Dynamic Scoring for Tax Legislation: A Review of Models

Changes from April 4, 2023 to June 20, 2023

This page shows textual changes in the document between the two versions indicated in the dates above. Textual matter removed in the later version is indicated with ~~red strikethrough~~ and textual matter added in the later version is indicated with blue.

Dynamic Scoring for Tax Legislation: A Review
~~April 4~~June 20, 2023 , 2023
of Models
Jane G. Gravelle
Dynamic scoring (or revenue estimating) for tax legislation has been discussed for more Dynamic scoring (or revenue estimating) for tax legislation has been discussed for more
than two Senior Specialist in Senior Specialist in
~~than two~~ decades. Beginning in 2003, House Rule 13 required that the Joint Committee decades. Beginning in 2003, House Rule 13 required that the Joint Committee
~~Economic Policy~~
on Taxation (JCT) on Taxation (JCT) Economic Policy provide a macroeconomic impact analysis of legislation to amend the provide a macroeconomic impact analysis of legislation to amend the

Internal Revenue Code or a Internal Revenue Code or a statement explaining why it is not calculable. In 2015, that statement explaining why it is not calculable. In 2015, that
requirement was for a point estimate of feedback effects, a rule suspended in 2019 but requirement was for a point estimate of feedback effects, a rule suspended in 2019 but

restored in 2023. These estimates are not part of restored in 2023. These estimates are not part of the official revenue estimate, but they could affect views on the official revenue estimate, but they could affect views on
legislative proposals. legislative proposals.
Official revenue estimates include many behavioral changes, but hold Official revenue estimates include many behavioral changes, but hold output (in their case, gross national~~gross domestic~~ product product ~~(GDP)~~ or GNP) constant. constant.
Dynamic scoring allows for changes in Dynamic scoring allows for changes in ~~GDP~~GNP. Models for estimating effects on . Models for estimating effects on ~~GDP~~output (GNP or gross domestic product, that is, GDP) that government agencies and that government agencies and
academics use are complicated. To those interested in dynamic feedback effects on academics use are complicated. To those interested in dynamic feedback effects on ~~GDP~~output, these models may , these models may
appear to be “black boxes.” This report, although necessarily technical itself, examines the models used for appear to be “black boxes.” This report, although necessarily technical itself, examines the models used for
dynamic scoring, their reflective effects, and their response consistency with empirical evidence. The following dynamic scoring, their reflective effects, and their response consistency with empirical evidence. The following
points summarize the major findings of the report: points summarize the major findings of the report:
• Revenue neutral income tax reform that lowers statutory income tax rates through broadening the Revenue neutral income tax reform that lowers statutory income tax rates through broadening the
base, base, although assumed by some to spur growth, can potentially contract the economy. The base although assumed by some to spur growth, can potentially contract the economy. The base
broadening, by making more income subject to tax, increases effective rates and offsets statutory broadening, by making more income subject to tax, increases effective rates and offsets statutory
rate reductions. Models must consider these effects to estimate effects of tax reform. rate reductions. Models must consider these effects to estimate effects of tax reform.
• When taxes increase or decrease, some effects that have been estimated may be less appropriate When taxes increase or decrease, some effects that have been estimated may be less appropriate
than others than others to include in the analysis. Some models estimate demand side stimulus effects, which to include in the analysis. Some models estimate demand side stimulus effects, which
are transitory and matter only when there is unemployment in the economy. These may not be are transitory and matter only when there is unemployment in the economy. These may not be
appropriate to consider in evaluating permanent tax policies. Questions may also be raised about appropriate to consider in evaluating permanent tax policies. Questions may also be raised about
including effects of deficits or surpluses in reducing or increasing investment due to changes in including effects of deficits or surpluses in reducing or increasing investment due to changes in
government borrowing. In both cases, these effects apply to spending as well as to tax changes. government borrowing. In both cases, these effects apply to spending as well as to tax changes.
• Sometimes claims are made that the feedback effects from reducing taxes will largely offset the Sometimes claims are made that the feedback effects from reducing taxes will largely offset the
revenue revenue loss through “supply side” effects that increase loss through “supply side” effects that increase ~~GDP~~output and the tax base. No reasonable and the tax base. No reasonable
estimate of the responses of labor supply or savings to tax changes can produce such offsets. The estimate of the responses of labor supply or savings to tax changes can produce such offsets. The
feedback effect from a simple and flexible growth model is less than 10%, given empirical feedback effect from a simple and flexible growth model is less than 10%, given empirical
evidence of supply responses, which are small and of uncertain direction. evidence of supply responses, which are small and of uncertain direction.
• More complex models for studying supply side effects (intertemporal models), which are based More complex models for studying supply side effects (intertemporal models), which are based
on a more on a more rigid theoretical structure, produce similar results for changes in taxes on wages if the rigid theoretical structure, produce similar results for changes in taxes on wages if the
assumptions of the models are consistent with the empirical evidence on labor supply. A review of assumptions of the models are consistent with the empirical evidence on labor supply. A review of
models currently or recently used by government agencies and academics suggests that is not models currently or recently used by government agencies and academics suggests that is not
generally the case (an exception is the JCT’s model). generally the case (an exception is the JCT’s model).
• Effects of tax cuts on capital income can be large in these more complex models, reflecting Effects of tax cuts on capital income can be large in these more complex models, reflecting
shifting of shifting of consumption and leisure to periods far in the future. These shifts, which can induce consumption and leisure to periods far in the future. These shifts, which can induce
large short-run increases in labor supply and saving, are generally not supported empirically and large short-run increases in labor supply and saving, are generally not supported empirically and
may be unlikely. An important question is whether the benefits of formal theory in these models may be unlikely. An important question is whether the benefits of formal theory in these models
outweigh their empirical weaknesses. outweigh their empirical weaknesses.
Congressional Research Service Congressional Research Service

link to page 38 link to page 40 link to page 38 link to page 40 Dynamic Scoring for Tax Legislation: A Review of Models

Appendixes
Appendix. A Simple Model of Feedback Effects .......................................................................... 34

Contacts
Author Information ........................................................................................................................ 36

Congressional Research Service Congressional Research Service

Dynamic Scoring for Tax Legislation: A Review of Models

ynamic scoring (or dynamic revenue estimating) for tax legislation has been an issue of ynamic scoring (or dynamic revenue estimating) for tax legislation has been an issue of
interest for at least the past 25 years.1 Beginning in 2003, House Rule 13 required that the interest for at least the past 25 years.1 Beginning in 2003, House Rule 13 required that the
D Joint Committee on Taxation (JCT) provide a macroeconomic impact analysis of D Joint Committee on Taxation (JCT) provide a macroeconomic impact analysis of
legislation to amend the Internal Revenue Code or a statement explaining why it is not calculable; legislation to amend the Internal Revenue Code or a statement explaining why it is not calculable;
the first analysis was in 2003.2 In 2015, the rules required a point estimate to be included in the first analysis was in 2003.2 In 2015, the rules required a point estimate to be included in
revenue estimates. An estimate was provided in 2017 for the Tax Cuts and Jobs Act (P.L. 115-97). revenue estimates. An estimate was provided in 2017 for the Tax Cuts and Jobs Act (P.L. 115-97).
No estimates were required in 2019-2022, but these rules were restored in 2023No estimates were required in 2019-2022, but these rules were restored in 2023~~. They require~~
and the JCT has since posted two dynamic estimates, one for the House-passed version of the Build Back Better Act (BBBA; H.R. 5376) and the other for an expansion of the child tax credit. The rule requires dynamic revenue estimates for tax legislation that has an impact of 0.25% of gross domestic product (GDP). These estimates for tax legislation that has an impact of 0.25% of gross domestic product (GDP). These
analyses and estimates are not part of the official score but rather provide projected feedback analyses and estimates are not part of the official score but rather provide projected feedback
effects, although some may argue that feedback effects should be included in revenue estimates. effects, although some may argue that feedback effects should be included in revenue estimates.
Many uncertainties arise with respect to dynamic scoring, which depend on the type of model Many uncertainties arise with respect to dynamic scoring, which depend on the type of model
used, the behavioral responses built into the models, and assumptions about activities of other used, the behavioral responses built into the models, and assumptions about activities of other
agents or supplemental policies that are necessary to solve some types of models. The complexity agents or supplemental policies that are necessary to solve some types of models. The complexity
is expanded in the case of tax reform, because base broadening can also have effects on effective is expanded in the case of tax reform, because base broadening can also have effects on effective
tax rates that could offset part or all of the behavioral effects due to changes in statutory rate tax rates that could offset part or all of the behavioral effects due to changes in statutory rate
reduction. reduction.
This report first explains dynamic scoring, including the types of effects incorporated and the This report first explains dynamic scoring, including the types of effects incorporated and the
types of models used, as well as what groups conduct or have conducted macroeconomic analyses types of models used, as well as what groups conduct or have conducted macroeconomic analyses
of tax changes. The following section discusses the specific issues associated with tax reform. of tax changes. The following section discusses the specific issues associated with tax reform.
The final section discusses general issues surrounding the use of various models and reviews the The final section discusses general issues surrounding the use of various models and reviews the
empirical evidence on supply side responses (labor supply and savings or investment) and how empirical evidence on supply side responses (labor supply and savings or investment) and how
these effects are incorporated in current models used by JCT, the Congressional Budget Office these effects are incorporated in current models used by JCT, the Congressional Budget Office
(CBO), the (CBO), the ~~Treasury Department~~Department of the Treasury, and nongovernmental researchers. , and nongovernmental researchers.
The discussion of economic modeling is necessarily more technical than that in most The discussion of economic modeling is necessarily more technical than that in most
Congressional Research Service (CRS) reports. The first section, therefore, provides an overview Congressional Research Service (CRS) reports. The first section, therefore, provides an overview
with a less technical summary of the analysis and findings in this report. The main body of the with a less technical summary of the analysis and findings in this report. The main body of the
report follows. report follows.
Overview
Dynamic scoring, as a general term, is revenue estimation that accounts for behavioral changes. , as a general term, is revenue estimation that accounts for behavioral changes.
When referring to tax legislation, the term dynamic revenue estimating is also used. The When referring to tax legislation, the term dynamic revenue estimating is also used. The
legislative requirements cited above, however, have a narrower effect because many behavioral legislative requirements cited above, however, have a narrower effect because many behavioral
responses are already included in conventional revenue estimates. The rules commonly referred to responses are already included in conventional revenue estimates. The rules commonly referred to
as requiring a dynamic score require macroeconomic effects, incorporating the effects of as requiring a dynamic score require macroeconomic effects, incorporating the effects of
~~legislative changes on aggregate economic output. Dynamic scoring as used in this report refers~~
~~to incorporating those macroeconomic effects. It is often discussed in connection with revenue~~

1 See CRS Report R46233, 1 See CRS Report R46233, Dynamic Scoring in the Congressional Budget Process, by Megan S. Lynch and Jane G. , by Megan S. Lynch and Jane G.
Gravelle, for a more detailed history. The first CRS report on this issue, CRS Report 94-1000, Gravelle, for a more detailed history. The first CRS report on this issue, CRS Report 94-1000, Dynamic Revenue
Estimating, by Jane G. Gravelle (December 14, 1994, now archived but available to congressional clients from the , by Jane G. Gravelle (December 14, 1994, now archived but available to congressional clients from the
author upon request) linked the growing interest in the past years to the greater importance of revenue estimates under author upon request) linked the growing interest in the past years to the greater importance of revenue estimates under
budget rules that provided additional constraints on tax cuts and spending changes. For example, the Budget budget rules that provided additional constraints on tax cuts and spending changes. For example, the Budget
Enforcement Act of 1990 provided for PAYGO rules. See CRS Report R41901, Enforcement Act of 1990 provided for PAYGO rules. See CRS Report R41901, Statutory Budget Controls in Effect
Between 1985 and 2002, by Megan S. Lynch, for a discussion of these rules. , by Megan S. Lynch, for a discussion of these rules.
2 See excerpt from 2 See excerpt from Congressional Record, 149 Cong. Rec. H3829-H3832, at https://www.jct.gov/publications.html?, 149 Cong. Rec. H3829-H3832, at https://www.jct.gov/publications.html?
func=startdown&id=1191. Other JCT documents relating to macroeconomic analysis are available at func=startdown&id=1191. Other JCT documents relating to macroeconomic analysis are available at
https://www.jct.gov/publications.html?func=select&id=4. https://www.jct.gov/publications.html?func=select&id=4.
Congressional Research Service Congressional Research Service

1 1

Dynamic Scoring for Tax Legislation: A Review of Models

legislative changes on aggregate economic output. Dynamic scoring as used in this report refers to incorporating those macroeconomic effects. It is often discussed in connection with revenue legislation because tax revisions may cause “supply side” effects (i.e., changes in labor supply legislation because tax revisions may cause “supply side” effects (i.e., changes in labor supply
and savings) due to changes in effective average and marginal tax rates. and savings) due to changes in effective average and marginal tax rates.
How Dynamic Scoring Differs from Conventional Scoring
Methods for Tax Legislation
The Joint Committee on Taxation’s current revenue estimates include a variety of microeconomic The Joint Committee on Taxation’s current revenue estimates include a variety of microeconomic
behavioral responses that affect revenue yields.3 For example, increasing capital gains taxes is behavioral responses that affect revenue yields.3 For example, increasing capital gains taxes is
assumed to cause a reduction in realizations that reduces the potential revenue gain. Various other assumed to cause a reduction in realizations that reduces the potential revenue gain. Various other
behavioral responses are considered in preparing estimates. These estimates, however, keep total behavioral responses are considered in preparing estimates. These estimates, however, keep total
output (i.e., output (i.e., ~~GDP~~GNP) fixed. Effects on output have been provided in some cases, but they are not ) fixed. Effects on output have been provided in some cases, but they are not
included in formal scorekeeping.4 included in formal scorekeeping.4
What Determines the Economic Effects from Dynamic Scoring?
The effects of dynamic scoring on revenues depend on numerous factors: the types of effects The effects of dynamic scoring on revenues depend on numerous factors: the types of effects
included, the types of models used, and the magnitude of behavioral responses (elasticities) included, the types of models used, and the magnitude of behavioral responses (elasticities)
incorporated in the model.5 JCT and CBO studies have considered three types of effects: (1) the incorporated in the model.5 JCT and CBO studies have considered three types of effects: (1) the
short-run stimulus effect where a tax cut increases demand and output in an underemployed short-run stimulus effect where a tax cut increases demand and output in an underemployed
economy, while a tax increase reduces output; (2) the effect of deficits or surpluses on crowding economy, while a tax increase reduces output; (2) the effect of deficits or surpluses on crowding
out or crowding in investment due to government borrowing; and (3) the supply side effects (i.e., out or crowding in investment due to government borrowing; and (3) the supply side effects (i.e.,
increases or decreases in labor supply, domestic savings, and net investment from abroad in increases or decreases in labor supply, domestic savings, and net investment from abroad in
response to changes in effective tax rates). response to changes in effective tax rates).
Reasons exist to consider only the supply side effects, because the other two effects also occur Reasons exist to consider only the supply side effects, because the other two effects also occur
with spending changes. There are especially strong reasons to exclude stimulus effects, because with spending changes. There are especially strong reasons to exclude stimulus effects, because
permanent changes in the tax code should not depend on fiscal timing. That is, a permanent tax permanent changes in the tax code should not depend on fiscal timing. That is, a permanent tax
code change should not be evaluated more or less favorably because it is enacted during a code change should not be evaluated more or less favorably because it is enacted during a
recession. Moreover, the Federal Reserve System may offset the short-run stimulus effect. recession. Moreover, the Federal Reserve System may offset the short-run stimulus effect.
Supply side effects from tax cuts are often presumed to increase output. However, they can either Supply side effects from tax cuts are often presumed to increase output. However, they can either
increase or decrease output because of offsetting income and substitution effects. A tax cut, by increase or decrease output because of offsetting income and substitution effects. A tax cut, by
increasing income, causes an increase in consumption, including consumption of leisure, which increasing income, causes an increase in consumption, including consumption of leisure, which
reduces labor supply. This effect is the income effect. A tax cut that affects marginal earnings will reduces labor supply. This effect is the income effect. A tax cut that affects marginal earnings will
cause leisure to be more costly relative to consumption, which will increase labor supply. This cause leisure to be more costly relative to consumption, which will increase labor supply. This
effect is the substitution effect. Income and substitution effects also occur for savings. A reduction effect is the substitution effect. Income and substitution effects also occur for savings. A reduction
in the tax rate on the return to savings, and the higher return, means that an individual can in the tax rate on the return to savings, and the higher return, means that an individual can
consume more now and more in the future, reducing savings. This effect is the income effect. At consume more now and more in the future, reducing savings. This effect is the income effect. At
the same time, the lower tax rate (and higher yield) makes the price of future consumption lower the same time, the lower tax rate (and higher yield) makes the price of future consumption lower
and increases savings, the substitution effect. These effects are typically measured as an elasticity: and increases savings, the substitution effect. These effects are typically measured as an elasticity:
~~the percentage change in quantity divided by the percentage change in price or income. For~~

3 Conventional scoring and macroeconomic analysis are discussed in Joint Committee on Taxation (JCT), 3 Conventional scoring and macroeconomic analysis are discussed in Joint Committee on Taxation (JCT), Summary of
Economic Models and Estimating Practices of the Staff of the Joint Committee on Taxation, JCX-46-11, September 19, , JCX-46-11, September 19,
2011, at https://www.jct.gov/publications.html?func=startdown&id=4373. 2011, at https://www.jct.gov/publications.html?func=startdown&id=4373.
4 JCT’s documents relating to macroeconomic analysis are available at https://www.jct.gov/publications 4 JCT’s documents relating to macroeconomic analysis are available at https://www.jct.gov/publications~~.html?func=~~
~~select&id=4~~/?searchWithin=&category_name=Macroeconomic+Analysis&find-publication=Find+a+Publication. .
5 Elasticities measure the underlying supply side relationship, for example, by what percentage does labor supply 5 Elasticities measure the underlying supply side relationship, for example, by what percentage does labor supply
increase or decrease for a given percentage change in wages. In some models they are explicit, whereas in others they increase or decrease for a given percentage change in wages. In some models they are explicit, whereas in others they
must be derived from other parameters. must be derived from other parameters.
Congressional Research Service Congressional Research Service

2 2

Dynamic Scoring for Tax Legislation: A Review of Models

the percentage change in quantity divided by the percentage change in price or income. For example, if the labor supply elasticity with respect to the wage rate is 0.2, a 10% increase in example, if the labor supply elasticity with respect to the wage rate is 0.2, a 10% increase in
wages will cause a 2% (0.2 times 10%) increase in labor supply. wages will cause a 2% (0.2 times 10%) increase in labor supply.
The projected effects of a tax change on output and revenues depend on the design of the tax The projected effects of a tax change on output and revenues depend on the design of the tax
change, the type of model, and the magnitude of income and substitution elasticities. Two very change, the type of model, and the magnitude of income and substitution elasticities. Two very
different types of models for estimating supply side response are a different types of models for estimating supply side response are a simple growth model with with
labor and savings supply responsive to wages and rates of return and an labor and savings supply responsive to wages and rates of return and an intertemporal model with with
a complex theoretical structure in which individuals allocate leisure and consumption over time. a complex theoretical structure in which individuals allocate leisure and consumption over time.
The behavioral responses rely on many aspects of these intertemporal models, which are not The behavioral responses rely on many aspects of these intertemporal models, which are not
always transparent. always transparent.
During the budget horizon, labor supply is likely to be the dominant factor, in part, because During the budget horizon, labor supply is likely to be the dominant factor, in part, because
additional capital tends to accumulate slowly. Output increases when the labor supply or the additional capital tends to accumulate slowly. Output increases when the labor supply or the
capital stock increases, with labor supply the larger input. A tax change affects the capital stock capital stock increases, with labor supply the larger input. A tax change affects the capital stock
by affecting savings or investment, which is typically only 2% to 3% of the capital stock. Even if by affecting savings or investment, which is typically only 2% to 3% of the capital stock. Even if
the saving rate increased by 50% in the first year, the capital stock would increase by only about the saving rate increased by 50% in the first year, the capital stock would increase by only about
1%. Outside the budget window, capital accumulation may become more important and, for some 1%. Outside the budget window, capital accumulation may become more important and, for some
reforms, can dominate the effects on labor. reforms, can dominate the effects on labor.
Special Issues with Revenue Neutral Tax Reform
With a revenue neutral tax reform, where base broadening finances rate cuts, the focus is With a revenue neutral tax reform, where base broadening finances rate cuts, the focus is
generally on supply side effects, because the effects on short-term demand or the deficit and generally on supply side effects, because the effects on short-term demand or the deficit and
crowding out should be negligible. Moreover, in a revenue neutral change, there are no income crowding out should be negligible. Moreover, in a revenue neutral change, there are no income
effects in the aggregate to reduce supply as would be the case in a rate cut alone. If the change is effects in the aggregate to reduce supply as would be the case in a rate cut alone. If the change is
also distributionally neutral, any effects arising from these factors are even less likely. Thusalso distributionally neutral, any effects arising from these factors are even less likely. Thus, the the
focus of dynamic effects is on substitution effects. focus of dynamic effects is on substitution effects.
In a tax reform, it is crucial to recognize that the behavioral response cannot be measured solely In a tax reform, it is crucial to recognize that the behavioral response cannot be measured solely
by statutory rate changes. The by statutory rate changes. The effective marginal tax rate determines this behavioral response and marginal tax rate determines this behavioral response and
changes in the income base that change the share of income taxed at the margin also affect this changes in the income base that change the share of income taxed at the margin also affect this
marginal effective tax rate. It is possible for base broadening provisions to raise effective marginal effective tax rate. It is possible for base broadening provisions to raise effective
marginal tax rates more than enough to offset the effects of a cut in statutory tax rates, leading to marginal tax rates more than enough to offset the effects of a cut in statutory tax rates, leading to
a contraction rather than an expansion in output.a contraction rather than an expansion in output.
This potential for base broadening to affect marginal effective rates means that it is not possible to This potential for base broadening to affect marginal effective rates means that it is not possible to
project the effects of a base broadening tax reform that specifies the rates but does not specify project the effects of a base broadening tax reform that specifies the rates but does not specify
how the revenue is to be offset by base broadening.how the revenue is to be offset by base broadening.
Many models, including those used by the JCT, use a microsimulation model to calculate marginal effects of tax revisions that include both rate and base changes. Expected Supply Side Effects of Dynamic Models
When there is a revenue loss or gain or when marginal effective tax rates change, there can be When there is a revenue loss or gain or when marginal effective tax rates change, there can be
supply side responses. The following points can be made: supply side responses. The following points can be made:
• In simple transparent supply side models that directly incorporate labor supply In simple transparent supply side models that directly incorporate labor supply
and savings responses as indicated by empirical evidence, feedback effects on and savings responses as indicated by empirical evidence, feedback effects on
revenues are expected to be small, in the neighborhood of 3% to 8%. That is, a revenues are expected to be small, in the neighborhood of 3% to 8%. That is, a
revenue loss will be reduced by 3% to 8% and a revenue gain will be increased revenue loss will be reduced by 3% to 8% and a revenue gain will be increased
by 3% to 8% in an overall tax cut. Effects might be slightly larger in open by 3% to 8% in an overall tax cut. Effects might be slightly larger in open
economies. economies.
Congressional Research Service 3 Dynamic Scoring for Tax Legislation: A Review of Models • More complex intertemporal models can yield similar results with respect to More complex intertemporal models can yield similar results with respect to
wage tax cuts, if similar elasticities are embedded in the models. In these models, wage tax cuts, if similar elasticities are embedded in the models. In these models,
~~Congressional Research Service~~

