Washington Wire: Macroeconomic Scoring of Tax Reform Proposals Could Improve Outlook for Investable Tax Credits

Published by Michael Novogradac on Tuesday, October 1, 2013
Journal thumb October 2013

As this column has noted several times, in the tax reform plans currently being created by House Ways and Means Committee Chair Dave Camp, R-Mich., and Senate Finance Chair Max Baucus, D-Mont., the overall net revenue effects of tax reform are a key point of contention.

Currently House Republicans are seeking revenue neutral tax reform, whereas the budget adopted by the Senate calls for $975 billion in new revenue and the budget that President Barack Obama submitted to Congress proposes $580 billion in new revenue. This is a gap that many say cannot be closed. As such, how the revenue effects are calculated, often referred to as scoring, is of great consequence.

Tax reform proposals will be scored on a “conventional” basis, and the above enumerated net revenue targets are based on this “conventional” scoring. However, under House Rule XIII(3)(h)(2), the Joint Committee on Taxation (JCT) will also provide a macroeconomic impact analysis to consider the broader macroeconomic revenue effects of various tax proposals, under various modeling assumptions. These additional revenue scores could have significant implications on the tax reform debate, and more specifically, on how certain tax credit provisions fare during the reform process.

About Scoring
The Congressional Budget Act of 1974, as amended, stipulates that revenue estimates provided by the JCT staff will be the official estimates for all tax legislation considered by Congress. The JCT web site says the objective of the estimating process is to produce accurate, consistent, fair, and impartial estimates that can be relied upon by Congress in making legislative decisions.

According to JCX 46-11, “Summary Of Economic Models And Estimating Practices Of The Staff Of The Joint Committee On Taxation,” the JCT staff is required by House Rule XIII(3)(h)(2) to provide a macroeconomic impact analysis of all tax legislation reported by the Ways and Means Committee. For many tax bills, the expected macroeconomic effects are so small that a brief statement is all that is required. But some legislation requires more detailed analysis, and obviously comprehensive tax reform fits this bill.

The reference point for revenue estimates prepared by JCT staff is the Congressional Budget Office (CBO) 10-year projection of federal receipts, referred to as the “revenue baseline.” The revenue baseline serves as the benchmark for measuring the effects of proposed tax law changes. The baseline assumes that present law remains unchanged during the 10-year budget period.

The JCT uses confidential tax return information to prepare revenue estimates. The Internal Revenue Service (IRS) Statistics of Income (SOI) division provides data that provides the primary building block for revenue estimates. JCT says that in the process of estimating a proposal, other information sources are also used frequently such as other government data, survey data, constituent data and third-party data.

In providing conventional estimates, the JTC follows long-standing scorekeeping conventions, observed also by CBO and the Treasury Department’s Office of Tax Analysis, that a proposal will not change total income. JCT staff therefore holds gross national product (GNP) fixed. Within this modeling framework, the JCT accounts for possible shifts in economic activity across sectors or markets and/or changes in the timing of such activity in response to the proposed tax change, so long as GNP remains unaffected.

Although conventional revenue estimates are sometimes referred to as “static,” for more than 25 years, the JCT revenue estimates have taken into account taxpayers’ likely behavioral responses to proposed changes in tax law. Behavioral effects can be broadly characterized as shifts in the timing of transactions and income recognition, shifts between business sectors and entity form, shifts in portfolio holdings, shifts in consumption, and tax planning and avoidance strategies.

About Macroeconomic Scoring
Broadly speaking, macroeconomic scoring predicts the impact of fiscal policy changes by forecasting the effects of reactions to those changes. Supporters of the method believe it yields a more accurate prediction of a policy’s impact by using all available information. Macroeconomic scoring proponents also argue that conventional estimates often overstate the amount of tax revenue that would be generated by tax increases as well the amount of revenue that would be lost to proposed tax rate reductions. However, macroeconomic scoring can be difficult to apply in practice because of its complexity.

As noted by in a discussion of the methodology used to produce revenue estimates, “The JCT Revenue Estimating Process,” published by the committee on Jan. 30, 2013, the JCT notes, “Forecasted macroeconomic impacts are very sensitive to assumptions about taxpayer responsiveness, fiscal and monetary policy, and general modeling frameworks – all sources of substantial uncertainty.”

That said, according to a report released on Aug. 26 by the Tax Foundation, using macroeconomic scoring could make tax reform “30 percent less challenging.” By this, the Foundation means that its macroeconomic analysis found that the cost of tax reform could be nearly 30 percent less than the conventional estimate, after accounting for the economic and fiscal benefits that accrue from reducing the cost of labor and capital. The foundation reached this conclusion using a model that is driven by changes in the cost of labor and the cost of capital. The model estimates the effect of tax changes on GDP, the cost of capital, wages and federal tax revenues. This macroeconomic analysis shows that cutting individual tax rates is 21 percent less costly than the conventional JCT estimate and lowering corporate tax rates would be 59 percent less costly. Combined, the Tax Foundation found these tax cuts would be 30 percent less expensive than the conventional estimates suggest.

What This Means for Investable Tax Credits
While there is disagreement about the specifics and degree, most economists agree there are macroeconomic effects from the low-income housing tax credit (LIHTC), new markets tax credit (NMTC), historic tax credit (HTC) and renewable energy tax credit (RETC) programs. For example, the LIHTC supports about 100,000 multi-family rental units a year, which generally accounts for a quarter to a third of all annual multi-family construction.

For the LIHTC and NMTC, the revenue costs are spread over a number of years and the macroeconomic benefits are greatest in the early years of the projects subsidized. As such, under macroeconomic scoring, these two tax credits might be considered revenue positive, or at least revenue-neutral, over a 10-year scoring period.

When discussing the use of macroeconomic analysis, issues arise regarding how to accurately measure overall macroeconomic impact. For instance, it’s important to consider to what extent the impact of incentivized activity in a given community from a particular investment is fully offset by a reduction in activity in another area. This offset or exchange is often referred to as a “crowding out” effect. Additional research is needed on the macroeconomic effects of investable tax credit programs, to best make the case for the positive macroeconomic impacts they generate.

For the HTC, the revenue cost comes when a property is placed in service, but the leverage is quite large, such that projected revenue loss should be substantially less and possibly positive. For RETCs, the production tax credit has a macroeconomic scoring impact more like the LIHTC and NMTC, and the investment tax credit is more similar to the HTC.

What This Could Mean in the Context of Tax Reform
If, during tax reform, a tax expenditure can be considered revenue-neutral, or even revenue-positive, that expenditure has a greater chance of survival. And when added to the tangible benefits provided by the affordable housing created, communities revitalized, historic neighborhoods preserved and clean energy generated, that revenue-neutral or revenue-positive score is even more impressive.