New Unit Will Explore Effect of Tax Cuts

The Treasury Department is setting up a new division to analyze the economic impact of proposed tax changes -- a move that critics fear is intended to boost dubious arguments in favor of tax cuts.

It’s not the return of the “Laffer curve,” the economic tool of a generation ago that held that under certain conditions, the government would gain tax revenue if it cut tax rates. But in its political pronouncements, that is just the message the Bush administration is delivering.

“Since we cut taxes on income, tax revenues from income has jumped by 17%,” President Bush told the Economic Club of Chicago last month.

“The evidence is in,” Vice President Dick Cheney told the Conservative Political Action Conference last week. “It’s time for everyone to admit that sensible tax cuts increase economic growth and add to the federal treasury.”

The announcement of Treasury’s new division of dynamic analysis -- included in the administration’s proposed budget for fiscal year 2007 -- comes as the White House is pushing Congress to make its expiring tax cuts permanent.

In announcing the new division, the department emphasized that it would analyze the economic impact of tax cuts, but would not go to the next step and estimate the resulting effects on revenue -- a process known as “dynamic scoring.”

For the moment, it will stick with “static scoring,” which estimates the revenue effects of tax proposals without factoring in their economic impact.

However, the department’s announcement continued, “It is envisioned that dynamic analysis eventually might evolve into dynamic scoring as ... the approach becomes more widely accepted.”

Few economists would go so far as to argue that reducing tax rates increases tax revenue.

William W. Beach, director of the Heritage Foundation’s Center for Data Analysis, said that for every dollar returned to the public in tax cuts, the best the government could hope for was 50 cents in tax revenue. And some forms of tax cuts -- notably, reductions in taxes on wages -- yield a lot less, Beach said.

At the Cato Institute, another bastion of support for lower tax rates, Chris Edwards, director of tax policy studies, said, “Some share of [today’s] strong economic growth, but I don’t know how much of a share, is attributable to the tax cuts.”

At the skeptical end of the spectrum, Leonard E. Burman, co-director of the Urban Institute-Brookings Institution Tax Policy Center, sees “dynamic analysis” as part of a Bush administration effort to advance the cause of tax cuts.

“It’s so irresponsible,” Burman said. “It’s like some kind of miracle will keep us from having to make any hard choices.”

The revenue “miracle” has its modern origins in 1974, when economist Arthur B. Laffer, according to an account by then-Wall Street Journal editorial writer Jude Wanniski, drew his now-famous curve on a napkin during a dinner attended by Dick Cheney, then President Ford’s deputy chief of staff, and others.

Laffer’s curve illustrated his conclusion that at high enough tax rates, further tax increases would so discourage productive work that they would reduce the revenue flowing to the Treasury.

Conversely, he argued, tax cuts would boost revenue since the savings in taxes would spread through the economy via increased expenditures. That greater spending power, the theory went, would create higher tax revenue as businesses hired additional workers, increased wages and invested in materials.

The Laffer curve became an intellectual underpinning of President Reagan’s gigantic tax cuts, which sent the top income-tax rate tumbling from 70% in 1981 to 28% in 1988.

Among the skeptics of the idea that lower tax rates create higher revenue is UC Berkeley economist Emmanuel Saez who has examined the record from 1960, when the top income tax rate was 91%, to 2000, by which time it had risen to 39.6% from its lowest point 12 years earlier.

He found that only the 1% of richest Americans showed any sign of working harder -- and thus building up their taxable income -- in response to tax cuts, earning about twice as much after the 1988 cuts as before. But they also saw a sharp increase in their income at the end of the 1990s, despite a large tax increase in 1993.

It is this unpredictability that Treasury’s new dynamic analysis division will try to interpret. The department is striving to have the division up and analyzing in time to contribute to July’s review of the budget.

Two congressional staff units, the Joint Committee on Taxation and the Congressional Budget Office, already subject major tax proposals to dynamic analysis.

Douglas Holtz-Eakin, who recently resigned as director of the budget office, said there was still too much art and not enough science to make dynamic analysis more than an informal adjunct to traditional scoring. “We don’t know how to do it well,” he said, “and it should be kept supplemental, which is how we did it.”

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Times staff writer Matthew O’Rourke contributed to this report.