3

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

spending must match taxes in the long run, so the results depend on how deficits spending must match taxes in the long run, so the results depend on how deficits
or surpluses are addressed. An examination of models currently or recently used or surpluses are addressed. An examination of models currently or recently used
indicates that many of these models have implicit behavioral responses for labor indicates that many of these models have implicit behavioral responses for labor
supply that are much larger than those that are contained in simpler growth supply that are much larger than those that are contained in simpler growth
models or those that can be supported with empirical evidence.models or those that can be supported with empirical evidence. ~~The JCT’s~~
~~intertemporal model, however, has elasticities similar to those found in empirical~~
~~studies.~~
 • Responses in intertemporal models to changes in taxes on capital income can be Responses in intertemporal models to changes in taxes on capital income can be
large, depending on how the revenues are offset and the size of elasticities. These large, depending on how the revenues are offset and the size of elasticities. These
models have a rigid structure that causes responses in savings that reflect models have a rigid structure that causes responses in savings that reflect
reducing consumption today for more consumption many years in the future to a reducing consumption today for more consumption many years in the future to a
degree that is unlikely and not empirically studied. In addition, they cause an degree that is unlikely and not empirically studied. In addition, they cause an
increase in labor supply to shift leisure from the present to many years in the increase in labor supply to shift leisure from the present to many years in the
future that is also not likely or supported by empirical evidence. An important future that is also not likely or supported by empirical evidence. An important
question is whether the more desirable theoretical structure of these models question is whether the more desirable theoretical structure of these models
balances the lack of empirical justification. balances the lack of empirical justification.
The remainder of this report provides a more detailed analysis. The remainder of this report provides a more detailed analysis.
Types of Effects and Types of Models
Dynamic scoring normally employs models of the aggregate economy. Some of these models Dynamic scoring normally employs models of the aggregate economy. Some of these models
have a single rate of return and a single type of saving and supply of capital; changes in taxes that have a single rate of return and a single type of saving and supply of capital; changes in taxes that
affect the rate of return directly or indirectly can lead to changes in savings. affect the rate of return directly or indirectly can lead to changes in savings.
These models typically do not address certain features of the corporate tax. Although corporate These models typically do not address certain features of the corporate tax. Although corporate
tax revenues are relatively small compared with individual tax revenues, corporate changes could tax revenues are relatively small compared with individual tax revenues, corporate changes could
have significant effects on the overall rate of return. Aggregate economy models capture these have significant effects on the overall rate of return. Aggregate economy models capture these
effects on savings rates. Corporate taxes, however, may also have immediate and larger effects on effects on savings rates. Corporate taxes, however, may also have immediate and larger effects on
capital, because they may affect flows of capital to and from the rest of the world. This process capital, because they may affect flows of capital to and from the rest of the world. This process
could occur more quickly than the effects (if any) on increased domestic saving. Most aggregate could occur more quickly than the effects (if any) on increased domestic saving. Most aggregate
models have relatively primitive (if any) adjustment for this effect, although corporate models models have relatively primitive (if any) adjustment for this effect, although corporate models
that focus separately on international capital flows exist. that focus separately on international capital flows exist.
Aggregate Models of the Economy
The three types of revenue feedback effects are The three types of revenue feedback effects are
1. short-run stimulus, or Keynesian (demand side) effects; 1. short-run stimulus, or Keynesian (demand side) effects;
2. crowding out effects of deficits on investment (and crowding in effects of 2. crowding out effects of deficits on investment (and crowding in effects of
surpluses); and surpluses); and
3. supply side effects. 3. supply side effects.
Stimulus effects, such as those in a tax cut, can increase output temporarily in an underemployed Stimulus effects, such as those in a tax cut, can increase output temporarily in an underemployed
economy by increasing income and spending. This increase in demand leads to the return of some economy by increasing income and spending. This increase in demand leads to the return of some
unemployed individuals and resources to production. Crowding out occurs because the increase unemployed individuals and resources to production. Crowding out occurs because the increase
in federal borrowing due to increased deficits displaces capital that would otherwise be used for in federal borrowing due to increased deficits displaces capital that would otherwise be used for
private investment. The magnitude of the effect depends on how much government borrowing is private investment. The magnitude of the effect depends on how much government borrowing is
from foreign sources. from foreign sources.
The third type of effect, which is often of the most interest, is commonly called a supply side The third type of effect, which is often of the most interest, is commonly called a supply side
effect because it refers to the effects of tax or other policies on the amount of labor supplied or the effect because it refers to the effects of tax or other policies on the amount of labor supplied or the
Congressional Research Service Congressional Research Service

4 4

Dynamic Scoring for Tax Legislation: A Review of Models

amount of savings or investment (which would affect the size of the capital stock). This effect is amount of savings or investment (which would affect the size of the capital stock). This effect is
more closely associated with tax changes, although it could apply to some spending programs as more closely associated with tax changes, although it could apply to some spending programs as
well. (For example, spending on infrastructure such as bridges or highways would affect well. (For example, spending on infrastructure such as bridges or highways would affect
productivity, and means-tested transfer payments can affect work incentives.) productivity, and means-tested transfer payments can affect work incentives.)
These different effects may not be precisely separated (for instance, deficits increase interest These different effects may not be precisely separated (for instance, deficits increase interest
rates, which can cause a change in savings that is a supply side effect, and tax cuts could rates, which can cause a change in savings that is a supply side effect, and tax cuts could
simultaneously cause demand side and supply side effects). All three effects can be isolated by simultaneously cause demand side and supply side effects). All three effects can be isolated by
sensitivity analysis that includes policies to control for stimulus and deficit effects (as the JCT sensitivity analysis that includes policies to control for stimulus and deficit effects (as the JCT
often has done). often has done).
There are three basic types of economic models (plus combinations) that vary in whether and how There are three basic types of economic models (plus combinations) that vary in whether and how
they reflect the three types of effects. they reflect the three types of effects.
• Short-run models (also referred to as IS-LM models) with underemployed Short-run models (also referred to as IS-LM models) with underemployed
resources typically used for short-run forecasting and to estimate short-run resources typically used for short-run forecasting and to estimate short-run
stimulus effects on aggregate demand, but they are not effects of deficits or stimulus effects on aggregate demand, but they are not effects of deficits or
supply side effects. They can be solved only by assuming some particular supply side effects. They can be solved only by assuming some particular
monetary policy of the Federal Reserve System. These models are often used in monetary policy of the Federal Reserve System. These models are often used in
the private sector for forecasting and tend to have multiple sectors. the private sector for forecasting and tend to have multiple sectors.
• Basic neoclassical growth models (also called Solow models) with direct Basic neoclassical growth models (also called Solow models) with direct
estimates of labor and savings supply responses. This type of model, in its pure estimates of labor and savings supply responses. This type of model, in its pure
form, assumes full employment and does not capture short-run stimulus, but can form, assumes full employment and does not capture short-run stimulus, but can
capture crowding out effects and supply side effects. Its effects are driven by the capture crowding out effects and supply side effects. Its effects are driven by the
labor supply elasticities (the percentage change in labor divided by the labor supply elasticities (the percentage change in labor divided by the
percentage change in wages) and savings elasticities (the percentage change in percentage change in wages) and savings elasticities (the percentage change in
savings rates with a percentage change in after-tax rate of return). savings rates with a percentage change in after-tax rate of return).
• Intertemporal growth models, where individuals allocate leisure and consumption Intertemporal growth models, where individuals allocate leisure and consumption
within periods and across time. These actions give rise to changes in labor supply within periods and across time. These actions give rise to changes in labor supply
and savings responses. These models capture only supply side responses, as full and savings responses. These models capture only supply side responses, as full
employment is assumed and deficits are offset by some other policy change.6 The employment is assumed and deficits are offset by some other policy change.6 The
models are of two forms. One form is the Ramsey, or infinite horizon, model models are of two forms. One form is the Ramsey, or infinite horizon, model
where people are represented by an infinitely lived agent.7 The other form is the where people are represented by an infinitely lived agent.7 The other form is the
overlapping generation (OLG) life-cycle model where agents have finite lives overlapping generation (OLG) life-cycle model where agents have finite lives
(typically around 55 years to cover the working period and retirement), and a (typically around 55 years to cover the working period and retirement), and a
new generation is born each year, while an old one dies (hence the term new generation is born each year, while an old one dies (hence the term
overlapping generations). Agents in intertemporal models often have perfect overlapping generations). Agents in intertemporal models often have perfect
foresight (i.e., know all of the wage rates and rates of return in the futureforesight (i.e., know all of the wage rates and rates of return in the future),

as well as the consequences of responses on those variables), although they can be constructed to allow risk and uncertainty. While the basic intertemporal model 6 The offset of deficits is not a choice, but a requirement in these forward-looking models, as a solution requires solving 6 The offset of deficits is not a choice, but a requirement in these forward-looking models, as a solution requires solving
for a steady-state or a long-run solution that is asymptotically approached. Deficits can exist in these models, but they for a steady-state or a long-run solution that is asymptotically approached. Deficits can exist in these models, but they
must have a stable debt-to-GDP ratio. An OLG model with myopia can be solved with deficits. must have a stable debt-to-GDP ratio. An OLG model with myopia can be solved with deficits.
7 The original Ramsey model was a planning model that was then adapted to the study of tax and other policies in a 7 The original Ramsey model was a planning model that was then adapted to the study of tax and other policies in a
steady state growth model as a descriptive model. Macroeconomists adapted this model to the study of business cycles steady state growth model as a descriptive model. Macroeconomists adapted this model to the study of business cycles
due to exogenous shocks, which is referred to as a real business cycle model, which claims to explain business cycles due to exogenous shocks, which is referred to as a real business cycle model, which claims to explain business cycles
without involuntary unemployment. A term for a more general class of these models is dynamic stochastic general without involuntary unemployment. A term for a more general class of these models is dynamic stochastic general
equilibrium (DSGE) models, which can be designed to allow unemployment. Tax economists have tended to favor the equilibrium (DSGE) models, which can be designed to allow unemployment. Tax economists have tended to favor the
life-cycle form of the intertemporal model, perhaps because it allows distribution across generations that is an life-cycle form of the intertemporal model, perhaps because it allows distribution across generations that is an
important aspect of shifting to consumption taxes. This model is very difficult to construct. Macroeconomists tend to important aspect of shifting to consumption taxes. This model is very difficult to construct. Macroeconomists tend to
favor the simpler infinite horizon model, in part because they are often interested in business cycles and in favor the simpler infinite horizon model, in part because they are often interested in business cycles and in
intertemporal shifts of labor in response to wage rates. intertemporal shifts of labor in response to wage rates.
Congressional Research Service Congressional Research Service

5 5

Dynamic Scoring for Tax Legislation: A Review of Models

~~although they can be constructed to allow risk and uncertainty, and OLG models~~
~~can be myopic.8 Intertemporal models~~has agents with perfect foresight, and can be myopic, meaning that they know expected wage and interest rates, they do not account for how actions will affect those measures.8 Intertemporal models (other than myopic models) cannot indefinitely have deficits or cannot indefinitely have deficits or
surpluses, and in the Ramsey model even temporary deficits have no effects. surpluses, and in the Ramsey model even temporary deficits have no effects.
Because these models have a relatively rigid structure, they include a labor Because these models have a relatively rigid structure, they include a labor
supply response to changes in the rate of return. For some tax changes, this supply response to changes in the rate of return. For some tax changes, this
response to the rate of return may be the major source of a short-term labor response to the rate of return may be the major source of a short-term labor
response. response.
• Hybrid models combine short-term stimulus effects with growth models. For Hybrid models combine short-term stimulus effects with growth models. For
example, an IS-LM model can be combined with a Solow model. Hybrid models example, an IS-LM model can be combined with a Solow model. Hybrid models
that allow unemployment through sticky wages (i.e., wages do not immediately that allow unemployment through sticky wages (i.e., wages do not immediately
adjust to changes in demand) can combine with a Ramsey infinite horizon model. adjust to changes in demand) can combine with a Ramsey infinite horizon model.
~~In the latter case, some agents in the economy are presumed to be liquidity~~
~~constrained (cannot borrow). This type of model is called a dynamic stochastic~~
~~general equilibrium (DSGE) model~~These types of models are also referred to as dynamic stochastic general equilibrium (DSGE) models. DSGE models may have a single representative agent or more than one type of agent; for example, some agents in the economy may be liquidity constrained (cannot borrow). .
The alternative models can produce different results both due to the model choice and to the The alternative models can produce different results both due to the model choice and to the
elasticities, or assumed responsiveness, embedded in the model. In addition, some models can elasticities, or assumed responsiveness, embedded in the model. In addition, some models can
(but may not) allow capital flows to and from the rest of the world. In general, these models do (but may not) allow capital flows to and from the rest of the world. In general, these models do
not include an explicit modeling of open economy effects but may include open economy effects not include an explicit modeling of open economy effects but may include open economy effects
on supply in a variety of ways. The infinite horizon model, however, is incompatible with on supply in a variety of ways. The infinite horizon model, however, is incompatible with
perfectly mobile international capital. Rule-of-thumb offsets against crowding out are used in perfectly mobile international capital. Rule-of-thumb offsets against crowding out are used in
some of the Solow growth models to assign part of borrowing to foreign sources. some of the Solow growth models to assign part of borrowing to foreign sources.
Corporate Models
Corporate models of a closed economy have long existed, but they have not generally been used Corporate models of a closed economy have long existed, but they have not generally been used
to measure feedback effects. These models, in fact, often simplified the requirements of aggregate to measure feedback effects. These models, in fact, often simplified the requirements of aggregate
modeling because the standard analysis concluded that the corporate tax fell on capital in general, modeling because the standard analysis concluded that the corporate tax fell on capital in general,
given a fixed capital stock. For purposes of a dynamic model, the corporate tax could then be given a fixed capital stock. For purposes of a dynamic model, the corporate tax could then be
treated no different from a general tax on the rate of return. In addition, even though changes in treated no different from a general tax on the rate of return. In addition, even though changes in
the corporate tax rate could shift capital between the corporate and non-corporate sectors, the the corporate tax rate could shift capital between the corporate and non-corporate sectors, the
corporate tax base would be unlikely to change, because, although the capital stock in the corporate tax base would be unlikely to change, because, although the capital stock in the
corporate sector decreases with a higher corporate rate, the rate of return rises and these two corporate sector decreases with a higher corporate rate, the rate of return rises and these two
effects tend to be offsetting.9 effects tend to be offsetting.9
Open economy considerations suggest that the corporate tax should be considered differently Open economy considerations suggest that the corporate tax should be considered differently
from other types of taxes on capital income. The tax on corporate equity, which is effectively or at from other types of taxes on capital income. The tax on corporate equity, which is effectively or at
least partly a source-based tax, unlike individual income taxes on interest and dividends, can least partly a source-based tax, unlike individual income taxes on interest and dividends, can
directly affect capital flows into and out of the country, thereby increasing output through another directly affect capital flows into and out of the country, thereby increasing output through another
route (rather than indirectly affecting the rate of return to savings). Indeed, given the evidence route (rather than indirectly affecting the rate of return to savings). Indeed, given the evidence
~~that saving is relatively unresponsive to rates of return and tends to accumulate slowly, capital~~
~~flows from abroad could be one of the more important dynamic issues to consider.~~

8 Risk causes individuals to have precautionary savings, which tend to be less responsive to changes in the rate of 8 Risk causes individuals to have precautionary savings, which tend to be less responsive to changes in the rate of
return. It is possible to construct a life-cycle model with myopia, where agents assume current wages and returns will return. It is possible to construct a life-cycle model with myopia, where agents assume current wages and returns will
continue and re-optimize their labor supply and savings each period. Other things equal, myopia results in larger continue and re-optimize their labor supply and savings each period. Other things equal, myopia results in larger
responses to changes in tax rates because agents do not recognize the feedback effects of their responses on these responses to changes in tax rates because agents do not recognize the feedback effects of their responses on these
variables. variables.
9 Certain types of production functions and utility functions indicate a perfect offset and a constant share of total output 9 Certain types of production functions and utility functions indicate a perfect offset and a constant share of total output
in corporate revenues; for others, the effect is likely small. Corporate taxes produce distortions, but those distortions do in corporate revenues; for others, the effect is likely small. Corporate taxes produce distortions, but those distortions do
not affect aggregate output in a significant way. not affect aggregate output in a significant way.
Congressional Research Service Congressional Research Service

6 6

Dynamic Scoring for Tax Legislation: A Review of Models

that saving is relatively unresponsive to rates of return and tends to accumulate slowly, capital flows from abroad could be one of the more important dynamic issues to consider. The Organizations and Researchers That Study
Dynamic Effects
Several government organizations have prepared dynamic scores or macroeconomic analyses of Several government organizations have prepared dynamic scores or macroeconomic analyses of
effects that would permit estimates of dynamic feedback effects. In addition, numerous academic effects that would permit estimates of dynamic feedback effects. In addition, numerous academic
researchers have constructed models that estimate macroeconomic effects. researchers have constructed models that estimate macroeconomic effects.
Joint Committee on Taxation
The JCT is the most important source of dynamic estimates for U.S. legislative proposals, The JCT is the most important source of dynamic estimates for U.S. legislative proposals,
because it is responsible for official scoring of most tax legislation. The JCT also provides because it is responsible for official scoring of most tax legislation. The JCT also provides
macroeconomic analysis as required by the House Rules. The JCT has been preparing and then macroeconomic analysis as required by the House Rules. The JCT has been preparing and then
performing macroeconomic analyses since 1997, when they commissioned numerous researchers performing macroeconomic analyses since 1997, when they commissioned numerous researchers
to estimate the overall effects on output, labor, savings and other variables of the same proposal to estimate the overall effects on output, labor, savings and other variables of the same proposal
using a variety of different modeling approaches. This modeling exercise, along with others done using a variety of different modeling approaches. This modeling exercise, along with others done
over the years, is on its website.10 In their first analysis in 2003, researchers used three types of over the years, is on its website.10 In their first analysis in 2003, researchers used three types of
models to analyze macroeconomic effects: macroeconomic short-term effects based on models to analyze macroeconomic effects: macroeconomic short-term effects based on
commercial models, a Solow growth/hybrid model, and an OLG life-cycle model. They added a commercial models, a Solow growth/hybrid model, and an OLG life-cycle model. They added a
Ramsey hybrid (DSGE) model in 2006, but that model was subsequently revised. The OLG life-Ramsey hybrid (DSGE) model in 2006, but that model was subsequently revised. The OLG life-
cycle model has recently been revised to include corporate tax modeling. Currently, the JCT uses cycle model has recently been revised to include corporate tax modeling. Currently, the JCT uses
the Solow hybrid model (called the Macroeconomic Growth Model, or MEG), the OLG model, the Solow hybrid model (called the Macroeconomic Growth Model, or MEG), the OLG model,
and the DSGE model, which were all used in estimating the effects of the Tax Cuts and Jobs Act and the DSGE model, which were all used in estimating the effects of the Tax Cuts and Jobs Act
(P.L. 115-97(P.L. 115-97 ~~).11~~).11 The JCT has developed a new OLG model, which has been used to estimate the effects of some proposals, including the Build Back Better Act (BBBA; H.R. 5376) as passed by the House of Representatives, posted in 2023.12
The MEG is basically a Solow growth model that allows short-term stimulus effects, effects of The MEG is basically a Solow growth model that allows short-term stimulus effects, effects of
deficits and surplus, and includes a direct labor supply elasticity and deficits and surplus, and includes a direct labor supply elasticity and ~~a life-cycle treatment of~~
~~consumption that generates a savings effect~~savings response that reflects results from a myopic Ramsey model. In many ways, MEG could be viewed as a pragmatic . In many ways, MEG could be viewed as a pragmatic
combination of labor supply responses, short-run stimulus effects, crowding out effects, and a combination of labor supply responses, short-run stimulus effects, crowding out effects, and a
savings response from consumption with the same type of microeconomic foundations as savings response from consumption with the same type of microeconomic foundations as
intertemporal models but without the labor supply response to the interest rate. Meaning, there is intertemporal models but without the labor supply response to the interest rate. Meaning, there is
intertemporal substitution in consumption but not in leisure. The JCT studies prior to the point intertemporal substitution in consumption but not in leisure. The JCT studies prior to the point
estimate requirements frequently provided sensitivity analyses that allow a separation of stimulus estimate requirements frequently provided sensitivity analyses that allow a separation of stimulus
and crowding out effects from supply side effects.and crowding out effects from supply side effects.12
13 10 The Joint Committee’s documents relating to macroeconomic analysis are posted on its website at https://www.jct.gov/publications/?category_name=Macroeconomic%20Analysis. 11 JCT, Overview of Joint Committee Macroeconomic Modeling, JCX-33-18, April 23, 2018, https://www.jct.gov/publications/2018/jcx-33-18/. 12 JCT, Macroeconomic Analysis Of H.R. 5376, The “Build Back Better Act,” As Passed By The House Of Representatives, On November 19, 2021, December 6, 2021, https://www.jct.gov/publications/2021/macroeconomic-analysis-of-h-r-5376/. 13 Stimulus effects can be eliminated by assuming an offsetting policy of the Federal Reserve. Deficit effects can be eliminated by assuming offsetting changes in spending. Congressional Research Service 7 Dynamic Scoring for Tax Legislation: A Review of Models The JCT has tended not to use the short-term macroeconomic models after the first study, and in The JCT has tended not to use the short-term macroeconomic models after the first study, and in
some estimates has used only MEG. Its recent estimates include inputs from all three models: some estimates has used only MEG. Its recent estimates include inputs from all three models:
MEG, OLG, and DSGE. The analysis of the $1.5 trillion Tax Cuts and Jobs Act (P.L. 115-97MEG, OLG, and DSGE. The analysis of the $1.5 trillion Tax Cuts and Jobs Act (P.L. 115-97 ) )
gave a weight of 40% to MEG, 40% to OLG, and 20% to DSGE. It estimated that the gave a weight of 40% to MEG, 40% to OLG, and 20% to DSGE. It estimated that the
macroeconomic effects would offset 26% of revenue.macroeconomic effects would offset 26% of revenue.1314 In the estimate of the effects of the Protecting Family and Small Business Tax Cuts of 2018 (H.R. 6760), it gave a weight of 40% to MEG, 30% to OLG, and 30% to DSGE.15 The recent estimate of the House-passed BBBA assigned a weight of 35% to MEG, 35% to the OLG model, and 30% to the DSGE model. The most recent estimate, for an expansion of the child tax credit, assigned a weight of 50% to MEG and 50% to the OLG model.16 As noted above, the OLG model used in these simulations is from a new in-house model. ~~In the estimate of the effects of the~~

