are different.  They are different in international trade, and that can be an important factor in terms of displacement of domestic activity, and for foreign activity, the ability or inability to transport gas across the ocean.  It is growing, but it is much more limited than the oil industry.  All those factors we do try and take into account, sir.

Mr. Boustany.  Thank you.  Mr. Holtz‑Eakin would you like to comment, or Mr. Beach?

Mr. Beach.  I would add one thing, and that is even though it is true that investment dollars may flow to another sector and thus benefit that sector, there are sectors of the economy, once you degrade the capital structure, that are very difficult to rebuild.  The transmission system, the production system, and the refining system associated with natural gas and petroleum must be continuously revitalized in order to keep them at their highest level of productivity and return.

So changes in tax policy that you make for an industry must be taken with great care to think about the long‑term consequences of that act.  For example, in a model of the economy, we would have to treat it that way.

Mr. Boustany.  Thank you.

Chairman Camp.  Ms. Black is recognized.

Mrs. Black.  Thank you, Mr. Chairman, and thank you, panel, for being here today with this really complicated issue.

I want to return to the issue of the corporate taxes and ask if there are any models out there that assume the burden of the corporate tax where they assume in the economy?  Did they assume it on the company, the shareholder, or the consumer?  And does this impact the model’s results?  Each one of you address that, please.

Mr. Barthold.  Ms. Black, that is another important question.  The most basic answer is we always assume that taxes are borne by individuals.  The question you are asking is what is the incidence of the corporate tax or, more generally, what is the incidence of all the taxes that we have on capital?  In the case of the corporate tax, is it borne by domestic shareholders, is it borne by domestic labor or a combination of the two?

Economics literature is divided on this.  There has been change through time.  The ability of capital to flow across borders leads a number of people to conclude that there can be substantial shifting onto labor.  There is not uniform consensus on that. The corporate tax affects the after‑tax rate of return ultimately to investors.  That is a factor that goes into our modeling, and our modeling is ultimately about individuals.

Mrs. Black.  Others want to address that?

Mr. Holtz‑Eakin.  I simply want to concur with what Mr. Barthold just said.  This is how the economics professional handles this.  There has been evolution over time in their perception of who ultimately bears the burden of this tax, with it shifting more and more toward labor as opposed to owners of domestic capital.

Mr. Buckley.  I would say there is a sharp distinction between the corporate executives and economic models as to who bears the incidence of the tax.  The executives believe, that they and their shareholder bear the burden.  So there is a difference of opinion here between the more technical economic analysis where it may be assumed to be borne by different factors, and what I have seen, just from the basic reaction of the corporate executives, where they are quite confident it is borne by their shareholders.

Mrs. Black.  Mr. Holtz‑Eakin.

Mr. Holtz‑Eakin.  I think there is unanimity that corporations respond to the corporate tax.  I mean, they will rearrange their financial policies and they will alter their capital investment decisions.  They will change the location of expansions.  All of that is part of the transmission mechanism by which the tax gets shifted somewhere in the economy.  And if they turn out to be less productive and less able to pay high wages, labor ends up bearing that burden.  That is the mechanism.

Mr. Beach.  Well, the corporate tax is borne by labor.  That is the way we handle it in our model.  That is the bearing of the tax.  It goes to an individual.  The effect of the tax, of course, is widespread.  So depending upon the corporate strategies that are changed by the change in your tax policy here, you can see wages, standard of living for a lot of people who are affected in the private sector, the revenues of State and local governments.  So it permeates throughout the whole economy.  There are the effects and then there is the economically, theoretically‑driven notion of bearing.

So for your deliberations I would always think about the taxes borne by labor and the taxes borne by capital, and then think about the corporate tax and which of those does it really affect most?  In our view, it mostly affects the amount and the compensation of labor.

Mrs. Black.  Well it seems ultimately it will be borne by individuals as they purchase the product or the service, but that is not really considered in the model.  So in the model, is it?

Mr. Beach.  Yes, it is.  It is like the discussion we had about eliminating Social Security.  If we reduce the Social Security in the models that I use, there would be a definite effect in the reduction in transfers to individuals.  And so consumption expenditures would fall, and you would see a change in relative prices, and we would all have an effect.  So nothing happens in isolation inside these models at all.

Mrs. Black.  Thank you.  I yield back.

Chairman Camp.  Well, thank you.  And I want to thank our witnesses for their testimony and time today.  And with that, this hearing is adjourned.

[Whereupon, at 12:36 p.m., the committee was adjourned.]


Joint Committee on Taxation


The Honorable Sam Johnson


Center for Fiscal Equity
Grover L. Porter
National Small Business Association