Treasury Confirms Tax Reform Revenue Neutral

Budget impacts of pro-growth tax reform remain a significant issue, and reasonably so given the large projected deficits the Obama administration left behind. On Monday, the Treasury Department’s Office of Tax Policy released its analysis confirming what we and others have argued – that in the real world the tax reform about to be finalized in Congress may not improve the budget picture, but it does not make matters worse. It will, however, significantly raise economic growth for years to come.

Much has been made of the legislation’s sticker price, namely its $1.5 trillion “static” score as permitted under reconciliation instructions and scored by the Joint Committee on Taxation (JCT). Tax reform’s opponents, their concerns for budget deficits having awoken from an 8-year slumber, have harped incessantly about our inability to afford such a deficit increase.

Treasury shed some very useful light into this carefully crafted gloom. For example, Treasury observes that even before one considers the additional growth and revenue feedback from tax reform, the bill’s JCT static cost overstates the true revenue effect by about one-third, though the fault lies not with JCT but elsewhere. How does this overstatement arise? Through the still-uncorrected artifice of analyzing tax changes using a distorted lens.

In general, when a spending program is slated to expire the Congressional Budget Office (CBO) assumes in its spending baseline that Congress, having once created the program, is unlikely to let it die. Consequently, extending the program without change is not reported as increasing spending, and so there is no suggestion the renewed program raises the deficit or otherwise needs to be “paid for.” It’s a reasonable assumption and results in a “current policy” baseline.

In contrast, CBO assumes the opposite for tax provisions: When a tax provision is slated to expire, CBO assumes Congress, having created the program, will now let the program expire. This results in a “current law” baseline. This nonsense produces the fairly bizarre situation whereby to be revenue neutral, if Congress seeks to prevent a tax hike by extending an existing tax provision, then Congress must enact a different tax hike. Hiking taxes to prevent tax hikes may sound crazy, but that’s what comes of a current law baseline.

A good case exists for using a current policy baseline for budgeting, but no argument justifies using different baseline concepts for spending and taxes. As Treasury reminds us, moving to a current policy tax baseline eliminates about $500 billion of tax reform’s advertised (current law) sticker price. The drop in the sticker price isn’t a budget gimmick, but rather is what happens when one eliminates a budget gimmick.

Treasury then examined the additional economic growth from the Senate’s version of tax reform and concluded GDP will be about 3.5% higher after ten years. (Treasury also advised growth under the House bill would not be “materially different” from that under the Senate bill.) Treasury then estimates the revenue feedback from this higher GDP at about $1 trillion.

Jettisoning CBO’s distorted “current law” baseline and incorporating the growth effects from tax reform – both fairly obvious steps if one wanted to assess tax reform’s budgetary impact honestly – leaves tax reform revenue neutral. While tax reform’s opponents will do everything they can to twist the story, the Treasury analysis falls well within the norm of other credible analysis. The tax reform working through Congress really is essentially deficit neutral, a rare feat for any significant legislation.

About the authors

J.D. Foster

Dr. J.D. Foster is the former senior vice president, Economic Policy Division, and former chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.