~~10 The Joint Committee’s documents relating to macroeconomic analysis are posted on its website at~~
~~https://www.jct.gov/publications/?category_name=Macroeconomic%20Analysis.~~
~~11 JCT, Overview of Joint Committee Macroeconomic Modeling, JCX-33-18, April 23, 2018, https://www.jct.gov/~~
~~publications/2018/jcx-33-18/.~~
~~12 Stimulus effects can be eliminated by assuming an offsetting policy of the Federal Reserve. Deficit effects can be~~
~~eliminated by assuming offsetting changes in spending.~~
~~13 JCT, Macroeconomic Analysis Of The Conference Agreement For H.R. 1, The Tax Cuts And Jobs Act, JCX-16-19,~~
~~December 27, 2017, https://www.jct.gov/publications/2017/jcx-69-17/.~~
~~Congressional Research Service~~

7

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

~~Protecting Family and Small Business Tax Cuts of 2018 (H.R. 6760), it gave a weight of 40% to~~
~~MEG, 30% to OLG, and 30% to DSGE.14~~
Until 2017, the JCT prepared dynamic analyses that provided sensitivity analysis and separate Until 2017, the JCT prepared dynamic analyses that provided sensitivity analysis and separate
effects of the different types of models, so that the effect of different assumptions could be effects of the different types of models, so that the effect of different assumptions could be
shown. Under the single point estimate effect adopted in 2015, none of the separate effects were shown. Under the single point estimate effect adopted in 2015, none of the separate effects were
reported. reported.
Congressional Budget Office
CBO has provided estimates of the economic effects of the President’s budget, which includes tax CBO has provided estimates of the economic effects of the President’s budget, which includes tax
provisions, from 2003 to 2016. It also provides economic effects of budget projections of provisions, from 2003 to 2016. It also provides economic effects of budget projections of
different types. CBO is charged with the responsibility for dynamic estimates, assisted by the different types. CBO is charged with the responsibility for dynamic estimates, assisted by the
JCT. JCT.
The first CBO study employed the same four types of models that JCT has used, although it The first CBO study employed the same four types of models that JCT has used, although it
introduced its own supply responses into the macroeconomic short-term models.introduced its own supply responses into the macroeconomic short-term models.1517 CBO CBO
ultimately dropped one of its models (the Ramsey infinite horizon) in its later ultimately dropped one of its models (the Ramsey infinite horizon) in its later ~~analyses16~~analyses18 and did and did
not use any intertemporal model in its 2014 analysis of budget options.not use any intertemporal model in its 2014 analysis of budget options.1719 The CBO OLG model The CBO OLG model
has recently been revised.has recently been revised.1820 CBO transitions from the short-run effects in macro model to the CBO transitions from the short-run effects in macro model to the
longer-term effects in its Solow and OLG models.longer-term effects in its Solow and OLG models.1921 CBO does not generally perform dynamic CBO does not generally perform dynamic
~~scores for tax legislation, although it included its own estimates of economic growth in a~~
~~discussion of the effects of the 2017 tax cut.20~~

14 14 JCT, Macroeconomic Analysis Of The Conference Agreement For H.R. 1, The Tax Cuts And Jobs Act, JCX-16-19, December 27, 2017, https://www.jct.gov/publications/2017/jcx-69-17/. 15 JCT, JCT, Macroeconomic Analysis Of H.R. 6760, The “Protecting Family And Small Business Tax Cuts Act Of 2018” As
Reported By The Committee On Ways And Means, JCX-79-18, September 26, 2018, https://www.jct.gov/publications/, JCX-79-18, September 26, 2018, https://www.jct.gov/publications/
2018/jcx-79-18/. 2018/jcx-79-18/.
1516 JCT, Macroeconomic Analysis Of A Permanent Child Tax Credit Expansion, October 5, 2022, https://www.jct.gov/publications/2022/macroeconomic-analysis-of-a-permanent-child-tax-credit-expansion/. 17 The initial analysis is described in The initial analysis is described in How CBO Analyzed the Macroeconomic Effects of the President’s Budget, April, , April,
2003, at http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/44xx/doc4454/07-28-presidentsbudget.pdf. 2003, at http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/44xx/doc4454/07-28-presidentsbudget.pdf.
1618 The most recent analysis of the President’s budget was in The most recent analysis of the President’s budget was in The Economic Impact of the President’s 2013 Budget, ,
April 20, 2012, at http://www.cbo.gov/publication/42972. April 20, 2012, at http://www.cbo.gov/publication/42972.
1719 See See Macroeconomic Effects of Alternative Budget Paths, February 2013, at http://www.cbo.gov/publication/43769. , February 2013, at http://www.cbo.gov/publication/43769.
1820 This model was presented in Shinichi Nishiyama, This model was presented in Shinichi Nishiyama, Fiscal Policy Effects in a Heterogeneous-Agent Overlapping-
Generations Economy With an Aging Population, Congressional Budget Office, Working Paper 2013-07, December , Congressional Budget Office, Working Paper 2013-07, December
2013, http://www.cbo.gov/sites/default/files/cbofiles/attachments/44941-Nishiyama.pdf. 2013, http://www.cbo.gov/sites/default/files/cbofiles/attachments/44941-Nishiyama.pdf.
1921 CBO, CBO, How CBO Analyzes the Effects of Changes in Federal Fiscal Policies on the Economy, November 2014, , November 2014,
https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/reports/49494-FiscalPolicies.pdf. See also https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/reports/49494-FiscalPolicies.pdf. See also The
Long-Term Budget Outlook Under Alternative Scenarios for Fiscal Policy, August 2018, https://www.cbo.gov/, August 2018, https://www.cbo.gov/
publication/54325. publication/54325.
~~20 CBO, The Budget and Economic Outlook: 2018 to 2028, Appendix B, April 9, 2018, https://www.cbo.gov/~~
~~publication/53651. See also The Long-Term Budget Outlook Under Alternative Scenarios for Fiscal Policy, August~~
~~2018, https://www.cbo.gov/publication/54325, where CBO examined the effects of retaining the temporary tax cuts.~~
~~Congressional Research Service~~

8

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

Congressional Research Service 8 Dynamic Scoring for Tax Legislation: A Review of Models scores for tax legislation, although it included its own estimates of economic growth in a discussion of the effects of the 2017 tax cut.22 Department of the Treasury Office of Tax Analysis
The Office of Tax Analysis (OTA) performed two dynamic analyses in 2006, one on the The Office of Tax Analysis (OTA) performed two dynamic analyses in 2006, one on the
President’s Advisory Panel on Tax Reform’s President’s Advisory Panel on Tax Reform’s ~~proposals21~~proposals23 and one on the extension of the 2001- and one on the extension of the 2001-
2003 tax cuts.2003 tax cuts.2224
For the first analysis, OTA used a Solow model, a Ramsey model, and an OLG model. The Solow For the first analysis, OTA used a Solow model, a Ramsey model, and an OLG model. The Solow
model had a fixed labor supply but a positive savings response to higher returns. In its analysis of model had a fixed labor supply but a positive savings response to higher returns. In its analysis of
the tax cuts, it used only the OLG model. the tax cuts, it used only the OLG model.
Treasury provided a one-page analysis of the Tax Cuts and Jobs Act ahead of the Senate vote that Treasury provided a one-page analysis of the Tax Cuts and Jobs Act ahead of the Senate vote that
projected the tax bill would raise revenue of $0.3 trillion. No models were cited and the analysis projected the tax bill would raise revenue of $0.3 trillion. No models were cited and the analysis
was apparently based on a specified increase in the growth rate.was apparently based on a specified increase in the growth rate.2325
Other Models and Researchers
The Solow growth model is the simplest of the models to construct, and government agencies and The Solow growth model is the simplest of the models to construct, and government agencies and
think tanks have used it primarily to examine the effects of tax changes, largely in the longer run. think tanks have used it primarily to examine the effects of tax changes, largely in the longer run.
The Urban Brookings Tax Policy Center uses a Solow model and a short-term macroeconomic The Urban Brookings Tax Policy Center uses a Solow model and a short-term macroeconomic
model, as well as model, as well as ~~partners~~partnering with the Penn Wharton Budget Center on an OLG model. The Tax with the Penn Wharton Budget Center on an OLG model. The Tax
Foundation uses a model similar to the Solow model, which projects the long-run capital stock Foundation uses a model similar to the Solow model, which projects the long-run capital stock
assuming a fixed after tax return, and then solves backward to determine savings over time.assuming a fixed after tax return, and then solves backward to determine savings over time.2426
Short-term macroeconomic models are largely used by commercial forecasters and government Short-term macroeconomic models are largely used by commercial forecasters and government
agencies, such as central banks; many central banks also have a hybrid model that couples short-agencies, such as central banks; many central banks also have a hybrid model that couples short-
~~run unemployment with a Ramsey infinite horizon model, the DSGE model.25 Some of these~~

21 22 CBO, The Budget and Economic Outlook: 2018 to 2028, Appendix B, April 9, 2018, https://www.cbo.gov/publication/53651. See also The Long-Term Budget Outlook Under Alternative Scenarios for Fiscal Policy, August 2018, https://www.cbo.gov/publication/54325, where CBO examined the effects of retaining the temporary tax cuts. 23 Robert Carroll, John Diamond, Craig Johnson, and James Makie III, Robert Carroll, John Diamond, Craig Johnson, and James Makie III, A Summary of the Dynamic Analysis of the Tax
Reform Options Prepared for the President’s Advisory Panel on Federal Tax Reform, U.S. Department of the Treasury, , U.S. Department of the Treasury,
Office of Tax Analysis, May 25, 2006, prepared for the American Enterprise Institute Conference on Tax Reform and Office of Tax Analysis, May 25, 2006, prepared for the American Enterprise Institute Conference on Tax Reform and
Dynamic Analysis, May 2006. This analysis was discussed in CRS Report RL33545, Dynamic Analysis, May 2006. This analysis was discussed in CRS Report RL33545, The Advisory Panel’s Tax Reform
Proposals, by Jane G. Gravelle. , by Jane G. Gravelle.
2224 U.S. Office of Management and Budget, U.S. Office of Management and Budget, Fiscal Year 2007 Mid-Session Review, Budget of the U.S. Government, July , Budget of the U.S. Government, July
11, 2006. This analysis is discussed in CRS Report RL33672, 11, 2006. This analysis is discussed in CRS Report RL33672, Revenue Feedback from the 2001-2004 Tax Cuts, by Jane , by Jane
G. Gravelle. G. Gravelle.
2325 Department of the Treasury, Department of the Treasury, Analysis of Growth and Revenue Estimates Based on the U.S. Senate Committee on
Finance Tax Reform Plan, December 11, 2017, https://www.crapo.senate.gov/imo/media/doc/, December 11, 2017, https://www.crapo.senate.gov/imo/media/doc/
2017DEC_TreasuryGrowthMemo.pdf; and https://oig.treasury.gov/sites/oig/files/Audit_Reports_and_Testimonies/2017DEC_TreasuryGrowthMemo.pdf; and https://oig.treasury.gov/sites/oig/files/Audit_Reports_and_Testimonies/
Response%20to%20Requests%20for%20Inquiry%20Re%20Analysis%20of%20Tax%20Reform%20Bill.pdf. Response%20to%20Requests%20for%20Inquiry%20Re%20Analysis%20of%20Tax%20Reform%20Bill.pdf.
2426 For example, see Robert Carroll and Gerald Prante, “Long-Run Macroeconomic Impact of Increasing Tax Rates on For example, see Robert Carroll and Gerald Prante, “Long-Run Macroeconomic Impact of Increasing Tax Rates on
High-Income Taxpayers in 2013,” Ernst & Young LLP, July 2012, http://s-corp.org/wp-content/uploads/2012/07/EY-High-Income Taxpayers in 2013,” Ernst & Young LLP, July 2012, http://s-corp.org/wp-content/uploads/2012/07/EY-
Study-Long-run-macroeconomic-impact-of-increasing-tax-rates-on-high-income-taxpayers-in-2013-2012-07-16-Study-Long-run-macroeconomic-impact-of-increasing-tax-rates-on-high-income-taxpayers-in-2013-2012-07-16-
FINAL1.pdf. Steve Entin and William McBride, FINAL1.pdf. Steve Entin and William McBride, Simulating the Economic Effects of Romney’s Tax Plan, Tax , Tax
Foundation, Fiscal Fact No. 330, http://taxfoundation.org/article/simulating-economic-effects-romneys-tax-plan used a Foundation, Fiscal Fact No. 330, http://taxfoundation.org/article/simulating-economic-effects-romneys-tax-plan used a
neoclassical growth model, but reported effects in the long run steady state, and not the transition. Benjamin R. Page neoclassical growth model, but reported effects in the long run steady state, and not the transition. Benjamin R. Page
and Kent Smetters, “Dynamic Analysis of Tax Plans,” Tax Policy Center, April 5, 2017, https://www.urban.org/sites/and Kent Smetters, “Dynamic Analysis of Tax Plans,” Tax Policy Center, April 5, 2017, https://www.urban.org/sites/
default/files/publication/89456/2001217-dynamic-analysis-of-tax-plans-an-update.pdf; Stephen J. Entin, Huaqun Li, default/files/publication/89456/2001217-dynamic-analysis-of-tax-plans-an-update.pdf; Stephen J. Entin, Huaqun Li,
and Kyle Pomerleau, “Overview of the Tax Foundation’s General Equilibrium Model,” April 2018, and Kyle Pomerleau, “Overview of the Tax Foundation’s General Equilibrium Model,” April 2018,
https://files.taxfoundation.org/20180419195810/TaxFoundaton_General-Equilibrium-Model-Overview1.pdf?_gl=https://files.taxfoundation.org/20180419195810/TaxFoundaton_General-Equilibrium-Model-Overview1.pdf?_gl=
~~1*1oy7o6l*_ga*MjEyMzIxMDM0Mi4xNjcxODA3NDI1*_ga_FP7KWDV08V*MTY3ODgxOTEwNC4zMS4xLjE2N~~
~~zg4MTkxMTUuNDkuMC4w.~~
~~25 For a discussion of these models, see CRS Report R42700,~~ ~~The “Fiscal Cliff”: Macroeconomic Consequences of Tax~~
~~Increases and Spending Cuts, by Jane G. Gravelle; and Felix Reichling and Charles Whalen,~~ ~~Assessing the Short-Term~~
~~Effects on Output of Changes in Federal Fiscal Policies, CBO Working Paper 2012-08, May 2012, at~~1.
Congressional Research Service Congressional Research Service

9 9

Dynamic Scoring for Tax Legislation: A Review of Models

run unemployment with a Ramsey infinite horizon model, the DSGE model.27 Some of these models are very complex, with many sectors and interactions. JCT’s MEG model and DSGE models are very complex, with many sectors and interactions. JCT’s MEG model and DSGE
model allow for short-term demand effects. CBO relies on macro forecasting models model allow for short-term demand effects. CBO relies on macro forecasting models
(Macroeconomic Advisers and IHS Global Insight), as well as a macroeconomic model (Macroeconomic Advisers and IHS Global Insight), as well as a macroeconomic model
developed by the Federal Reserve.developed by the Federal Reserve.2628
The Ramsey infinite horizon model is generally straightforward to construct, and there are The Ramsey infinite horizon model is generally straightforward to construct, and there are
numerous modeling efforts in academia and government. These models are more frequently used numerous modeling efforts in academia and government. These models are more frequently used
by macroeconomists interested in business cycles and the effects of shocks to the economy, rather by macroeconomists interested in business cycles and the effects of shocks to the economy, rather
than modeling tax changes. Tax economists interested in intertemporal models are more likely to than modeling tax changes. Tax economists interested in intertemporal models are more likely to
turn to the OLG life-cycle model, which can capture intergenerational income shifts, even though turn to the OLG life-cycle model, which can capture intergenerational income shifts, even though
this model is more difficult to construct. Because of this difficulty in construction, only a limited this model is more difficult to construct. Because of this difficulty in construction, only a limited
number of researchers have done life-cycle modeling. The pioneers in this effort were Alan number of researchers have done life-cycle modeling. The pioneers in this effort were Alan
Auerbach and Laurence Kotlikoff, and their associates, including those who constructed a Auerbach and Laurence Kotlikoff, and their associates, including those who constructed a
variation of the OLG life-cycle model at CBO.variation of the OLG life-cycle model at CBO.2729 The JCT and the Treasury both used an OLG The JCT and the Treasury both used an OLG
model created by John Diamond through a contract with Tax Policy Advisors, LLC.model created by John Diamond through a contract with Tax Policy Advisors, LLC.28
~~Researchers at Ernst and Young have an OLG model that is similar to the JCT model, but with an~~
~~open economy, and estimated the effects of the Tax Cuts and Jobs Act.29 Two academic~~
~~researchers—George Zodrow and John Diamond—often estimate the effects of policies using~~
~~OLG models. Zodrow and Diamond have examined tax changes,30 and Diamond most recently~~

30 JCT has now developed an in-house OLG model.31 27 For a discussion of these models, see CRS Report R42700, The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases and Spending Cuts, by Jane G. Gravelle; and Felix Reichling and Charles Whalen, Assessing the Short-Term Effects on Output of Changes in Federal Fiscal Policies, CBO Working Paper 2012-08, May 2012, at http://www.cbo.gov/sites/default/files/cbofiles/attachments/WorkingPaper2012-08-Effects_of_Fiscal_Policies.pdf. http://www.cbo.gov/sites/default/files/cbofiles/attachments/WorkingPaper2012-08-Effects_of_Fiscal_Policies.pdf.
2628 Congressional Budget Office, Congressional Budget Office, How CBO Analyzes the Effects of Changes in Federal Fiscal Policies on the Economy, ,
November 2014, https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/reports/49494-FiscalPolicies.pdf, November 2014, https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/reports/49494-FiscalPolicies.pdf,
and and The Economic Impact of the President’s 2013 Budget, April 2012, at http://www.cbo.gov/sites/default/files/, April 2012, at http://www.cbo.gov/sites/default/files/
cbofiles/attachments/04-20-Economic_Budget.pdf. cbofiles/attachments/04-20-Economic_Budget.pdf.
2729 The details of a typical OLG model were presented in Alan J. Auerbach and Laurence J. Kotlikoff, The details of a typical OLG model were presented in Alan J. Auerbach and Laurence J. Kotlikoff, Dynamic Fiscal
Policy, Cambridge University Press, New York, New York, 1987. A version of their model with additional coauthors , Cambridge University Press, New York, New York, 1987. A version of their model with additional coauthors
Kent Smetters and Jan Walliser was included in the Joint Committee On Taxation Kent Smetters and Jan Walliser was included in the Joint Committee On Taxation Tax Modeling Project And 1997 Tax
Symposium Papers, Joint Committee Print, November 20, 1997, posted on the JCT website at https://www.jct.gov/, Joint Committee Print, November 20, 1997, posted on the JCT website at https://www.jct.gov/
publications.html?func=startdown&id=2940. Another more detailed study with more sectors was David Altig, Alan J. publications.html?func=startdown&id=2940. Another more detailed study with more sectors was David Altig, Alan J.
Auerbach, Laurence J. Kotlikoff, Kent A. Smetters, and Jan Walliser, Simulating Fundamental Tax Reform in the Auerbach, Laurence J. Kotlikoff, Kent A. Smetters, and Jan Walliser, Simulating Fundamental Tax Reform in the
United States, United States, American Economic Review, vol. 91, no. 3, June 2001, pp. 575-595, at http://www2.wiwi.hu-berlin.de/, vol. 91, no. 3, June 2001, pp. 575-595, at http://www2.wiwi.hu-berlin.de/
institute/wpol/html/jprof/aer.pdf. The CBO model was initially developed by Shinichi Nishiyama and Kent Smetters, institute/wpol/html/jprof/aer.pdf. The CBO model was initially developed by Shinichi Nishiyama and Kent Smetters,
Consumption Taxes and Economic Efficiency in a Stochastic OLG Model, Technical Working Paper 2002-6, Consumption Taxes and Economic Efficiency in a Stochastic OLG Model, Technical Working Paper 2002-6,
December 2002, at http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/40xx/doc4007/2002- \6.pdf. It includes risk December 2002, at http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/40xx/doc4007/2002- \6.pdf. It includes risk
and different types of households. The JCT symposium included two other life-cycle models, one by Don Fullerton and and different types of households. The JCT symposium included two other life-cycle models, one by Don Fullerton and
Diane Rogers (now Diane Lim), which had multiple sectors and households and one by Eric Engen and Bill Gale, Diane Rogers (now Diane Lim), which had multiple sectors and households and one by Eric Engen and Bill Gale,
which included risk. Including the discussant Charles Ballard, input was provided from all the multiple generation life-which included risk. Including the discussant Charles Ballard, input was provided from all the multiple generation life-
cycle modelers at that time. The JCT symposium also included one infinite horizon model, by Dale W. Jorgenson and cycle modelers at that time. The JCT symposium also included one infinite horizon model, by Dale W. Jorgenson and
Peter J. Wilcoxin, along with five models that were Solow-type models or hybrid macroeconomic/Solow models. Peter J. Wilcoxin, along with five models that were Solow-type models or hybrid macroeconomic/Solow models.
Kotlikoff and his colleagues subsequently developed a multi-country OLG model which recently was used to estimate a Kotlikoff and his colleagues subsequently developed a multi-country OLG model which recently was used to estimate a
shift to a cash flow tax. See Seth G. Benzell, Laurence J. Kotlikoff, Guillermo LaGarda & Victor Yifan Ye, shift to a cash flow tax. See Seth G. Benzell, Laurence J. Kotlikoff, Guillermo LaGarda & Victor Yifan Ye, Simulating
Business Cash Flow Taxation, NBER Working Paper 23675, August 2017, https://www.nber.org/papers/w23675. This , NBER Working Paper 23675, August 2017, https://www.nber.org/papers/w23675. This
model is driven largely by international capital flows as it assumes immediate reallocation of capital assuming perfect model is driven largely by international capital flows as it assumes immediate reallocation of capital assuming perfect
substitution of capital across countries, in a one-sector model. Also, while there is significant detail about the OLG part substitution of capital across countries, in a one-sector model. Also, while there is significant detail about the OLG part
of the model, the corporate model that tends to drive short-run effects is of a limited form that does not account for of the model, the corporate model that tends to drive short-run effects is of a limited form that does not account for
noncorporate sectors or adjustment periods. noncorporate sectors or adjustment periods.
2830 John Diamond is the CEO of Tax Policy Advisors, and is at the James A. Baker III Institute for Public Policy at Rice John Diamond is the CEO of Tax Policy Advisors, and is at the James A. Baker III Institute for Public Policy at Rice
University. University.
~~29 Brandon Pizzola, Robert Carroll and James Mackie,~~ ~~Analyzing the Macroeconomic Impacts of the Tax Cuts and Jobs~~
~~Act on the US Economy and Key Industries, https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/growth/~~
~~growth-pdfs/ey-tax-reform-projected-to-grow-us-economy.pdf.~~
~~30John Diamond, The Economic Effects of the Romney Plan, Rice University’s Baker Institute for Public Policy, August~~
~~3, 2012, at https://www.bakerinstitute.org/research/the-economic-effects-of-the-romney-tax-plan. John Diamond and~~
~~Congressional Research Service~~

10

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

~~provided an estimate of the effect of the Inflation Protection Act (P.L. 117-169).31 The Penn~~
~~Wharton Budget Model uses an OLG model and frequently provides analysis of tax proposals.32~~
~~For example, it estimated the economic effects of the White House Build Back Better proposal.33~~31 See Joint Committee on Taxation, An Overview Of A New Overlapping Generations Model With An Example Application In Policy Analysis, JCX-22R-20, October 22, 2020, https://www.jct.gov/publications/2020/jcx-22r-20/. A technical explanation can be found in Rachel Moore and Brandon Pecoraro, “Macroeconomic Implications of Modeling the Internal Revenue Code in a Heterogeneous-Agent Framework,” Economic Modeling, vol. 87 (May 2020), pp. 72-91. Congressional Research Service 10 Dynamic Scoring for Tax Legislation: A Review of Models Researchers at Ernst and Young have an OLG model that is similar to the Diamond model, but with an open economy, and estimated the effects of the Tax Cuts and Jobs Act.32 Two academic researchers—George Zodrow and John Diamond—often estimate the effects of policies using OLG models. Zodrow and Diamond have examined tax changes,33 and Diamond most recently provided an estimate of the effect of the Inflation Protection Act (P.L. 117-169).34 The Penn Wharton Budget Model uses an OLG model and frequently provides analysis of tax proposals.35 For example, it estimated the economic effects of the White House Build Back Better proposal.36
Researchers can use the Penn Wharton and input their own parameters. This OLG model allows Researchers can use the Penn Wharton and input their own parameters. This OLG model allows
for uncertainty and for closed, fully open, and partially open economies. DeBacker, Evans, and for uncertainty and for closed, fully open, and partially open economies. DeBacker, Evans, and
Philips also have an OLG model.Philips also have an OLG model.3437
Special Issues Associated with Revenue-Neutral
Income Tax Reform
Some argue tax reform should be revenue neutral. Others believe that it should raise revenue. A Some argue tax reform should be revenue neutral. Others believe that it should raise revenue. A
revenue neutral, or largely revenue neutral, tax reform that lowers the rate and broadens the base revenue neutral, or largely revenue neutral, tax reform that lowers the rate and broadens the base
is unlikely to have a large effect on the economy. It could contract, rather than expand, the is unlikely to have a large effect on the economy. It could contract, rather than expand, the
economy, depending on the design. economy, depending on the design.
All of the effects that might be considered in a dynamic estimate, including short-run stimulus, All of the effects that might be considered in a dynamic estimate, including short-run stimulus,
long-run crowding out or crowding in investments through deficits, and supply side responses, long-run crowding out or crowding in investments through deficits, and supply side responses,
would likely be eliminated or dampened in a revenue neutral tax reform. would likely be eliminated or dampened in a revenue neutral tax reform.
Short-Run Stimulus, or Demand Side, Effects
Because there would be no change in income under a revenue neutral reform, there would be no Because there would be no change in income under a revenue neutral reform, there would be no
effects on aggregate demand, unless there was a shift in the distribution of the tax burden. For effects on aggregate demand, unless there was a shift in the distribution of the tax burden. For
example, if the relative burden shifts to high-income individuals, there may be a small stimulus example, if the relative burden shifts to high-income individuals, there may be a small stimulus
because lower-income individuals tend to spend more. Likewise, a shift to low-income because lower-income individuals tend to spend more. Likewise, a shift to low-income
~~individuals would provide a small contraction. A distributionally and revenue neutral tax revision~~
~~should have virtually no short-run stimulus effect.~~
~~Deficits and Crowding Out or Crowding In~~
~~A tax revision that is revenue neutral would have no direct effects on crowding out or crowding in~~
~~because there is no change in the deficit. If the analysis extends beyond the budget window, then~~
~~a tax reform that is revenue neutral in the short run may not be neutral in the long run. Some base~~
~~broadening provisions (such as slowing depreciation deductions) have a larger revenue gain in the~~

32 Brandon Pizzola, Robert Carroll and James Mackie, Analyzing the Macroeconomic Impacts of the Tax Cuts and Jobs Act on the US Economy and Key Industries, https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/growth/growth-pdfs/ey-tax-reform-projected-to-grow-us-economy.pdf. 33 John Diamond, The Economic Effects of the Romney Plan, Rice University’s Baker Institute for Public Policy, August 3, 2012, at https://www.bakerinstitute.org/research/the-economic-effects-of-the-romney-tax-plan. John Diamond and George Zodrow, George Zodrow, The Dynamic Effects of Eliminating or Curtailing the Home Mortgage Interest Deduction, December , December
7, 2012, https://scholarship.rice.edu/bitstream/handle/1911/91695/TEPP-pub-7, 2012, https://scholarship.rice.edu/bitstream/handle/1911/91695/TEPP-pub-
DiamondZodrowHomeMortgageInterestDeduction-120712.pdf?sequence=1&isAllowed=y; John W. Diamond and DiamondZodrowHomeMortgageInterestDeduction-120712.pdf?sequence=1&isAllowed=y; John W. Diamond and
George R. Zodrow, George R. Zodrow, Dynamic Macroeconomic Estimates of the Effects of Chairman Camp’s 2014 Tax Reform
Proposal, Tax Policy Advisers LLC, prepared for the Business Roundtable, http://businessroundtable.org/sites/default/, Tax Policy Advisers LLC, prepared for the Business Roundtable, http://businessroundtable.org/sites/default/
files/reports/Diamond-Zodrow%20Analysis%20for%20Business%20Roundtable_Final%20for%20Release.pdf. files/reports/Diamond-Zodrow%20Analysis%20for%20Business%20Roundtable_Final%20for%20Release.pdf.
3134 John Diamond, John Diamond, Macroeconomic Effects of the Inflation Reduction Act, Working Paper, Rice University’s Baker , Working Paper, Rice University’s Baker
Institute for Public Policy, August 4, 2022, https://www.bakerinstitute.org/research/macroeconomic-effects-inflation-Institute for Public Policy, August 4, 2022, https://www.bakerinstitute.org/research/macroeconomic-effects-inflation-
reduction-act. reduction-act.
3235 Penn Wharton Budget Model, Penn Wharton Budget Model, Dynamic OLG, https://budgetmodel.wharton.upenn.edu/dynamic-olg. , https://budgetmodel.wharton.upenn.edu/dynamic-olg.
3336 Penn Wharton Budget Model, Penn Wharton Budget Model, Macroeconomic Effects of the White House Build Back Better Budget Reconciliation
Framework, November 4, 2021, https://budgetmodel.wharton.upenn.edu/issues/2021/11/4/macro-effects-of-build-back-, November 4, 2021, https://budgetmodel.wharton.upenn.edu/issues/2021/11/4/macro-effects-of-build-back-
better-reconciliation-package. better-reconciliation-package.
3437 Jason DeBacker, Richard W. Evans, and Kerk L. Phillips, “Integrating Microsimulation Models of Tax Policy into a Jason DeBacker, Richard W. Evans, and Kerk L. Phillips, “Integrating Microsimulation Models of Tax Policy into a
DGE Macroeconomic Model,” DGE Macroeconomic Model,” Public Finance Review, vol. 47, no. 2 (2019), pp. 207-275. , vol. 47, no. 2 (2019), pp. 207-275.
Congressional Research Service Congressional Research Service

11 11

Dynamic Scoring for Tax Legislation: A Review of Models

individuals would provide a small contraction. A distributionally and revenue neutral tax revision should have virtually no short-run stimulus effect. Deficits and Crowding Out or Crowding In A tax revision that is revenue neutral would have no direct effects on crowding out or crowding in because there is no change in the deficit. If the analysis extends beyond the budget window, then a tax reform that is revenue neutral in the short run may not be neutral in the long run. Some base broadening provisions (such as slowing depreciation deductions) have a larger revenue gain in the short run than in the long run. In addition, flattening the individual income tax rate structure leads short run than in the long run. In addition, flattening the individual income tax rate structure leads
to lower revenues in the long run by reducing real bracket creep (i.e., the rise in the average to lower revenues in the long run by reducing real bracket creep (i.e., the rise in the average
effective tax rate in a progressive tax system as real incomes rise). Thus, crowding out could effective tax rate in a progressive tax system as real incomes rise). Thus, crowding out could
occur in the longer run. occur in the longer run.
Supply Side Responses
The supply side responses are frequently the major focus of dynamic scoring for taxes.The supply side responses are frequently the major focus of dynamic scoring for taxes.3538 In a In a
revenue neutral income tax reform, there are no aggregate income effects. There could be effects revenue neutral income tax reform, there are no aggregate income effects. There could be effects
on labor and saving if there are distributional effects across income classes and if the model on labor and saving if there are distributional effects across income classes and if the model
reflects those effects, but a distributionally neutral income tax reform would not have those reflects those effects, but a distributionally neutral income tax reform would not have those
effects.effects.3639 Thus, it is the substitution effect that is the driver of supply side responses to a revenue Thus, it is the substitution effect that is the driver of supply side responses to a revenue
neutral tax cut. A rate reduction financed by base broadening cannot be analyzed by looking neutral tax cut. A rate reduction financed by base broadening cannot be analyzed by looking
solely at marginal statutory rates. The base broadening provisions, which increase tax burdens, solely at marginal statutory rates. The base broadening provisions, which increase tax burdens,
can affect effective marginal tax rates that may have effects on supply side responses of labor, can affect effective marginal tax rates that may have effects on supply side responses of labor,
savings, and investment.savings, and investment.3740
Corporate Tax Reform
This effect on effective marginal tax rates is perhaps most clear when discussing corporate tax This effect on effective marginal tax rates is perhaps most clear when discussing corporate tax
reform. Moreover, in an open economy, changing tax burdens at the corporate level is more reform. Moreover, in an open economy, changing tax burdens at the corporate level is more
important for investment (because the corporate tax directly affects international capital flows, important for investment (because the corporate tax directly affects international capital flows,
whereas taxes on interest and dividends apply to both domestic and foreign investment). Most of whereas taxes on interest and dividends apply to both domestic and foreign investment). Most of
the major provisions that could be used for base broadening in a revenue neutral corporate tax the major provisions that could be used for base broadening in a revenue neutral corporate tax
reform directly offset effects on investment incentives of lowering rates. One of the largest, reform directly offset effects on investment incentives of lowering rates. One of the largest,
accelerated depreciation, if traded for a statutory rate reduction, would increase the effective tax accelerated depreciation, if traded for a statutory rate reduction, would increase the effective tax
rate on new investment and discourage investment.rate on new investment and discourage investment.3841 This effect arises because the rate cut has a 38 ~~This effect arises because the rate cut has a~~
~~windfall benefit for old capital whereas accelerated depreciation does not.39 Accelerated~~
~~depreciation, however, is being phased out, in large part, after 2022. Assuming corporate tax~~
~~reform is neutral in the long-run estimates suggests that eliminating all tax expenditures other~~
~~than accelerated depreciation could reduce statutory corporate tax rates by about 6 percentage~~
~~points, from 21% to 13%.40 Out of that amount, about half would be due to eliminating~~

35 See, for example, Curtis S. Dubay, See, for example, Curtis S. Dubay, Tax Reform is about Economic Growth, The Heritage Foundation, October 11, , The Heritage Foundation, October 11,
2012, http://www.heritage.org/research/commentary/2012/10/tax-reform-is-about-economic-growth; and Dylan 2012, http://www.heritage.org/research/commentary/2012/10/tax-reform-is-about-economic-growth; and Dylan
Matthews, “Why Tax Reform Could Help Growth,” Matthews, “Why Tax Reform Could Help Growth,” Washington Post, October 16, 2012, , October 16, 2012,
http://www.washingtonpost.com/blogs/wonkblog/wp/2012/10/16/why-tax-reform-could-help-growth/. http://www.washingtonpost.com/blogs/wonkblog/wp/2012/10/16/why-tax-reform-could-help-growth/.
3639 In OLG models, a revenue neutral shifts from an income tax to a consumption tax, a subject that has been a primary In OLG models, a revenue neutral shifts from an income tax to a consumption tax, a subject that has been a primary
focus of modeling using OLG models, can have pronounced effects due both to intergenerational distribution and the focus of modeling using OLG models, can have pronounced effects due both to intergenerational distribution and the
timing of tax payments. This type of reform, however, is not the type currently under discussion. timing of tax payments. This type of reform, however, is not the type currently under discussion.
3740 Alan Auerbach and Joel Slemrod indicated that the Tax Reform Act of 1986 left incentives roughly unchanged. See Alan Auerbach and Joel Slemrod indicated that the Tax Reform Act of 1986 left incentives roughly unchanged. See
“The Economic Effects of the Tax Reform Act of 1986,” “The Economic Effects of the Tax Reform Act of 1986,” Journal of Economic Literature, vol. 35, no. 2, June 1997, pp. , vol. 35, no. 2, June 1997, pp.
589-632. Alan Viard, in “Statutory and Effective Tax Rates: Part 1,” 589-632. Alan Viard, in “Statutory and Effective Tax Rates: Part 1,” Tax Notes, August 20, 2012, pp. 943-947, and , August 20, 2012, pp. 943-947, and
Bruce Bartlett, “Misunderstanding Tax Expenditures and Tax Rates,” Tax Notes, November 22, 2010, pp. 931-932, Bruce Bartlett, “Misunderstanding Tax Expenditures and Tax Rates,” Tax Notes, November 22, 2010, pp. 931-932,
also make the general point that revenue neutral tax reform is unlikely to alter work incentives. also make the general point that revenue neutral tax reform is unlikely to alter work incentives.
3841 See Jane G. Gravelle, “Reducing Depreciation Allowances to Finance a Lower Corporate Tax Rate,” See Jane G. Gravelle, “Reducing Depreciation Allowances to Finance a Lower Corporate Tax Rate,” National Tax
Journal, vol. 64, December 2011, pp 1039-1053, and Statement of Jane G. Gravelle Before The Committee on Finance , vol. 64, December 2011, pp 1039-1053, and Statement of Jane G. Gravelle Before The Committee on Finance
~~United States Senate, March 6, 2012 on Tax Reform Options: Incentives for Capital Investment and Manufacturing, at~~
~~http://www.finance.senate.gov/hearings/hearing/?id=7ef25099-5056-a032-52a2-7e15cca1ba5d.~~
~~39 A similar effect would occur if research and development costs were expensed rather than capitalized.~~
~~40 See CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by Jane G. Gravelle, for a translation of base~~
~~Congressional Research Service~~

12

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

(continued...) Congressional Research Service 12 Dynamic Scoring for Tax Legislation: A Review of Models windfall benefit for old capital whereas accelerated depreciation does not.42 Accelerated depreciation, however, is being phased out, in large part, after 2022. Assuming corporate tax reform is neutral in the long-run estimates suggests that eliminating all tax expenditures other than accelerated depreciation could reduce statutory corporate tax rates by about 6 percentage points, from 21% to 13%.43 Out of that amount, about half would be due to eliminating international preferences. The preferences that favor treatment of corporate income relating to international preferences. The preferences that favor treatment of corporate income relating to
international activities would have a relatively neutral effect on overall investment but would international activities would have a relatively neutral effect on overall investment but would
encourage more investment in the United States. Most of the other important tax expenditures encourage more investment in the United States. Most of the other important tax expenditures
would have similar effects to accelerating depreciation and raise the cost of capital used to reduce would have similar effects to accelerating depreciation and raise the cost of capital used to reduce
tax rates. tax rates.
The JCT used The JCT used ~~the new~~a version of the OLG model, which version of the OLG model, which ~~affected~~reflected the shift of intellectual property the shift of intellectual property
from foreign countries to the United States, as reported in a from foreign countries to the United States, as reported in a ~~recent~~ simulation of former Ways and simulation of former Ways and
Means Committee Chairman Camp’s tax reform proposal.Means Committee Chairman Camp’s tax reform proposal.~~41 This channel of growth is~~
~~questionable, because intellectual capital is not located physically. Once it exists it can be used~~
~~everywhere. For example, when a firm discovers Lipitor, it uses the formula no matter where the~~
~~pills are made. When a firm develops the technology for a smart phone, or a search algorithm,~~
~~that knowledge can be applied costlessly to production everywhere. It does not matter if the~~
~~patent is held in country A and licensed to country B, or vice versa. Therefore, shifting ownership~~
~~of intellectual property to the United States cannot increase productivity in the United States~~
~~because that input is already in existence. Shifts in intellectual property may alter revenues, but~~
~~not output. The case is similarly weak for marketing intangibles. For general property such as~~
~~trademarks, firms like Starbucks and products like Coca-Cola share the benefits of trademarks~~
~~regardless of which country holds ownership rights.42~~44 This model and the intellectual property shift is no longer used by the JCT.45
Individual Tax Reform
Taxes can cause three supply side effects: labor supply, domestic savings, and net inflows of Taxes can cause three supply side effects: labor supply, domestic savings, and net inflows of
capital from the rest of the world. Individual income tax reform can affect labor supply and capital from the rest of the world. Individual income tax reform can affect labor supply and
savings. savings.
In a revenue neutral change, there is generally no change in overall income and income effects are In a revenue neutral change, there is generally no change in overall income and income effects are
negligible. Thus, an analysis of revenue neutral tax reform that relied only on cuts in marginal negligible. Thus, an analysis of revenue neutral tax reform that relied only on cuts in marginal
statutory rates would find larger supply side effects than a rate cut that was not revenue neutral. statutory rates would find larger supply side effects than a rate cut that was not revenue neutral.
Labor supply would unambiguously increase from cuts in marginal rates on labor income. In Labor supply would unambiguously increase from cuts in marginal rates on labor income. In
intertemporal models, labor supply also responds to the rate of return. The substitution effect intertemporal models, labor supply also responds to the rate of return. The substitution effect
~~means that, with a higher rate of return, future consumption, including future leisure, becomes~~
~~cheaper so agents work more in the present to save and have more leisure in the future. This~~
~~behavior would directly increase output in the short run through increases in labor input and~~
~~would cause a larger savings response and increase in the capital stock.43~~

United States Senate, March 6, 2012 on Tax Reform Options: Incentives for Capital Investment and Manufacturing, at http://www.finance.senate.gov/hearings/hearing/?id=7ef25099-5056-a032-52a2-7e15cca1ba5d. 42 A similar effect would occur if research and development costs were expensed rather than capitalized. 43 See CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by Jane G. Gravelle, for a translation of base broadening provisions into the rate reductions they could finance. broadening provisions into the rate reductions they could finance.
41 44 JCT, Macroeconomic Analysis of the “Tax Reform Act of 2014,” JCX-22-14, February 26, 2014, https://www.jct.gov/Macroeconomic Analysis of the “Tax Reform Act of 2014,” JCX-22-14, February 26, 2014, https://www.jct.gov/
publications.html?func=startdown&id=4564. The JCT indicates that this modeling follows that of Michael P. Devereux publications.html?func=startdown&id=4564. The JCT indicates that this modeling follows that of Michael P. Devereux
and Ruud de Mooij in “An Applied Analysis of ACE and CBIT Reforms in the EU,” and Ruud de Mooij in “An Applied Analysis of ACE and CBIT Reforms in the EU,” International Tax and Public
Finance, vol. 18, no. 1, vol. 18, no. 1~~, 2011~~ (2011), pp. 93-120, and Leon Battendorf et al., “Corporate Tax Harmonization in the EU,” , pp. 93-120, and Leon Battendorf et al., “Corporate Tax Harmonization in the EU,”
Economic Policy, vol. 63, vol. 63~~, 2010~~ (2010), pp. 537-590. The authors do not present any empirical evidence to support entering , pp. 537-590. The authors do not present any empirical evidence to support entering
what they refer to as firm-specific capital into the production function, or the importance of it in the economy. what they refer to as firm-specific capital into the production function, or the importance of it in the economy.
4245 This channel of growth is questionable, because intellectual capital is not located physically. Once it exists it can be used everywhere. For example, when a firm discovers Lipitor, it uses the formula no matter where the pills are made. When a firm develops the technology for a smart phone, or a search algorithm, that knowledge can be applied costlessly to production everywhere. It does not matter if the patent is held in country A and licensed to country B, or vice versa. Therefore, shifting ownership of intellectual property to the United States cannot increase productivity in the United States because that input is already in existence. Shifts in intellectual property may alter revenues, but not output. The case is similarly weak for marketing intangibles. For general property such as trademarks, firms like Starbucks and products like Coca-Cola share the benefits of trademarks regardless of which country holds ownership rights. A similar critique was made by William McBride, A similar critique was made by William McBride, Some Questions Regarding the Diamond and Zodrow Modeling of
Camp’s Tax Plan, Tax Foundation, March 17, 2014, http://taxfoundation.org/blog/some-questions-regarding-diamond-, Tax Foundation, March 17, 2014, http://taxfoundation.org/blog/some-questions-regarding-diamond-
and-zodrow-modeling-camps-tax-plan. The intangibles effect in the JCT simulation in the OLG model also reflected a and-zodrow-modeling-camps-tax-plan. The intangibles effect in the JCT simulation in the OLG model also reflected a
much higher elasticity (the percentage shift in profits divided by the percentage point change in the tax rate much higher elasticity (the percentage shift in profits divided by the percentage point change in the tax rate
differential), 8.6, than the consensus elasticity of 0.8. See Dhammika Darmapala, “What Do We Know About Base differential), 8.6, than the consensus elasticity of 0.8. See Dhammika Darmapala, “What Do We Know About Base
Erosion and Profit Shifting? A Review of the Empirical Literature,” Illinois Public Law and Legal Theory Research Erosion and Profit Shifting? A Review of the Empirical Literature,” Illinois Public Law and Legal Theory Research
~~Papers Series No. 14-23, December 2013.~~
~~43 One study of the effects on savings that eliminated all taxes on capital income and replaced them with higher wage~~
~~taxes found a savings response in the life-cycle model with variable labor that was almost five times as large as in a~~
~~Congressional Research Service~~

13

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

Papers Series No. 14-23, December 2013. Congressional Research Service 13 Dynamic Scoring for Tax Legislation: A Review of Models means that, with a higher rate of return, future consumption, including future leisure, becomes cheaper so agents work more in the present to save and have more leisure in the future. This behavior would directly increase output in the short run through increases in labor input and would cause a larger savings response and increase in the capital stock.46 This approach would overstate supply side effects because individual income tax reforms that This approach would overstate supply side effects because individual income tax reforms that
broaden the base could also have effects on the marginal effective tax rates. Depending on the broaden the base could also have effects on the marginal effective tax rates. Depending on the
provision, a revenue neutral change could increase or decrease labor supply and savings because provision, a revenue neutral change could increase or decrease labor supply and savings because
these behaviors are affected by the change in the share of the income at the margin subject to tax. these behaviors are affected by the change in the share of the income at the margin subject to tax.
The most straightforward example of how base broadening provisions could affect marginal The most straightforward example of how base broadening provisions could affect marginal
effective tax rates is the itemized deduction for state and local income taxes. According to effective tax rates is the itemized deduction for state and local income taxes. According to
Internal Revenue Service (IRS) statistics in 2017 (before temporary provisions limited the Internal Revenue Service (IRS) statistics in 2017 (before temporary provisions limited the
itemized deduction), the average deduction on itemized returns for state and local income taxes itemized deduction), the average deduction on itemized returns for state and local income taxes
was 5.9% of income for those with an adjusted gross income (AGI) of $200,000 or greater.was 5.9% of income for those with an adjusted gross income (AGI) of $200,000 or greater.4447
Because most state income tax rates are progressive, income taxes paid as a share of income Because most state income tax rates are progressive, income taxes paid as a share of income
would be even higher at the margin. Using an example of 6%, if the federal statutory income tax would be even higher at the margin. Using an example of 6%, if the federal statutory income tax
rate is 35%, and the state income tax is deductible, the total tax rate that applies to the last dollar rate is 35%, and the state income tax is deductible, the total tax rate that applies to the last dollar
of income is 35% plus 6% minus the value of the tax deduction (0.35 times 6%), or 38.9%. If the of income is 35% plus 6% minus the value of the tax deduction (0.35 times 6%), or 38.9%. If the
state and local income tax deduction is eliminated or capped, the effective marginal tax rate rises state and local income tax deduction is eliminated or capped, the effective marginal tax rate rises
to 41% (35% plus 6%). On average then, disallowing the state income tax deduction is the to 41% (35% plus 6%). On average then, disallowing the state income tax deduction is the
equivalent of raising the marginal tax rate by 2.1 percentage points for taxpayers claiming equivalent of raising the marginal tax rate by 2.1 percentage points for taxpayers claiming
itemized deductions. itemized deductions.
Although state and local income taxes make this point clearly, any source or use of income that is Although state and local income taxes make this point clearly, any source or use of income that is
tax favored and applies at the margin would have the same effect on supply response.tax favored and applies at the margin would have the same effect on supply response.4548 The scope The scope
of this marginal effect is also significantly broadened when considering that part of the labor of this marginal effect is also significantly broadened when considering that part of the labor
supply response to changes in wages is a participation response, making the margin for this supply response to changes in wages is a participation response, making the margin for this
purpose the average tax on the participant’s wage income. For example, the earned income credit purpose the average tax on the participant’s wage income. For example, the earned income credit
has been estimated to increase the participation of lower-income unmarried women; a reduction has been estimated to increase the participation of lower-income unmarried women; a reduction
in that credit, even though it does not apply to last dollar, would have a participation effect.in that credit, even though it does not apply to last dollar, would have a participation effect.4649 The The
tax benefit of excluding employer health insurance, for example, may not have an effect of tax benefit of excluding employer health insurance, for example, may not have an effect of
marginal wage but could affect a participation response. marginal wage but could affect a participation response.
A Congressional Research Service report estimated that, for taxpayers at the top marginal income A Congressional Research Service report estimated that, for taxpayers at the top marginal income
tax rate, a revenue neutral elimination of itemized deductions would leave effective marginal tax rate, a revenue neutral elimination of itemized deductions would leave effective marginal
~~rates largely unchanged.47 The effect was largely due to the elimination of the itemized deduction~~
~~for state and local taxes and charitable deductions, which tend to rise continually with income.~~
~~Some provisions may have marginal effects in the long run but may not induce much response~~
~~within the budget horizon. For example, restricting the mortgage interest deduction or property~~
~~tax deduction for those who already have mortgages or homes is not likely to change their choices~~

46 One study of the effects on savings that eliminated all taxes on capital income and replaced them with higher wage taxes found a savings response in the life-cycle model with variable labor that was almost five times as large as in a model with fixed labor. In the infinite horizon model, it was about 50% larger. See Eric Engen, Jane Gravelle, and Kent model with fixed labor. In the infinite horizon model, it was about 50% larger. See Eric Engen, Jane Gravelle, and Kent
Smetters, “Dynamic Tax Models: Why They Do the Things They Do,” Smetters, “Dynamic Tax Models: Why They Do the Things They Do,” National Tax Journal, vol. 50, September 1997, , vol. 50, September 1997,
pp. 657-682. pp. 657-682.
4447 Internal Revenue Service, Statistics of Income 2017, Individual Income Tax Returns with Itemized Deductions, at Internal Revenue Service, Statistics of Income 2017, Individual Income Tax Returns with Itemized Deductions, at
https://www.irs.gov/statistics/soi-tax-stats-individual-statistical-tables-by-size-of-adjusted-gross-income. https://www.irs.gov/statistics/soi-tax-stats-individual-statistical-tables-by-size-of-adjusted-gross-income.
4548 See Jane G. Gravelle and G. Thomas Woodward, “Clarifying the Relation Between Base-Broadening and Effective See Jane G. Gravelle and G. Thomas Woodward, “Clarifying the Relation Between Base-Broadening and Effective
Marginal Tax Rates,” presented at the National Tax Association Conference, November 2013, which showed marginal Marginal Tax Rates,” presented at the National Tax Association Conference, November 2013, which showed marginal
effects for several itemized deductions; and CRS Report R42435, effects for several itemized deductions; and CRS Report R42435, The Challenge of Individual Income Tax Reform: An
Economic Analysis of Tax Base Broadening, by Jane G. Gravelle and Thomas L. Hungerford, which showed these , by Jane G. Gravelle and Thomas L. Hungerford, which showed these
patterns are likely for many other tax benefits. patterns are likely for many other tax benefits.
4649 Nada Eissa and Jeffrey B. Liebman, “Labor Supply Response to the Earned Income Tax Credit,” Nada Eissa and Jeffrey B. Liebman, “Labor Supply Response to the Earned Income Tax Credit,” Quarterly Journal
of Economics, vol. 111, no. 2, May 1996, pp. 605-637. , vol. 111, no. 2, May 1996, pp. 605-637.
~~47 See CRS Report R43079, Restrictions on Itemized Tax Deductions: Policy Options and Analysis, by Jane G. Gravelle~~
~~and Sean Lowry.~~
~~Congressional Research Service~~

14

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

Congressional Research Service 14 Dynamic Scoring for Tax Legislation: A Review of Models rates largely unchanged.50 The effect was largely due to the elimination of the itemized deduction for state and local taxes and charitable deductions, which tend to rise continually with income. Some provisions may have marginal effects in the long run but may not induce much response within the budget horizon. For example, restricting the mortgage interest deduction or property tax deduction for those who already have mortgages or homes is not likely to change their choices for labor supply in the short run because the choices have already been made, although it might for labor supply in the short run because the choices have already been made, although it might
affect individuals who plan to become homeowners. affect individuals who plan to become homeowners.
Some benefits are marginal in some income ranges but not in others. For example, contributions Some benefits are marginal in some income ranges but not in others. For example, contributions
to employer pension plans and 401(k) plans are more likely to rise with earnings for all but very to employer pension plans and 401(k) plans are more likely to rise with earnings for all but very
high-income individuals where caps are effective, and thus have marginal effects along with high-income individuals where caps are effective, and thus have marginal effects along with
participation effects. An elimination of the child credit would reduce marginal taxes at some participation effects. An elimination of the child credit would reduce marginal taxes at some
higher-income levels because of phaseouts, but increase them at certain low-income levels due to higher-income levels because of phaseouts, but increase them at certain low-income levels due to
limits on refundability. limits on refundability.
The effect of revenue-neutral base broadening depends not only on the type of provision but also The effect of revenue-neutral base broadening depends not only on the type of provision but also
on how the change is made. For example, proposals have been made for capping tax on how the change is made. For example, proposals have been made for capping tax
expenditures, which would leave the increased marginal tax effect intact for taxpayers above the expenditures, which would leave the increased marginal tax effect intact for taxpayers above the
cap but provide less revenue to permit statutory rate reductions. Thus, this change would be more cap but provide less revenue to permit statutory rate reductions. Thus, this change would be more
likely to raise effective marginal tax rates for high-income households. likely to raise effective marginal tax rates for high-income households.
Some models, including those used by JCT, use microsimulation models that can take into account important base broadening features to estimate effective marginal tax rates based on the legislative proposal. Addressing the marginal effects of base broadening is much more complicated in individual Addressing the marginal effects of base broadening is much more complicated in individual
income tax reforms and therefore adds to the general challenges of estimating macroeconomic income tax reforms and therefore adds to the general challenges of estimating macroeconomic
effects. Nevertheless, the message is clear: dynamic scoring that does not take account of these effects. Nevertheless, the message is clear: dynamic scoring that does not take account of these
offsetting effects and rests on statutory tax rate changes will overstate the effects of rate offsetting effects and rests on statutory tax rate changes will overstate the effects of rate
reductions financed with base broadening, and possibly project positive effects, when the effects reductions financed with base broadening, and possibly project positive effects, when the effects
are negative. are negative.
General Issues with Dynamic Scoring for Taxes
Tax reform may not be revenue neutral, so that stimulus and crowding out effects could be part of Tax reform may not be revenue neutral, so that stimulus and crowding out effects could be part of
the macroeconomic analysis. Even a revenue neutral tax reform could affect marginal tax rates, the macroeconomic analysis. Even a revenue neutral tax reform could affect marginal tax rates,
which could generate supply side effects. This section discusses issues that arise when a tax which could generate supply side effects. This section discusses issues that arise when a tax
revision decreases or increases revenue or alters effective marginal tax rates. The following revision decreases or increases revenue or alters effective marginal tax rates. The following
discussion addresses whether stimulus or crowding out effects should be considered and whether discussion addresses whether stimulus or crowding out effects should be considered and whether
the various supply side models are appropriate. It also reviews the empirical evidence on the various supply side models are appropriate. It also reviews the empirical evidence on
behavioral responses and how they compare with those in some of the current models. behavioral responses and how they compare with those in some of the current models.
Should Short-Run Stimulus Effects (Demand Side Effects)
Be Considered?
As noted briefly in the overview, there are several reasons that short-run stimulus effects, which As noted briefly in the overview, there are several reasons that short-run stimulus effects, which
cause a tax cut to lose less revenue than a static score and a tax increase to raise less revenue, cause a tax cut to lose less revenue than a static score and a tax increase to raise less revenue,
should not be considered in dynamic revenue scoring in general, even in models where these should not be considered in dynamic revenue scoring in general, even in models where these
effects can be considered. effects can be considered.
50 See CRS Report R43079, Restrictions on Itemized Tax Deductions: Policy Options and Analysis, by Jane G. Gravelle and Sean Lowry. Congressional Research Service 15 Dynamic Scoring for Tax Legislation: A Review of Models The short-run stimulus effect affects aggregate demand through increased spending due to tax The short-run stimulus effect affects aggregate demand through increased spending due to tax
cuts. This increased spending increases output by re-employing unemployed resources (workers cuts. This increased spending increases output by re-employing unemployed resources (workers
who have lost their jobs and idle capital). As some workers become employed and increase their who have lost their jobs and idle capital). As some workers become employed and increase their
own spending and profits rise, the additional income introduces new spending, which in turn own spending and profits rise, the additional income introduces new spending, which in turn
leads to additional production. The successive rounds of output effects are called multipliers. leads to additional production. The successive rounds of output effects are called multipliers.
These effects occur only in an underemployed economy (otherwise the stimulus increases the These effects occur only in an underemployed economy (otherwise the stimulus increases the
~~Congressional Research Service~~

15

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

price level), and they are transitory because eventually the economy would have returned to full price level), and they are transitory because eventually the economy would have returned to full
employment without the stimulus.employment without the stimulus.4851
Numerous reasons exist that this effect might be inappropriate to consider in dynamic estimation. Numerous reasons exist that this effect might be inappropriate to consider in dynamic estimation.
The most basic argument is that changes in the tax code should not depend on the fiscal timing, as The most basic argument is that changes in the tax code should not depend on the fiscal timing, as
tax changes can be hard to reverse. A permanent tax cut should, arguably, not be viewed more tax changes can be hard to reverse. A permanent tax cut should, arguably, not be viewed more
favorably because it was enacted in a recession. favorably because it was enacted in a recession.
A second reason for not including these effects, is that they also occur with spending changes. A second reason for not including these effects, is that they also occur with spending changes.
Moreover, spending multipliers are typically more powerful than tax cut multipliers because a Moreover, spending multipliers are typically more powerful than tax cut multipliers because a
part of tax cuts is not spent. If the purpose of the change is to stimulate the economy, then that part of tax cuts is not spent. If the purpose of the change is to stimulate the economy, then that
decision would be better informed by comparing tax cuts with spending increases, rather than decision would be better informed by comparing tax cuts with spending increases, rather than
considering the effects of tax cuts alone. In a sense, dynamic estimates are already accounted for considering the effects of tax cuts alone. In a sense, dynamic estimates are already accounted for
when multipliers for different spending and tax cuts are estimated. when multipliers for different spending and tax cuts are estimated.
Third, the magnitude and even existence of a stimulus effect depends on assumptions about the Third, the magnitude and even existence of a stimulus effect depends on assumptions about the
behavior of the country’s central bank, the Federal Reserve System. The Federal Reserve can take behavior of the country’s central bank, the Federal Reserve System. The Federal Reserve can take
measures to offset a fiscal stimulus with a monetary contraction or a fiscal contraction with a measures to offset a fiscal stimulus with a monetary contraction or a fiscal contraction with a
monetary expansion to keep output constant. It can also fully accommodate the change by monetary expansion to keep output constant. It can also fully accommodate the change by
keeping interest rates constant and strengthening the stimulus or contraction, or it can do anything keeping interest rates constant and strengthening the stimulus or contraction, or it can do anything
in between. If, however, the Federal Reserve has a fixed objective for output, fiscal policy would in between. If, however, the Federal Reserve has a fixed objective for output, fiscal policy would
simply be one more factor to counteract in its policies and a tax cut or tax increase would not simply be one more factor to counteract in its policies and a tax cut or tax increase would not
affect output. When the JCT does dynamic estimates, it generally includes a case where the affect output. When the JCT does dynamic estimates, it generally includes a case where the
Federal Reserve offsets the policy, which is helpful in interpreting the contribution of these Federal Reserve offsets the policy, which is helpful in interpreting the contribution of these
transitory effects. transitory effects.
Should Debt Effects Be Considered?
There is a somewhat more compelling case that the effects of tax changes on debt should be There is a somewhat more compelling case that the effects of tax changes on debt should be
considered in dynamic revenue scoring. For instance, taken in isolation, consider the tradeoff to considered in dynamic revenue scoring. For instance, taken in isolation, consider the tradeoff to
be either financing spending through taxes or borrowing. In addition, if the claim is made that a be either financing spending through taxes or borrowing. In addition, if the claim is made that a
tax cut will largely pay for itself, then analyzing it as a stand-alone policy including both supply tax cut will largely pay for itself, then analyzing it as a stand-alone policy including both supply
side effects and the effects on crowding out from debt might be appropriate. side effects and the effects on crowding out from debt might be appropriate.
The counter-argument to this view is that spending cuts have the same types of effects on debt as The counter-argument to this view is that spending cuts have the same types of effects on debt as
revenue increases, so that it may not be appropriate to consider them only for taxes. If dynamic revenue increases, so that it may not be appropriate to consider them only for taxes. If dynamic
scoring is considered for both spending and tax changes, including crowding out might be more scoring is considered for both spending and tax changes, including crowding out might be more
appropriate. appropriate.
The main uncertainty about the effects of debt is the extent to which foreigners can finance debt. The main uncertainty about the effects of debt is the extent to which foreigners can finance debt.
If foreigners financed all of the debt, there would be no crowding out and no effect on revenues at If foreigners financed all of the debt, there would be no crowding out and no effect on revenues at
least within the budget horizon. least within the budget horizon.
51 See CRS Report R42700, The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases and Spending Cuts, by Jane G. Gravelle, which reports the range of multipliers considered by CBO and discusses alternative models. Congressional Research Service 16 link to page 38 link to page 22 Dynamic Scoring for Tax Legislation: A Review of Models Note that the intertemporal models (Ramsey infinite horizon and OLG life-cycle) cannot be Note that the intertemporal models (Ramsey infinite horizon and OLG life-cycle) cannot be
solved without some resolution of the debt although there can be effects in the interim. A solved without some resolution of the debt although there can be effects in the interim. A
temporary debt that is resolved eventually with transfers has no crowding out effect in the interim temporary debt that is resolved eventually with transfers has no crowding out effect in the interim
in the Ramsey model because private saving offsets it. in the Ramsey model because private saving offsets it.
This issue of debt with intertemporal models means, however, that a tax change that affects the This issue of debt with intertemporal models means, however, that a tax change that affects the
deficit can never be considered in isolation, but is accompanied by some other measure to address deficit can never be considered in isolation, but is accompanied by some other measure to address

~~48 See CRS Report R42700, The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases and Spending Cuts, by~~
~~Jane G. Gravelle, which reports the range of multipliers considered by CBO and discusses alternative models.~~
~~Congressional Research Service~~

16

~~link to page 38 link to page 22~~ ~~Dynamic Scoring for Tax Legislation: A Review of Models~~

the deficit and whether it is a change in spending, transfers, or taxes makes a difference in the the deficit and whether it is a change in spending, transfers, or taxes makes a difference in the
results. results.
Supply Side Effects
Although there is little disagreement that incorporating supply side responses when analyzing tax Although there is little disagreement that incorporating supply side responses when analyzing tax
changes would contribute, in theory, to evaluating legislative proposals, the case is less clear changes would contribute, in theory, to evaluating legislative proposals, the case is less clear
when these projections provide an uncertain or unrealistic picture of expected effects. The Solow when these projections provide an uncertain or unrealistic picture of expected effects. The Solow
model is straightforward and can easily be used to calculate the expected magnitude of feedback model is straightforward and can easily be used to calculate the expected magnitude of feedback
effects. Intertemporal models, in particular, have results that are driven by assumptions embedded effects. Intertemporal models, in particular, have results that are driven by assumptions embedded
in the nature of the model, but which appear unrealistic and have no empirical support in some in the nature of the model, but which appear unrealistic and have no empirical support in some
cases. cases.
A Solow Model Estimate of an Illustrative Tax Cut
The Solow model uses labor, capital, and technology to explain economic growth, particularly to The Solow model uses labor, capital, and technology to explain economic growth, particularly to
explain observable data such as the capital labor ratio.explain observable data such as the capital labor ratio.4952 That is, it began as a model that could That is, it began as a model that could
explain observations, much as the Keynesian IS-LM model was developed to explain the Great explain observations, much as the Keynesian IS-LM model was developed to explain the Great
Depression. The Solow growth model was easily adapted to examining tax changes by making Depression. The Solow growth model was easily adapted to examining tax changes by making
the labor supply a function of after tax wages and the savings rate a function of the after tax rate the labor supply a function of after tax wages and the savings rate a function of the after tax rate
of return. of return.
A simple version of this model, presented in th A simple version of this model, presented in the Appendix, can be used to illustrate the n be used to illustrate the
magnitude of expected feedback effects. Although the model abstracts from specific features of magnitude of expected feedback effects. Although the model abstracts from specific features of
the tax system, it roughly represents current taxes with a 25% income tax. The results suggest that the tax system, it roughly represents current taxes with a 25% income tax. The results suggest that
a 20% reduction in marginal tax rates on labor taxes would increase output in the short run by a 20% reduction in marginal tax rates on labor taxes would increase output in the short run by
around 0.5% to 1% and revenue feedback effects would be around 3% to 7% (assuming the around 0.5% to 1% and revenue feedback effects would be around 3% to 7% (assuming the
capital stock is fixed, a fairly reasonable short-run assumption). This estimate uses a labor supply capital stock is fixed, a fairly reasonable short-run assumption). This estimate uses a labor supply
elasticity of 0.1 and 0.2, similar to the elasticities used by JCT and CBO (as discussed elasticity of 0.1 and 0.2, similar to the elasticities used by JCT and CBO (as discussed
subsequently). These feedback effects are relatively minor. subsequently). These feedback effects are relatively minor.
The feedback effects for capital income are somewhat more complex, because it takes a period of The feedback effects for capital income are somewhat more complex, because it takes a period of
time to achieve them. For example, if the capital stock is growing at 3% due to savings, even a time to achieve them. For example, if the capital stock is growing at 3% due to savings, even a
100% increase in investment (either from savings or from capital inflows) would increase the 100% increase in investment (either from savings or from capital inflows) would increase the
capital stock by only 3%. For growth in the capital stock arising from savings, one simulation capital stock by only 3%. For growth in the capital stock arising from savings, one simulation
showed that by the fifth year (the midpoint of the budget horizon) only 9.6% of the final showed that by the fifth year (the midpoint of the budget horizon) only 9.6% of the final
adjustment in the capital stock had occurred.adjustment in the capital stock had occurred.5053
To illustrate the possible feedback effect To illustrate the possible feedback effects, Table 1 uses a 0.1 and 0.2 labor supply elasticity along uses a 0.1 and 0.2 labor supply elasticity along
various savings rate elasticities to derive the long-run steady state. The first two savings various savings rate elasticities to derive the long-run steady state. The first two savings
elasticities are 0.0 and 0.4. A zero savings elasticity is a central tendency from the literature that elasticities are 0.0 and 0.4. A zero savings elasticity is a central tendency from the literature that
~~used aggregate time series data to estimate the elasticity; 0.4 is toward the larger positive~~
~~estimates in that literature.51 An infinite elasticity is provided to show maximum potential long-~~
~~run effects (that is, savings must eventually rise or fall to return to the initial after-tax return).~~

49 52 Robert M. Solow, (1956), “A Contribution to the Theory of Economic Growth,” Robert M. Solow, (1956), “A Contribution to the Theory of Economic Growth,” Quarterly Journal of Economics, ,
vol. 70, iss. 1 (The MIT Press, 1956), pp. 65-94. vol. 70, iss. 1 (The MIT Press, 1956), pp. 65-94.
5053 See Eric Engen, Jane Gravelle, and Kent Smetters, “Dynamic Tax Models: Why They Do the Things They Do,” See Eric Engen, Jane Gravelle, and Kent Smetters, “Dynamic Tax Models: Why They Do the Things They Do,”
National Tax Journal, vol. 50, September 1997, pp. 657-682. , vol. 50, September 1997, pp. 657-682.
~~51 See Jane G. Gravelle, The Economic Effects of Taxing Capital Income (MIT Press: Cambridge, MA, 1994), p. 27.~~
Congressional Research Service Congressional Research Service

17 17

link to page 38 link to page link to page 38 link to page 2223 Dynamic Scoring for Tax Legislation: A Review of Models

used aggregate time series data to estimate the elasticity; 0.4 is toward the larger positive estimates in that literature.54 An infinite elasticity is provided to show maximum potential long-run effects (that is, savings must eventually rise or fall to return to the initial after-tax return). Table 1. Long-Run Revenue Offsets from Supply Side Effects in a Solow Model
(Assumes a 25% Tax Rate on Labor and Capital Income) (Assumes a 25% Tax Rate on Labor and Capital Income)

Labor Income Tax
Capital Income Tax
Income Tax
Labor Supply Elasticity: 0.1

Savings Elasticity Savings Elasticity

0.0 0.0
4.4% 4.4%
0.0% 0.0%
3.3% 3.3%
0.4 0.4
4.4% 4.4%
14.5% 14.5%
6.8% 6.8%
Infinity Infinity
4.4% 4.4%
48.9% 48.9%
15.6% 15.6%
Labor Supply Elasticity: 0.2

Savings Elasticity Savings Elasticity

0.0 0.0
8.9% 8.9%
0.0% 0.0%
4.8% 4.8%
0.4 0.4
8.9% 8.9%
15.2% 15.2%
10.5% 10.5%
Infinity Infinity
8.9% 8.9%
53.3% 53.3%
20% 20%
Source: SSee Appendix.
Notes: In each case, the effect on total taxes in the economy is considered. ThusIn each case, the effect on total taxes in the economy is considered. Thus, a cut in the labor income tax a cut in the labor income tax
alone wil affect labor income tax revenue and capital income tax revenue. alone wil affect labor income tax revenue and capital income tax revenue.
These longer-run effects are not very different from the short-run effects when the savings supply These longer-run effects are not very different from the short-run effects when the savings supply
elasticity is zero. For example, the feedback from a labor income tax cut is 4% to 9% rather than elasticity is zero. For example, the feedback from a labor income tax cut is 4% to 9% rather than
3% to 7%. Larger savings elasticities can eventually lead to more significant feedback effects, 3% to 7%. Larger savings elasticities can eventually lead to more significant feedback effects,
although none is large enough to fully offset the revenue loss. although none is large enough to fully offset the revenue loss.
For budget horizon estimates, a Solow growth model takes a long time to reach the steady state. For budget horizon estimates, a Solow growth model takes a long time to reach the steady state.
Effects from labor tax changes in the budget horizon are already close to the long-run steady Effects from labor tax changes in the budget horizon are already close to the long-run steady
state. When capital income tax cuts were involved, the effects in the budget horizon tend to be state. When capital income tax cuts were involved, the effects in the budget horizon tend to be
small relative to the long-run steady state (when an effect occurs). In a study of capital income tax small relative to the long-run steady state (when an effect occurs). In a study of capital income tax
cuts with a 0.4 elasticity, on average in the first five years (the mid-point of the budget horizon) cuts with a 0.4 elasticity, on average in the first five years (the mid-point of the budget horizon)
only about 10% of the adjustment was complete, and by year 25 only about a third.only about 10% of the adjustment was complete, and by year 25 only about a third.5255 Strictly Strictly
speaking, an infinite elasticity would imply immediate adjustment, but such a large change in the speaking, an infinite elasticity would imply immediate adjustment, but such a large change in the
savings rate is not plausible, and this is one reason some economists found this type of model to savings rate is not plausible, and this is one reason some economists found this type of model to
account for savings responses unsatisfactory. account for savings responses unsatisfactory.
Table 2 shows the output effects for a 20% tax cut, so some idea of the magnitude of output shows the output effects for a 20% tax cut, so some idea of the magnitude of output
effects might be gained. effects might be gained.
~~Table 2. Long-Run Output Effects of a 20% Tax Cut in a Solow Model~~
~~(Assumes an Initial 25% Tax Rate on Capital and Labor Income)~~

~~Labor Income Tax~~
~~Capital Income Tax~~
~~Income Tax~~
~~Labor Supply Elasticity: 0.1~~

~~Savings Elasticity~~

~~0.0~~
~~0.7%~~
~~0.0%~~
~~0.7%~~
~~0.4~~
~~0.7%~~
~~0.7%~~
~~1.4%~~

52 54 See Jane G. Gravelle, The Economic Effects of Taxing Capital Income (MIT Press: Cambridge, MA, 1994), p. 27. 55 Eric Engen, Jane Gravelle, and Kent Smetters, “Dynamic Tax Models: Why They Do the Things They Do,” Eric Engen, Jane Gravelle, and Kent Smetters, “Dynamic Tax Models: Why They Do the Things They Do,” National
Tax Journal, vol. 50, September 1997, pp. 657-682. , vol. 50, September 1997, pp. 657-682.
Congressional Research Service Congressional Research Service

18 18

link to page 38 link to page 38 ~~link to page 22 link to page 22~~ Dynamic Scoring for Tax Legislation: A Review of Models

~~Labor Income Tax~~
~~Capital Income Tax~~
~~Income Tax~~
Table 2. Long-Run Output Effects of a 20% Tax Cut in a Solow Model (Assumes an Initial 25% Tax Rate on Capital and Labor Income) Labor Income Tax Capital Income Tax Income Tax Labor Supply Elasticity: 0.1 Savings Elasticity 0.0 0.7% 0.0% 0.7% 0.4 0.7% 0.7% 1.4% Infinity Infinity
0.7% 0.7%
2.4% 2.4%
3.1% 3.1%
Labor Supply Elasticity: 0.2

Savings Savings Elasticity Elasticity

0.0 0.0
1.3% 1.3%
0.0% 0.0%
1.3% 1.3%
0.4 0.4
1.3% 1.3%
0.8% 0.8%
2.1% 2.1%
Infinity Infinity
1.3% 1.3%
2. 2. 7% 7%
4.0% 4.0%
Source: SSee Appendix.
Notes: In each case, the effect on total output in the economy is considered. ThusIn each case, the effect on total output in the economy is considered. Thus, a cut in the labor income tax a cut in the labor income tax
alone wil affect both labor and capital inputs. The effects are derived for a small change and evaluated at the alone wil affect both labor and capital inputs. The effects are derived for a small change and evaluated at the
midpoint between the old and new rate, 22.5%. midpoint between the old and new rate, 22.5%.
The JCT has found slightly larger effects for rate cuts in its MEG model (controlling for deficit The JCT has found slightly larger effects for rate cuts in its MEG model (controlling for deficit
and stimulus effects) with an average feedback effect of 9% to 10% in the first five years.and stimulus effects) with an average feedback effect of 9% to 10% in the first five years.5356 The The
model is, however, not a pure Solow model, but model is, however, not a pure Solow model, but ~~a combination of a Solow and OLG model.~~
~~Open Economy Considerations~~
incorporates an intertemporal substitution elasticity that reflects choices from an infinite horizon model where the representative agent is myopic (i.e., assumes relevant parameters like the interest rate will not change in response to a tax change). Open Economy Considerations The Solow model discussed above is a closed economy. The capital stock might change more The Solow model discussed above is a closed economy. The capital stock might change more
quickly with an open economy where investment is not constrained by a savings response. The quickly with an open economy where investment is not constrained by a savings response. The
effects would depend on whether the capital income tax is residence based (where the foreign effects would depend on whether the capital income tax is residence based (where the foreign
investor is not subject to tax, such as a tax on dividends or interest) or source based (the corporate investor is not subject to tax, such as a tax on dividends or interest) or source based (the corporate
income tax where the foreign investor is subject to tax). In the latter case, the maximum effect income tax where the foreign investor is subject to tax). In the latter case, the maximum effect
assuming perfectly mobile capital would be the same as the capital stock elasticity at infinity for a assuming perfectly mobile capital would be the same as the capital stock elasticity at infinity for a
small country with perfect product substitution and a sourcesmall country with perfect product substitution and a source -based tax. However, that extreme based tax. However, that extreme
case is unlikely to occur, because estimates suggest the investment substitution elasticity is closer case is unlikely to occur, because estimates suggest the investment substitution elasticity is closer
to 3.to 3.5457 Moreover, the United States is a large country, products are imperfect substitutes, and taxes Moreover, the United States is a large country, products are imperfect substitutes, and taxes
are a combination of source based and residence based. All of these factors would reduce the are a combination of source based and residence based. All of these factors would reduce the
effects. One study of a 10 percentage point decrease in the corporate tax rate (a partial cut in effects. One study of a 10 percentage point decrease in the corporate tax rate (a partial cut in
56 Joint Committee on Taxation, Macroeconomic Analysis Of Various Proposals To Provide $500 Billion In Tax Relief, JCX-4-05, March 1, 2005, https://www.jct.gov/publications/2005/jcx-4-05/. 57 For a review, see Jennifer Gravelle, “Corporate Tax Incidence: Review of General Equilibrium Estimates and Analysis,” National Tax Journal, vol. 66, March 2013, pp. 185-214. A working paper version is available at http://cbo.gov/sites/default/files/cbofiles/ftpdocs/115xx/doc11519/05-2010-working_paper-corp_tax_incidence-review_of_gen_eq_estimates.pdf. Congressional Research Service 19 link to page 22 link to page 23 Dynamic Scoring for Tax Legislation: A Review of Models capital income taxes) suggested an output increase of less than 0.2% for an elasticity of 3. This capital income taxes) suggested an output increase of less than 0.2% for an elasticity of 3. This
tax cut was a slightly larger percentage cut than the one itax cut was a slightly larger percentage cut than the one in Table 1 andand Table 2.5558
Intertemporal Models
Although the Solow model provided a labor supply response in a way that was consistent with Although the Solow model provided a labor supply response in a way that was consistent with
standard theory about consumer choices between consumption and leisure within a time period, standard theory about consumer choices between consumption and leisure within a time period,
many economists were dissatisfied with the treatment of savings responses. A simple savings many economists were dissatisfied with the treatment of savings responses. A simple savings
elasticity cannot be derived from underlying utility functions. Intertemporal models were elasticity cannot be derived from underlying utility functions. Intertemporal models were
developed to conform to fundamental economic theory about consumer choice by incorporating a developed to conform to fundamental economic theory about consumer choice by incorporating a
utility function to generate labor and savings supply responses. In these models, consumers utility function to generate labor and savings supply responses. In these models, consumers

~~53 Joint Committee on Taxation, Macroeconomic Analysis Of Various Proposals To Provide $500 Billion In Tax Relief,~~
~~JCX-4-05, March 1, 2005, https://www.jct.gov/publications.html?func=startdown&id=1189.~~
~~54 For a review, see Jennifer Gravelle, “Corporate Tax Incidence: Review of General Equilibrium Estimates and~~
~~Analysis,” National Tax Journal, vol. 66, March 2013, pp. 185-214. A working paper version is available at~~
~~http://cbo.gov/sites/default/files/cbofiles/ftpdocs/115xx/doc11519/05-2010-working_paper-corp_tax_incidence-~~
~~review_of_gen_eq_estimates.pdf.~~
~~55 See CRS Report R41743, International Corporate Tax Rate Comparisons and Policy Implications, by Jane G.~~
~~Gravelle.~~
~~Congressional Research Service~~

19

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

choose consumption and leisure over time. Some issues arise about intertemporal models of either choose consumption and leisure over time. Some issues arise about intertemporal models of either
type, and some are peculiar to either the Ramsey infinite horizon or life-cycle OLG models. type, and some are peculiar to either the Ramsey infinite horizon or life-cycle OLG models.
Some of the initial intertemporal models held labor constant and attempted to study saving in that Some of the initial intertemporal models held labor constant and attempted to study saving in that
way. However, modelers also wanted to incorporate labor supply. These models produce results way. However, modelers also wanted to incorporate labor supply. These models produce results
that may be theoretically elegant but are difficult or impossible to support with empirical that may be theoretically elegant but are difficult or impossible to support with empirical
research, particularly when labor supply can be shifted intertemporally. Moreover, the theoretical research, particularly when labor supply can be shifted intertemporally. Moreover, the theoretical
requirements of these models require some very strong assumptions about individuals’ requirements of these models require some very strong assumptions about individuals’
information. In a typical intertemporal model of either type, individuals have perfect foresight information. In a typical intertemporal model of either type, individuals have perfect foresight
and perfect information (they know how wages and rates of return will change over time for the and perfect information (they know how wages and rates of return will change over time for the
economy as a whole for an infinite period of time or a very long time). Intertemporal models, economy as a whole for an infinite period of time or a very long time). Intertemporal models,
however, can be constructed to include uncertainty, as is the case with the CBOhowever, can be constructed to include uncertainty, as is the case with the CBO or the PennWharton OLG model, OLG model,
which assumes wage shocks and uncertain lifetimes. In this type of model, individuals have which assumes wage shocks and uncertain lifetimes. In this type of model, individuals have
precautionary savings, which is less responsive to changes in the rate of return. precautionary savings, which is less responsive to changes in the rate of return.
It is difficult, if not impossible, to incorporate the various institutional rigidities in the labor and It is difficult, if not impossible, to incorporate the various institutional rigidities in the labor and
savings markets. Individuals in these models can generally enter and leave the work force without savings markets. Individuals in these models can generally enter and leave the work force without
penalty, for example, even though in reality leaving the work force may make re-entry at the same penalty, for example, even though in reality leaving the work force may make re-entry at the same
wage more difficult. They can change hours even though for many jobs a fixed workweek, such wage more difficult. They can change hours even though for many jobs a fixed workweek, such
as a 40-hour week, is the norm. They can borrow and lend without constraints and at the same as a 40-hour week, is the norm. They can borrow and lend without constraints and at the same
rate (although some models have introduced borrowing constraints for some agents who cannot rate (although some models have introduced borrowing constraints for some agents who cannot
borrow).borrow).
The new JCT model reflects this constraint by allowing only discrete choices of employment (no employment, part time, or full time). In addition, intertemporal models cannot permit a permanent deficit that leads to unlimited In addition, intertemporal models cannot permit a permanent deficit that leads to unlimited
growth in the debt-to-GDP ratio; a way to deal with the deficit must be incorporated in the growth in the debt-to-GDP ratio; a way to deal with the deficit must be incorporated in the
modeling exercise. Thusmodeling exercise. Thus, an intertemporal model cannot be used to examine a tax cut or tax an intertemporal model cannot be used to examine a tax cut or tax
increase; it must be a tax cut or increase and something else, such as a spending change or a increase; it must be a tax cut or increase and something else, such as a spending change or a
future change in taxes, or a lump sum payment, each producing a different result. future change in taxes, or a lump sum payment, each producing a different result.
The JCT has, however, developed ways to make this issue relatively unimportant by delaying the fiscal adjustment.59 Intertemporal models also presume a certain type of behavior with respect to savings behavior Intertemporal models also presume a certain type of behavior with respect to savings behavior
that may not characterize actual behavior. Agents in these models look ahead and base their that may not characterize actual behavior. Agents in these models look ahead and base their
current savings on all of the future periods in their life (even up to infinity). However, many current savings on all of the future periods in their life (even up to infinity). However, many
individuals either cannot or will not behave that way. For example, some individuals are young individuals either cannot or will not behave that way. For example, some individuals are young
58 See CRS Report R41743, International Corporate Tax Rate Comparisons and Policy Implications, by Jane G. Gravelle. 59 Rachel Moore and Brandon Pecoraro, “Dynamic Scoring: An Assessment of Fiscal Closing Assumptions,” Public Finance Review, vol. 48, iss. 3 (2020), pp. 340-353. Congressional Research Service 20 Dynamic Scoring for Tax Legislation: A Review of Models and have no assets or cannot borrow, and if they would like to consume more than their income at and have no assets or cannot borrow, and if they would like to consume more than their income at
this stage of their life, they cannot, so they save nothing and change consumption only when this stage of their life, they cannot, so they save nothing and change consumption only when
income goes up. Some individuals do not have enough information or knowledge to operate by income goes up. Some individuals do not have enough information or knowledge to operate by
some type of “rule-of-thumb,” such as saving a fixed dollar amount or a fixed share of income. some type of “rule-of-thumb,” such as saving a fixed dollar amount or a fixed share of income.
Others may be at a stage where they want to build a rainy day fund for precautionary purposes, or Others may be at a stage where they want to build a rainy day fund for precautionary purposes, or
they may be saving for a target (such as enough to make a down payment on a house). Douglas they may be saving for a target (such as enough to make a down payment on a house). Douglas
Elmendorf discusses some of these alternative models of savings.Elmendorf discusses some of these alternative models of savings.5660 As noted above, the CBO As noted above, the CBO
OLG model includes risk and precautionary savings, along with age-related borrowing OLG model includes risk and precautionary savings, along with age-related borrowing
constraintsconstraints. Models can also allow individuals to value wealth directly and save for the purpose of accumulating wealth, as is the case in the new JCT OLG model. .
There are also issues specific to each type of model. Since individuals do not live an infinite There are also issues specific to each type of model. Since individuals do not live an infinite
period of time, the infinite horizon, or Ramsey, model version of the intertemporal model appears period of time, the infinite horizon, or Ramsey, model version of the intertemporal model appears
on its face to be unrealistic. It can be justified only as a depiction of actual individuals’ choices on its face to be unrealistic. It can be justified only as a depiction of actual individuals’ choices
rather than as the prescriptive planning model it was originally developed as,rather than as the prescriptive planning model it was originally developed as,5761 if individuals are ~~if individuals are~~

~~56 Douglas W. Elmendorf, “The Effect of Interest-Rate Changes on Household Saving and Consumption,” Federal~~
~~Reserve Board, June 1996, http://www.federalreserve.gov/pubs/feds/1996/199627/199627pap.pdf.~~
~~57 The Ramsey model was originally a social planning model: a prescriptive rather than descriptive model where~~
~~treating society as a single infinitely-lived optimizer representing society was appropriate. See Frank P. Ramsey, “A~~
~~Congressional Research Service~~

20

~~link to page 33 link to page 35~~ ~~Dynamic Scoring for Tax Legislation: A Review of Models~~

assumed to take into account the welfare of their descendants (who in turn consider the welfare of assumed to take into account the welfare of their descendants (who in turn consider the welfare of
their descendants, who in turn consider their descendants, and so forth). In general, there is no their descendants, who in turn consider their descendants, and so forth). In general, there is no
marriage in these models, which could have implications for bequests; agents grow through an marriage in these models, which could have implications for bequests; agents grow through an
asexual reproduction process; in addition, there is no allowance for those without children. The asexual reproduction process; in addition, there is no allowance for those without children. The
long-run elasticity of savings is infinite, so that the after tax return always returns to its original long-run elasticity of savings is infinite, so that the after tax return always returns to its original
value. It is for this reason that the model is inconsistent with an open economy. value. It is for this reason that the model is inconsistent with an open economy.
The OLG life-cycle model seems more realistic, although lack of marriage and the presence of The OLG life-cycle model seems more realistic, although lack of marriage and the presence of
childless agents in childless agents in ~~the~~some models currently used still have potential implications for the savings models currently used still have potential implications for the savings
response (because these may affect response (because these may affect ~~bequests).~~ intended bequests, which respond to the rate of return). Some models have uncertainty in lifespans that lead to accidental bequests. The OLG model, at least in some forms, allows The OLG model, at least in some forms, allows
those who are retired to return to the labor force without accounting for the unlikelihood of those who are retired to return to the labor force without accounting for the unlikelihood of
returning to the work force after many years of retirement. This feature appeared in the original returning to the work force after many years of retirement. This feature appeared in the original
Auerbach-Kotlikoff model.Auerbach-Kotlikoff model.5862 Some models, including those of John Diamond, however, have a Some models, including those of John Diamond, however, have a
fixed retirement age.fixed retirement age.5963 The importance of this 60 Douglas W. Elmendorf, “The Effect of Interest-Rate Changes on Household Saving and Consumption,” Federal Reserve Board, June 1996, http://www.federalreserve.gov/pubs/feds/1996/199627/199627pap.pdf. 61 The Ramsey model was originally a social planning model: a prescriptive rather than descriptive model where treating society as a single infinitely-lived optimizer representing society was appropriate. See Frank P. Ramsey, “A ~~The importance of this feature varies with the type of tax revision, and the~~
~~feature can be very important in a reform that replaces income taxes with consumption taxes~~
~~because the loss in purchasing power of income from retired individuals causes them to return to~~
~~the labor market to restore income through an income effect.~~
~~Some of these aspects can be altered. Researchers have had some success in incorporating~~
~~uncertainty into models, which can account for some rainy day saving that responds differently~~
~~from saving for retirement or bequests. CBO’s OLG model and the Penn Wharton Budget Model~~
~~is of this type, although the magnitude of the effect is not clear.~~
~~With consistent parameters that produce the same income and substitution elasticities for labor~~
~~supply, the effect of a permanent tax cut on wages is similar in Solow and intertemporal models.60~~

Mathematical Theory of SavingMathematical Theory of Saving,” Economic Journal, vol. 3, 1928, pp. 543-559. In a history that is somewhat , vol. 3, 1928, pp. 543-559. In a history that is somewhat
complicated, it came to be used as an alternative model of both growth and of business cycles. Economists who were complicated, it came to be used as an alternative model of both growth and of business cycles. Economists who were
dissatisfied with the ad hoc treatment of savings in the Solow model and economists who were dissatisfied with IS-LM dissatisfied with the ad hoc treatment of savings in the Solow model and economists who were dissatisfied with IS-LM
type models of business cycles where problems arose through the lack of market clearing prices adapted the Ramsey type models of business cycles where problems arose through the lack of market clearing prices adapted the Ramsey
model as both a descriptive model of growth and a model that could explain business cycles through normal market model as both a descriptive model of growth and a model that could explain business cycles through normal market
behavior. Basically, business cycles, in this view, occurred because a shock that caused wages to rise or fall temporarily behavior. Basically, business cycles, in this view, occurred because a shock that caused wages to rise or fall temporarily
caused workers to increase or decrease labor supply. In other words, unemployment during business cycles was caused workers to increase or decrease labor supply. In other words, unemployment during business cycles was
voluntary rather than involuntary. This development, particularly for business cycles, has been was criticized by many voluntary rather than involuntary. This development, particularly for business cycles, has been was criticized by many
economists. See, for example, Larry Summers “Some Skeptical Observations on the Real Business Cycle Theory,” economists. See, for example, Larry Summers “Some Skeptical Observations on the Real Business Cycle Theory,”
Federal Reserve Bank of Minneapolis Quarterly Review, vol. 10, 1986, pp. 23-27, and Robert Solow, “The State of , vol. 10, 1986, pp. 23-27, and Robert Solow, “The State of
Macroeconomics,”Macroeconomics,” Journal of Economic Perspective, vol. 22, Winter 2008, pp. 243-249. Short-term macroeconomic , vol. 22, Winter 2008, pp. 243-249. Short-term macroeconomic
forecasting, both government and commercial, remains rooted in IS-LM models with sticky prices and wages, and forecasting, both government and commercial, remains rooted in IS-LM models with sticky prices and wages, and
usually multiple sectors. See CRS Report R42700, usually multiple sectors. See CRS Report R42700, The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases
and Spending Cuts, by Jane G. Gravelle, for a discussion of mainstream estimation. , by Jane G. Gravelle, for a discussion of mainstream estimation.
5862 Alan J. Auerbach and Laurence J. Kotlikoff, Alan J. Auerbach and Laurence J. Kotlikoff, Dynamic Fiscal Policy, Cambridge University Press, New York, New , Cambridge University Press, New York, New
York, 1987. York, 1987.
5963 See, for example, John Diamond, See, for example, John Diamond, The Economic Effects of the Romney Plan, August 3, 2012, at , August 3, 2012, at
http://bakerinstitute.org/files/474/; and John Diamond and George Zodrow, http://bakerinstitute.org/files/474/; and John Diamond and George Zodrow, The Dynamic Effects of Eliminating or
~~Curtailing the Home Mortgage Interest Deduction, December 7, 2012, http://bakerinstitute.org/media/files/Research/~~
~~b93d8df4/TEPP-pub-DiamondZodrowHomeMortgageInterestDeduction-120712.pdf.~~
~~60 The large increase in labor supply in the Joint Tax Committee’s study of the Camp tax proposal, which did not~~
~~indicate a change in effective tax rates on capital income, cannot be explained by the difference in labor substitution~~
~~elasticities. Overall, the JCT estimated an increase in labor supply in the first five years of 0.3% in the MEG model, but~~
~~of 1.4% in the OLG model. The substitution elasticities that should govern these effects were 0.2 and 0.24 respectively~~
~~(as shown below in Table 3 and Table 4). This elasticity difference suggests a 20% increase (0.24/0.2) in labor supply,~~
~~which would support a supply response of 0.4% increase in labor supply in the MEG model, not 1.4%. A separate study~~
~~of the Camp proposal co-authored by the model’s developer found a labor supply response of 0.5% slightly higher~~
~~elasticity, 0.28, consistent with the MEG results but not the JCT’s OLG results. See John W. Diamond and George R.~~
~~Zodrow, Dynamic Macroeconomic Estimates of the Effects of Chairman Camp’s 2014 Tax Reform Proposal, Tax~~
~~Congressional Research Service~~

21

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

(continued...) Congressional Research Service 21 link to page 33 link to page 35 Dynamic Scoring for Tax Legislation: A Review of Models feature varies with the type of tax revision, and the feature can be very important in a reform that replaces income taxes with consumption taxes because the loss in purchasing power of income from retired individuals causes them to return to the labor market to restore income through an income effect. Some of these aspects can be altered. Researchers have had some success in incorporating uncertainty about earnings into models, which can account for some rainy day saving that responds differently from saving for retirement or bequests. CBO’s OLG model and the Penn Wharton Budget Model is of this type, although the magnitude of the effect is not clear. With consistent parameters that produce the same income and substitution elasticities for labor supply, the effect of a permanent tax cut on wages is similar in Solow and intertemporal models.64 However, the effect of a change in the tax on capital income is different because it will elicit a However, the effect of a change in the tax on capital income is different because it will elicit a
labor supply response to a change in the tax rate on savings. The change in the timing and labor supply response to a change in the tax rate on savings. The change in the timing and
intergenerational distribution of taxes when income taxes are replaced by consumption taxes can intergenerational distribution of taxes when income taxes are replaced by consumption taxes can
also have important effects on labor supply, as noted above. also have important effects on labor supply, as noted above.
Are Explicit or Implicit Responses Used in Supply Side Models
Consistent With Empirical Evidence?
Even in the same model, projections can differ depending on the parameters or elasticities of the Even in the same model, projections can differ depending on the parameters or elasticities of the
model. Before examining the effects in models, a brief review of the empirical evidence is in model. Before examining the effects in models, a brief review of the empirical evidence is in
order. This evidence includes standard labor supply elasticities (that relate labor supply and order. This evidence includes standard labor supply elasticities (that relate labor supply and
savings to permanent wage differences), savings elasticities, intertemporal substitution savings to permanent wage differences), savings elasticities, intertemporal substitution
elasticities, and Frisch elasticities (intertemporal substitution of labor). The first two are relevant elasticities, and Frisch elasticities (intertemporal substitution of labor). The first two are relevant
to the Solow model, and all enter into or can be derived in intertemporal models. to the Solow model, and all enter into or can be derived in intertemporal models.
Standard Labor Supply Elasticities
The elasticities discussed in this subsection are estimates of the labor supply response to a The elasticities discussed in this subsection are estimates of the labor supply response to a
permanent wage change (such as one that would arise from a permanent tax cut or increase). That permanent wage change (such as one that would arise from a permanent tax cut or increase). That
type of supply response is incorporated in all of the dynamic models with supply side effects. The type of supply response is incorporated in all of the dynamic models with supply side effects. The
Frisch intertemporal elasticity discussed below is a different type of elasticity. Frisch intertemporal elasticity discussed below is a different type of elasticity.
As noted earlier, the labor supply response to a change in wage is uncertain in direction because it As noted earlier, the labor supply response to a change in wage is uncertain in direction because it
is the result of a positive elasticity of substitution and a negative elasticity of income. is the result of a positive elasticity of substitution and a negative elasticity of income.
~~A large body of evidence suggests the labor supply response to increases in wages is small, varies~~
~~across workers, and can be negative for men. This small response appears to reflect both income~~
~~and substitution elasticities that are small, so that even if a tax change substantially lowers~~
~~marginal relative to average rates (the first affecting substitution and the second affecting~~
~~income), the response would be small. This evidence includes historical observation, cross~~
~~section econometric studies, and estimates from experiments.61 Much of the interest and~~
~~challenge is estimating responses related to the behavior of married women, where a large~~
~~fraction of this group does not participate in the labor market. Studies of married women have~~
~~produced larger, although varying responses. In recent decades, however, as the participation of~~
~~married women in the labor market has increased, their responses have declined and have become~~
~~more like those of men.62~~

~~Policy Advisers LLC, prepared for the Business Roundtable, http://businessroundtable.org/sites/default/files/reports/~~
~~Diamond-Zodrow%20Analysis%20for%20Business%20Roundtable_Final%20for%20Release.pdf. The difference in~~
~~labor supply was responsible for close to half the difference between the GDP growth of 0.2% in the first five years~~
~~under MEG and the growth of 1.8% under the OLG model. The remaining difference is from the shifting of intangibles~~
~~discussed on p. 17.~~
~~61 A study of labor supply used cross-country estimates, comparing labor supply in the United States with other~~
~~countries. This study argued that cross-country differences reflected tax rates. See Edward C. Prescott, “Why Do~~
~~Americans Work So Much More Than Europeans?,” Federal Reserve Bank of Minneapolis, Quarterly Review, July~~
~~2004, pp. 2-13, http://www.minneapolisfed.org/research/qr/qr2811.pdf. Alberto F. Alesina, Edward L. Glaser, and~~
~~Bruce Sacerdote, “Work and Leisure in the United States and Europe: Why So Different?” in~~ ~~NBER Macroeconomics~~
~~Annual~~ ~~2005, ed. Mark Gertler and Kenneth Rogoff, vol. 20 (Cambridge, MA: MIT Press, 2006), pp. 1-64, attribute the~~
~~cross-national labor supply differences mainly to differences in unionization and labor market regulations.~~
~~62 See CRS Report RL31949, Issues in Dynamic Revenue Estimating, by Jane G. Gravelle, for an extensive review of~~
~~labor supply estimates. See also CRS Report R42111, Tax Rates and Economic Growth, by Jane G. Gravelle and~~
~~Congressional Research Service~~

22

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

Curtailing the Home Mortgage Interest Deduction, December 7, 2012, http://bakerinstitute.org/media/files/Research/b93d8df4/TEPP-pub-DiamondZodrowHomeMortgageInterestDeduction-120712.pdf. 64 The large increase in labor supply in the Joint Tax Committee’s study of the Camp tax proposal, which did not indicate a change in effective tax rates on capital income, cannot be explained by the difference in labor substitution elasticities. Overall, the JCT estimated an increase in labor supply in the first five years of 0.3% in the MEG model, but of 1.4% in the OLG model. The substitution elasticities that should govern these effects were 0.2 and 0.24 respectively (as shown below in Table 3 and Table 4). This elasticity difference suggests a 20% increase (0.24/0.2) in labor supply, which would support a supply response of 0.4% increase in labor supply in the MEG model, not 1.4%. A separate study of the Camp proposal co-authored by the model’s developer found a labor supply response of 0.5% slightly higher elasticity, 0.28, consistent with the MEG results but not the JCT’s OLG results. See John W. Diamond and George R. Zodrow, Dynamic Macroeconomic Estimates of the Effects of Chairman Camp’s 2014 Tax Reform Proposal, Tax Policy Advisers LLC, prepared for the Business Roundtable, http://businessroundtable.org/sites/default/files/reports/Diamond-Zodrow%20Analysis%20for%20Business%20Roundtable_Final%20for%20Release.pdf. The difference in labor supply was responsible for close to half the difference between the GDP growth of 0.2% in the first five years under MEG and the growth of 1.8% under the OLG model. The remaining difference is from the shifting of intangibles discussed on p. 17. Congressional Research Service 22 Dynamic Scoring for Tax Legislation: A Review of Models A large body of evidence suggests the labor supply response to increases in wages is small, varies across workers, and can be negative for men. This small response appears to reflect both income and substitution elasticities that are small, so that even if a tax change substantially lowers marginal relative to average rates (the first affecting substitution and the second affecting income), the response would be small. This evidence includes historical observation, cross section econometric studies, and estimates from experiments.65 Much of the interest and challenge is estimating responses related to the behavior of married women, where a large fraction of this group does not participate in the labor market. Studies of married women have produced larger, although varying responses. In recent decades, however, as the participation of married women in the labor market has increased, their responses have declined and have become more like those of men.66 A recent survey of labor supply responses of men indicated that labor supply was largely A recent survey of labor supply responses of men indicated that labor supply was largely
inelastic. The mean (average) of the studies was 0.06 and the median was 0.03. The studies inelastic. The mean (average) of the studies was 0.06 and the median was 0.03. The studies
indicated substitution elasticity with a mean of 0.31 and a median of 0.13. The income elasticity indicated substitution elasticity with a mean of 0.31 and a median of 0.13. The income elasticity
had a mean of -0.15 and a median of -0.12.had a mean of -0.15 and a median of -0.12.6367 A CBO 2012 working paper reviewed research and A CBO 2012 working paper reviewed research and
indicated a substitution elasticity for men from 0.1 to 0.3, with an income elasticity of 0.0 to -0.1. indicated a substitution elasticity for men from 0.1 to 0.3, with an income elasticity of 0.0 to -0.1.
Married women had substitution elasticities from 0.2 to 0.4, with the same income elasticity Married women had substitution elasticities from 0.2 to 0.4, with the same income elasticity
range. For the work force as a whole, it indicated a substitution elasticity of 0.1 to 0.3.range. For the work force as a whole, it indicated a substitution elasticity of 0.1 to 0.3.6468
A point to note about labor supply responses: if labor supply is very responsive in either direction, A point to note about labor supply responses: if labor supply is very responsive in either direction,
then it is difficult to explain why labor market participation rates and hours for men have been so then it is difficult to explain why labor market participation rates and hours for men have been so
constant over a long period of time when both real pre-tax wages and tax rates have been constant over a long period of time when both real pre-tax wages and tax rates have been
changing.changing.6569 Moreover, it is even more difficult to expect a large positive response when Moreover, it is even more difficult to expect a large positive response when
historically the rise in real wages in the latter part of the 19th century and early part of the 20th historically the rise in real wages in the latter part of the 19th century and early part of the 20th
century has been associated with a reduction in the workweek. (Women have increased their century has been associated with a reduction in the workweek. (Women have increased their
participation, largely during the 1970s and 1980s, but this change may reflect technological participation, largely during the 1970s and 1980s, but this change may reflect technological
advances in household production, declining fertility, and changes in cultural attitudes.)advances in household production, declining fertility, and changes in cultural attitudes.)66
~~Note that while labor supply elasticities are entered directly into Solow type models, they have to~~
~~be derived in some intertemporal models, given the standard form of the utility function (the~~
~~mathematical expression that yields the tradeoff between consumption and leisure) and depend on~~
~~the time endowment.~~
~~Savings Elasticities~~
~~A much more limited literature on savings elasticities developed during the late 1970s and 1980s.~~
~~These studies used aggregate data in the economy on savings rates and rates of return to estimate~~
~~the savings elasticity. The evidence generally showed small, possibly negative savings responses.~~
~~Although elasticities as large as 0.4 and 0.6 were found, later studies showed these effects were~~
~~sensitive to minor specification changes.67 In general, the evidence suggests savings is not~~
~~responsive to rates of return (a zero elasticity).~~
~~The savings response in a life-cycle model depends on the intertemporal substitution elasticity. It~~
~~is also affected by income effects (i.e., it takes less saving to consume a given amount in the~~

~~Donald J. Marples, for historical charts and updated evidence.~~
6370 65 A study of labor supply used cross-country estimates, comparing labor supply in the United States with other countries. This study argued that cross-country differences reflected tax rates. See Edward C. Prescott, “Why Do Americans Work So Much More Than Europeans?,” Federal Reserve Bank of Minneapolis, Quarterly Review, July 2004, pp. 2-13, http://www.minneapolisfed.org/research/qr/qr2811.pdf. Alberto F. Alesina, Edward L. Glaser, and Bruce Sacerdote, “Work and Leisure in the United States and Europe: Why So Different?” in NBER Macroeconomics Annual 2005, ed. Mark Gertler and Kenneth Rogoff, vol. 20 (Cambridge, MA: MIT Press, 2006), pp. 1-64, attribute the cross-national labor supply differences mainly to differences in unionization and labor market regulations. 66 See CRS Report RL31949, Issues in Dynamic Revenue Estimating, by Jane G. Gravelle, for an extensive review of labor supply estimates. See also CRS Report R42111, Tax Rates and Economic Growth, by Jane G. Gravelle and Donald J. Marples, for historical charts and updated evidence. 67 Michael P. Keane, “Labor Supply and Taxes: A Survey,” Michael P. Keane, “Labor Supply and Taxes: A Survey,” Journal of Economic Literature,” vol. 6, no. 4 (December ,” vol. 6, no. 4 (December
2011), Table 6, p. 1042. The author provided averages for the total labor supply elasticity (Marshallian) and the 2011), Table 6, p. 1042. The author provided averages for the total labor supply elasticity (Marshallian) and the
elasticity of substitution (Hicks); CRS calculated the remaining mean and the medians. elasticity of substitution (Hicks); CRS calculated the remaining mean and the medians.
6468 Robert McClelland and Shannon Mok, Robert McClelland and Shannon Mok, A Review of Recent Research on Labor Supply Elasticities, Working Paper, , Working Paper,
CBO, October 12, 2012, http://www.cbo.gov/sites/default/files/cbofiles/attachments/10-25-2012-CBO, October 12, 2012, http://www.cbo.gov/sites/default/files/cbofiles/attachments/10-25-2012-
Recent_Research_on_Labor_Supply_Elasticities.pdf. Recent_Research_on_Labor_Supply_Elasticities.pdf.
6569 A problem with an intertemporal model with an infinite horizon is that either a positive or negative labor supply A problem with an intertemporal model with an infinite horizon is that either a positive or negative labor supply
elasticity is incompatible with a balanced growth economy; otherwise, labor would grow to fill all available time, or elasticity is incompatible with a balanced growth economy; otherwise, labor would grow to fill all available time, or
shrink to virtually nothing. The CBO OLG model, for example, assumes a zero labor supply elasticity (income and shrink to virtually nothing. The CBO OLG model, for example, assumes a zero labor supply elasticity (income and
substitution effects offset each other), which is compatible with a model where wage rates grow indefinitely. Models substitution effects offset each other), which is compatible with a model where wage rates grow indefinitely. Models
that do not have a zero labor supply response have to assume some time dependent change in tastes for leisure versus that do not have a zero labor supply response have to assume some time dependent change in tastes for leisure versus
consumption to be compatible with growth. consumption to be compatible with growth.
6670 See CRS Report R42111, See CRS Report R42111, Tax Rates and Economic Growth, by Jane G. Gravelle and Donald J. Marples, for data on , by Jane G. Gravelle and Donald J. Marples, for data on
participation and hours. participation and hours.
~~67 These studies are reviewed in Jane G. Gravelle, The Economic Effects of Taxing Capital Income (Cambridge, MA,~~
~~MIT Press, 1994), p. 27. The most recent study was Jonathan Skinner and Daniel Feenberg, “The Impact of the 1986~~
~~Tax Reform on Personal Saving,” in Do Taxes Matter? The Impact of the Tax Reform Act of 1986, Ed. Joel Slemrod~~
~~(Cambridge MA: The MIT Press, 1990).~~
~~Congressional Research Service~~

23

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

Congressional Research Service 23 Dynamic Scoring for Tax Legislation: A Review of Models Note that while labor supply elasticities are entered directly into Solow type models, they have to be derived in some intertemporal models, given the standard form of the utility function (the mathematical expression that yields the tradeoff between consumption and leisure) and depend on the time endowment. Savings Elasticities A much more limited literature on savings elasticities developed during the late 1970s and 1980s. These studies used aggregate data in the economy on savings rates and rates of return to estimate the savings elasticity. The evidence generally showed small, possibly negative savings responses. Although elasticities as large as 0.4 and 0.6 were found, later studies showed these effects were sensitive to minor specification changes.71 In general, the evidence suggests savings is not responsive to rates of return (a zero elasticity). The savings response in a life-cycle model depends on the intertemporal substitution elasticity. It is also affected by income effects (i.e., it takes less saving to consume a given amount in the future), which produce a negative effect on savings, and wealth effects (including a reduction in future), which produce a negative effect on savings, and wealth effects (including a reduction in
the present value of labor income), as well as other parameters of the model as discussed by the present value of labor income), as well as other parameters of the model as discussed by
Elmendorf.Elmendorf.6872 A Ramsey model has an infinite savings elasticity so that savings will increase or A Ramsey model has an infinite savings elasticity so that savings will increase or
decrease to restore the after tax return. decrease to restore the after tax return.
Intertemporal Elasticity of Substitution
Partly because of the growing interest in intertemporal models, researchers began to study Partly because of the growing interest in intertemporal models, researchers began to study
intertemporal substitution elasticities rather than the effect of rates of return on saving rates. The intertemporal substitution elasticities rather than the effect of rates of return on saving rates. The
intertemporal elasticity of substitution (IES) measures the percentage change in the ratio of intertemporal elasticity of substitution (IES) measures the percentage change in the ratio of
consumption in two periods divided by their relative prices. For comparing two adjacent periods, consumption in two periods divided by their relative prices. For comparing two adjacent periods,
the price in the second period relative to the first is (1/(1+r)) (which is the discount factor for the price in the second period relative to the first is (1/(1+r)) (which is the discount factor for
money in the second period, where r is the after tax rate of return). Thus, the percentage change in money in the second period, where r is the after tax rate of return). Thus, the percentage change in
price is the change in r divided by (1+r). The IES is the primary driver of savings responses that price is the change in r divided by (1+r). The IES is the primary driver of savings responses that
arise from shifting consumption to the future, and contributes to the labor supply effect due to arise from shifting consumption to the future, and contributes to the labor supply effect due to
intertemporal shifting of leisure. intertemporal shifting of leisure.
Empirical studies have looked at changes in macroeconomic consumption aggregates in some Empirical studies have looked at changes in macroeconomic consumption aggregates in some
cases and have used individual consumption behavior in others to estimate the elasticity. The cases and have used individual consumption behavior in others to estimate the elasticity. The
pioneering study of intertemporal substitution elasticities was by Robert Hall,pioneering study of intertemporal substitution elasticities was by Robert Hall,6973 who found that who found that
the elasticity was extremely small, could be zero, was statistically insignificant and was no more the elasticity was extremely small, could be zero, was statistically insignificant and was no more
than 0.2. Early surveys of the value led to the use of elasticities of 0.25 to 0.33.than 0.2. Early surveys of the value led to the use of elasticities of 0.25 to 0.33.7074 Most subsequent Most subsequent
studies produced elasticities below 0.5, although some very large ones were estimated. studies produced elasticities below 0.5, although some very large ones were estimated.
~~Professors at Prague’s Charles University prepared a 2013 meta-analysis (i.e., a large analysis~~
~~that combines data from many studies) of estimates of the IES across many countries found an~~
~~overall elasticity of 0.5 for the world on average and 0.6 for the United States.71 About half the~~
~~169 studies were based on U.S. data. The authors cautioned that the cross-country estimates were~~
~~too large in value because of publication bias. Publication bias is a problem widely recognized in~~
~~many fields. Basically, if theory indicates an elasticity should be positive, and the estimate is~~
~~negative, peer reviewers are less likely to recommend publication, editors are less likely to~~
~~publish, and researchers, expecting the unlikelihood of publishing, tend not to submit their~~
~~articles (which often involve a fee) or even prepare a working paper. Yet, when a large number of~~
~~estimates have been made, because of the fundamental theory of statistical estimation, some~~

68 71 These studies are reviewed in Jane G. Gravelle, The Economic Effects of Taxing Capital Income (Cambridge, MA, MIT Press, 1994), p. 27. The most recent study was Jonathan Skinner and Daniel Feenberg, “The Impact of the 1986 Tax Reform on Personal Saving,” in Do Taxes Matter? The Impact of the Tax Reform Act of 1986, Ed. Joel Slemrod (Cambridge MA: The MIT Press, 1990). 72 See Douglas W. Elmendorf, See Douglas W. Elmendorf, The Effect of Interest-Rate Changes on Household Saving and Consumption: A Survey, ,
Federal Reserve Board, July 1997, https://www.federalreserve.gov/econres/feds/the-effect-of-interest-rate-changes-on-Federal Reserve Board, July 1997, https://www.federalreserve.gov/econres/feds/the-effect-of-interest-rate-changes-on-
household-saving-and-consumption-a-survey.htm. household-saving-and-consumption-a-survey.htm.
6973 Robert E. Hall, R.E., “Intertemporal Substitution in Consumption,” Robert E. Hall, R.E., “Intertemporal Substitution in Consumption,” Journal of Political Economy, vol. 96, no. 2, , vol. 96, no. 2,
April 1988, pp. 339-357. April 1988, pp. 339-357.
7074 Auerbach and Kotlikoff report the results of nine different studies that ranged in value from less than 0.1 to more Auerbach and Kotlikoff report the results of nine different studies that ranged in value from less than 0.1 to more
than 1. The median value was around 0.3 and a weighted average of eight of them using the mid-point of each range than 1. The median value was around 0.3 and a weighted average of eight of them using the mid-point of each range
((~~and excluding a study by Mankiw, Rotemberg and Summers in which it is clear the authors were not very satisfied~~
~~with the model) yielded an estimate of 0.39. See Alan J. Auerbach and Laurence J. Kotlikoff,~~ ~~Dynamic Fiscal Policy,~~
~~Cambridge University Press, New York, New York, 1987. They adopt a value of 0.25. Elmendorf undertakes a survey~~
~~of the studies most commonly cited and obtains a weighted average of 0.37; he uses 0.33 in his work. See Douglas W.~~
~~Elmendorf, “The Effect of Interest-Rate Changes on Household Saving and Consumption,” Federal Reserve Board,~~
~~June 1996, http://www.federalreserve.gov/pubs/feds/1996/199627/199627pap.pdf.~~
~~71 C Tomas Havraneka, Roman Horvathb, Zuzana Irsovab, and Marek Rusnaka, “Cross-Country Heterogeneity in~~
~~Intertemporal Substitution,” Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague,~~
~~http://ies.fsv.cuni.cz/sci/publication/show/id/4868/lang/cs. A meta-analysis does not simply average results of studies~~
~~but weights them according to the number of observations and sometimes by confidence intervals.~~
~~Congressional Research Service~~

24

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

continued...) Congressional Research Service 24 Dynamic Scoring for Tax Legislation: A Review of Models Professors at Prague’s Charles University prepared a 2013 meta-analysis (i.e., a large analysis that combines data from many studies) of estimates of the IES across many countries found an overall elasticity of 0.5 for the world on average and 0.6 for the United States.75 About half the 169 studies were based on U.S. data. The authors cautioned that the cross-country estimates were too large in value because of publication bias. Publication bias is a problem widely recognized in many fields. Basically, if theory indicates an elasticity should be positive, and the estimate is negative, peer reviewers are less likely to recommend publication, editors are less likely to publish, and researchers, expecting the unlikelihood of publishing, tend not to submit their articles (which often involve a fee) or even prepare a working paper. Yet, when a large number of estimates have been made, because of the fundamental theory of statistical estimation, some would be negative (particularly if the true value is low). Publication bias also suggests that would be negative (particularly if the true value is low). Publication bias also suggests that
estimates of the income and substitution elasticities are probably too large in absolute value. estimates of the income and substitution elasticities are probably too large in absolute value.
Havraneka, one of the co-authors of this meta-analysis, subsequently published the basic Havraneka, one of the co-authors of this meta-analysis, subsequently published the basic
(worldwide) results after correcting for estimated publication bias.(worldwide) results after correcting for estimated publication bias.7276 The correction indicates that The correction indicates that
the elasticity for macro aggregate studies is zero (as Hall originally found). In the basic case the elasticity for macro aggregate studies is zero (as Hall originally found). In the basic case
(without selecting across studies for other characteristics), the elasticity for micro studies (which (without selecting across studies for other characteristics), the elasticity for micro studies (which
were about a quarter of the studies) was 0.2. He also reported that the elasticity for micro studies were about a quarter of the studies) was 0.2. He also reported that the elasticity for micro studies
of asset holders was 0.36. His preferred estimate with various other characteristics selected was of asset holders was 0.36. His preferred estimate with various other characteristics selected was
0.33 for asset holders. In general, an IES for asset holders would be appropriate only if the model 0.33 for asset holders. In general, an IES for asset holders would be appropriate only if the model
identified a separate group of liquidity-constrained consumers. For a model without that feature, identified a separate group of liquidity-constrained consumers. For a model without that feature,
the elasticity for asset holders would be too high. If the macro elasticities were considered as well the elasticity for asset holders would be too high. If the macro elasticities were considered as well
as micro, then an IES of zero to 0.2 might be in order. as micro, then an IES of zero to 0.2 might be in order.
In addition, note that publication bias may also affect other types of estimates discussed in this In addition, note that publication bias may also affect other types of estimates discussed in this
section, including the estimates of standard labor substitution elasticities already reviewed, section, including the estimates of standard labor substitution elasticities already reviewed,
because they included only estimates in the direction expected by theory. because they included only estimates in the direction expected by theory.
There are two caveats about the empirical evidence on the IES for consumption. The first is that There are two caveats about the empirical evidence on the IES for consumption. The first is that
the estimates have considered periods that are close together, but the elasticity in models is the estimates have considered periods that are close together, but the elasticity in models is
applied over many periods of time and is determined by a utility function that assumes a constant applied over many periods of time and is determined by a utility function that assumes a constant
elasticity of substitution. Most of the effect on savings from a change in the tax rate on capital elasticity of substitution. Most of the effect on savings from a change in the tax rate on capital
income arises from reducing current consumption to shift it to these periods further into the income arises from reducing current consumption to shift it to these periods further into the
future. Therefore, applying these effects in intertemporal models assumes that individuals make future. Therefore, applying these effects in intertemporal models assumes that individuals make
the same sort of calculations into the future. One reason, for example, that individuals may be the same sort of calculations into the future. One reason, for example, that individuals may be
reluctant to shift consumption farther in the future is that they may not be as certain to be alive. In reluctant to shift consumption farther in the future is that they may not be as certain to be alive. In
addition, they may not have the information or cognitive skills to make choices about addition, they may not have the information or cognitive skills to make choices about
consumption far into the future, and there is evidence that most individuals have much shorter consumption far into the future, and there is evidence that most individuals have much shorter
~~planning horizons.73 Uncertainty about life span may also lead to a buffer stock of savings, or~~
~~target savings, which is not sensitive to the substitution effect. Some life-cycle models~~
~~incorporate this type of savings.~~
~~The second, and perhaps more important, concern for effects in the budget horizon, is that due to~~
~~the nature of the utility function, leisure also responds to changes in the rate of return, which then~~
~~generates a significant short-run labor supply response. No empirical evidence supports this~~
~~response, which can dominate the effects when taxes on capital income are cut deeply.74 Ballard,~~
~~a discussant of the JCT intertemporal model simulations, stated, “any simulation model that~~
~~generates a large elasticity of labor supply with respect to the interest rate is shooting in the~~
~~dark.”75 Ballard believes that the controlling of the response of labor supply to interest rates is~~

~~72 Tomas Havranek, “Intertemporal Substitution: The Importance of Method Choices and Selective Reporting,”~~ ~~Journal~~
~~of the European Economic Association, vol. 13(6), pp. 1180-1204.~~
~~73 Fisher and Montalto also report that 34% of individuals had a planning horizon of a year or less and 85% less than 10~~
~~years. See Patti J. Fisher and Catherine P. Montalto, 2010, “Effect of Saving Motives and Horizon on Saving~~
~~Behaviors,” Journal of Economic Psychology, vol. 31, no. 1 (2010), pp. 92-105.~~
~~74 In simulations of intertemporal models where a consumption tax was substituted for an income tax in a revenue~~
~~neutral change and the wage tax actually increased, labor supply increased by significant amounts throughout the first~~
~~10 years and dominated the change in output. See Eric Engen, Jane Gravelle, and Kent Smetters, “Dynamic Tax~~
~~Models: Why They Do the Things They Do,” National Tax Journal, vol. 50, September 1997, pp. 657-682.~~
~~75 Comment by Charles Ballard, Joint Committee On Taxation,~~ ~~Tax Modeling Project And 1997 Tax Symposium~~
~~Papers, Joint Committee Print, November 20, 1997, posted on the JCT website at https://www.jct.gov/~~
~~publications.html?func=startdown&id=2940.~~
~~Congressional Research Service~~

25

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

(and excluding a study by Mankiw, Rotemberg and Summers in which it is clear the authors were not very satisfied with the model) yielded an estimate of 0.39. See Alan J. Auerbach and Laurence J. Kotlikoff, Dynamic Fiscal Policy, Cambridge University Press, New York, New York, 1987. They adopt a value of 0.25. Elmendorf undertakes a survey of the studies most commonly cited and obtains a weighted average of 0.37; he uses 0.33 in his work. See Douglas W. Elmendorf, “The Effect of Interest-Rate Changes on Household Saving and Consumption,” Federal Reserve Board, June 1996, http://www.federalreserve.gov/pubs/feds/1996/199627/199627pap.pdf. 75 C Tomas Havraneka, Roman Horvathb, Zuzana Irsovab, and Marek Rusnaka, “Cross-Country Heterogeneity in Intertemporal Substitution,” Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, http://ies.fsv.cuni.cz/sci/publication/show/id/4868/lang/cs. A meta-analysis does not simply average results of studies but weights them according to the number of observations and sometimes by confidence intervals. 76 Tomas Havranek, “Intertemporal Substitution: The Importance of Method Choices and Selective Reporting,” Journal of the European Economic Association, vol. 13(6), pp. 1180-1204. Congressional Research Service 25 Dynamic Scoring for Tax Legislation: A Review of Models planning horizons.77 Uncertainty about life span may also lead to a buffer stock of savings, or target savings, which is not sensitive to the substitution effect. Some life-cycle models incorporate this type of savings. The second, and perhaps more important, concern for effects in the budget horizon, is that due to the nature of the utility function, leisure also responds to changes in the rate of return, which then generates a significant short-run labor supply response. No empirical evidence supports this response, which can dominate the effects when taxes on capital income are cut deeply.78 Ballard, a discussant of the JCT intertemporal model simulations, stated, “any simulation model that generates a large elasticity of labor supply with respect to the interest rate is shooting in the dark.”79 Ballard believes that the controlling of the response of labor supply to interest rates is crucial to modeling and that this can be achieved, in part, via the time endowment (limiting the crucial to modeling and that this can be achieved, in part, via the time endowment (limiting the
available supply of leisure). available supply of leisure).
Frisch (Intertemporal Labor Substitution Elasticity with Respect to Wages)
The Frisch elasticity, which estimates the response of workers to changes in the wage rate over The Frisch elasticity, which estimates the response of workers to changes in the wage rate over
time, is not likely to be of importance in an analysis of a permanent tax change.time, is not likely to be of importance in an analysis of a permanent tax change.7680 It is, however, It is, however,
an estimated parameter that can be compared with the implied elasticities in the intertemporal an estimated parameter that can be compared with the implied elasticities in the intertemporal
models. As is the case with standard labor supply estimates, it is calculated from other parameters models. As is the case with standard labor supply estimates, it is calculated from other parameters
in intertemporal models. in intertemporal models.
There are two types of estimates. Some are from micro data studies that examine individual There are two types of estimates. Some are from micro data studies that examine individual
behavior over time. These elasticities tend to be small, on the whole, at least for men. The other behavior over time. These elasticities tend to be small, on the whole, at least for men. The other
estimates are from aggregate micro data, which tend to be large, usually above 1 or 2. These estimates are from aggregate micro data, which tend to be large, usually above 1 or 2. These
macroeconomic estimates are largely based on variations in hours and wages over the business macroeconomic estimates are largely based on variations in hours and wages over the business
cycle. They rest on the assumption that unemployment during recessions is voluntary, whereas cycle. They rest on the assumption that unemployment during recessions is voluntary, whereas
most models of business cycles consider workers who lose their jobs or have their hours reduced most models of business cycles consider workers who lose their jobs or have their hours reduced
are largely involuntarily unemployed or underemployed.are largely involuntarily unemployed or underemployed.7781 Assuming some or most of Assuming some or most of
unemployment is involuntary, these estimates overstate the Frisch elasticity. unemployment is involuntary, these estimates overstate the Frisch elasticity.
The micro data studies largely concentrate on the response of hours of work and examine the The micro data studies largely concentrate on the response of hours of work and examine the
response with profiles of wages and hours over time. Both show an inverted U shape, with fewer response with profiles of wages and hours over time. Both show an inverted U shape, with fewer
hours when young and when old, and lower wages when young and old, respectively, but the hours when young and when old, and lower wages when young and old, respectively, but the
shapes are quite different, which leads to lower elasticities.shapes are quite different, which leads to lower elasticities.78
~~Turning to the microeconomic data, Keane also surveyed the Frisch elasticity studies for men for~~
~~hours of work. He lists 13 studies with a mean elasticity of 0.85. The estimate, however, was~~
~~greatly influenced by one outlier (of 6.25); with that study excluded, the mean was 0.4. The~~
~~median value was 0.31, although six of the studies had values clustered between 0.03 and 0.17,~~
~~whereas the others varied substantially. CBO researchers recently examined the Frisch~~
~~estimates.79 They relied on microeconomic evidence. As discussed in their paper, the few studies~~
~~of Frisch elasticities for married women tend to be higher than those of married men. The~~
~~elasticity estimates for women also appear to be declining, consistent with other work that shows~~

7682 77 Fisher and Montalto also report that 34% of individuals had a planning horizon of a year or less and 85% less than 10 years. See Patti J. Fisher and Catherine P. Montalto, 2010, “Effect of Saving Motives and Horizon on Saving Behaviors,” Journal of Economic Psychology, vol. 31, no. 1 (2010), pp. 92-105. 78 In simulations of intertemporal models where a consumption tax was substituted for an income tax in a revenue neutral change and the wage tax actually increased, labor supply increased by significant amounts throughout the first 10 years and dominated the change in output. See Eric Engen, Jane Gravelle, and Kent Smetters, “Dynamic Tax Models: Why They Do the Things They Do,” National Tax Journal, vol. 50, September 1997, pp. 657-682. 79 Comment by Charles Ballard, Joint Committee On Taxation, Tax Modeling Project And 1997 Tax Symposium Papers, Joint Committee Print, November 20, 1997, posted on the JCT website at https://www.jct.gov/publications.html?func=startdown&id=2940. 80 An exception would be where a tax cut today is offset by a tax cut in the future as a way of dealing with the An exception would be where a tax cut today is offset by a tax cut in the future as a way of dealing with the
requirement that deficits must be offset in intertemporal models. requirement that deficits must be offset in intertemporal models.
7781 See CRS Report R42700, See CRS Report R42700, The “Fiscal Cliff”: Macroeconomic Consequences of Tax Increases and Spending Cuts, by , by
Jane G. Gravelle, for a further discussion of differences in macroeconomic models. Jane G. Gravelle, for a further discussion of differences in macroeconomic models.
7882 Numerous studies have criticized either smaller or larger Frisch elasticities on various grounds. For example, Keane Numerous studies have criticized either smaller or larger Frisch elasticities on various grounds. For example, Keane
and Rogers argue that the low elasticities in micro studies for men could be higher if human capital formation were and Rogers argue that the low elasticities in micro studies for men could be higher if human capital formation were
~~considered, although responses to transitory effects would be smaller than the response to permanent changes in the~~
~~wage profile. See Michael Keane and Richard Rogerson, “Micro and Macro Labor Supply Elasticities: An Assessment~~
~~of Conventional Wisdom,” Journal of Economic Literature, vol. 50, no. 2 (June 2012), pp. 464-476. Card, however,~~
~~questions even the small elasticities. He provides diagrams showing wage patterns of those with elementary, high~~
~~school and college educations. They show very different patterns of wage growth (i.e., wages of college graduates tend~~
~~to rise initially and for some extended period of time, whereas wages of those with elementary education change very~~
~~little). These groups have very similar lifetime working profiles. This evidence suggests that there is little relationship~~
~~between wages and work effort; rather men begin working when they finish schooling and reduce hours slightly when~~
~~they get older. David Card, “Intertemporal Labor Supply: An Assessment,” in Christopher Sims, (ed.),~~ ~~Advances in~~
~~Econometrics, Sixth World Congress, New York, Cambridge University Press, 1994.~~
~~79 Felix Reichling and Charles Whalen, Review of Estimates of the Frisch Elasticity of Labor Supply, Working Paper~~
~~2012-13. October 2012, http://www.cbo.gov/sites/default/files/cbofiles/attachments/10-25-2012-~~
~~Frisch_Elasticity_of_Labor_Supply.pdf.~~
~~Congressional Research Service~~

26

~~link to page 35~~ ~~Dynamic Scoring for Tax Legislation: A Review of Models~~

(continued...) Congressional Research Service 26 Dynamic Scoring for Tax Legislation: A Review of Models Turning to the microeconomic data, Keane also surveyed the Frisch elasticity studies for men for hours of work. He lists 13 studies with a mean elasticity of 0.85. The estimate, however, was greatly influenced by one outlier (of 6.25); with that study excluded, the mean was 0.4. The median value was 0.31, although six of the studies had values clustered between 0.03 and 0.17, whereas the others varied substantially. CBO researchers recently examined the Frisch estimates.83 They relied on microeconomic evidence. As discussed in their paper, the few studies of Frisch elasticities for married women tend to be higher than those of married men. The elasticity estimates for women also appear to be declining, consistent with other work that shows married women’s labor supply response is becoming more like that of married men. The paper married women’s labor supply response is becoming more like that of married men. The paper
also reviews labor force participation elasticities, where studies have been focused on those close also reviews labor force participation elasticities, where studies have been focused on those close
to retirement. Overall, the authors suggest a range of the Frisch elasticity from 0.27 to 0.53, with to retirement. Overall, the authors suggest a range of the Frisch elasticity from 0.27 to 0.53, with
a central estimate of 0.4. Neither of these studies reference Ball, who found a zero Frisch a central estimate of 0.4. Neither of these studies reference Ball, who found a zero Frisch
elasticity.elasticity.8084 For Keane’s summary, including this study would reduce the mean to 0.34 and the For Keane’s summary, including this study would reduce the mean to 0.34 and the
median to 0.17. median to 0.17.
Elminegad, Havrenek and Horvath perform a meta-analysis of 36 studies, both macro and micro, Elminegad, Havrenek and Horvath perform a meta-analysis of 36 studies, both macro and micro,
and find an elasticity from all studies of 0.5. However, but when they correct for publication bias and find an elasticity from all studies of 0.5. However, but when they correct for publication bias
and identification issues, the elasticity is zero (with publication bias and identification each and identification issues, the elasticity is zero (with publication bias and identification each
accounting for about half the reduction) accounting for about half the reduction) 8185 Identification bias occurs when there is not enough Identification bias occurs when there is not enough
exogenous variation. Just accounting for publication bias, the value should be 0.25. A recent study exogenous variation. Just accounting for publication bias, the value should be 0.25. A recent study
of a Swiss tax holiday by Martinez, Saez, and Siegenthaler (2021) has a strong identifier, as the of a Swiss tax holiday by Martinez, Saez, and Siegenthaler (2021) has a strong identifier, as the
holiday years varied by canton.holiday years varied by canton.8286 The authors found no response for participation in the labor The authors found no response for participation in the labor
market or for hours of work for wage earners, and a small response (elasticity of 0.2) for self-market or for hours of work for wage earners, and a small response (elasticity of 0.2) for self-
employment earnings, which could be partially due to evasion. This quasi-experimental study employment earnings, which could be partially due to evasion. This quasi-experimental study
provides evidence of a virtually nonexistent elasticity. provides evidence of a virtually nonexistent elasticity.
A Note on Time Endowments
One of the most important, and yet often largely overlooked, parameters that affect the labor One of the most important, and yet often largely overlooked, parameters that affect the labor
supply response in intertemporal models used to analyze taxes is the time endowment.supply response in intertemporal models used to analyze taxes is the time endowment.~~83 Because~~
~~choices are made with a utility function where individuals choose leisure and consumption,~~
~~leisure demand has to be translated into labor supply, and the correspondence between those two~~
~~drives the relationship.84 A larger time endowment, which allows a larger amount of leisure,~~
~~causes all of the labor supply elasticities to be larger.~~
~~If this measure is set independently, there are no obvious guides to how big it should be. A 40-~~
~~hour workweek is 24% of the total hours in a week, and the leisure share is 76%. There is,~~
~~however, a biological need to sleep. If a 40-hour workweek is assumed, and 8 hours per day are~~
~~assigned to sleep, the share of leisure would be 64%. However, workers may have an embedded~~
~~lunch hour, and spend some necessary time commuting (which is like working, in that it provides~~
~~benefits such as lower housing prices), household activities, and care of family members. The~~
~~American Time Use Survey indicates that the ratio of leisure to the sum of leisure and work is~~
~~43% for men aged 35 to 44 and 47% for women in the same age range. These numbers tend to be~~
~~relatively steady throughout the primary working age of 25 to 54 for both groups.85 On average,~~
~~men between the ages of 35 and 44 work 42 hours a week and women work 29 hours (reflecting~~

8087 Because considered, although responses to transitory effects would be smaller than the response to permanent changes in the wage profile. See Michael Keane and Richard Rogerson, “Micro and Macro Labor Supply Elasticities: An Assessment of Conventional Wisdom,” Journal of Economic Literature, vol. 50, no. 2 (June 2012), pp. 464-476. Card, however, questions even the small elasticities. He provides diagrams showing wage patterns of those with elementary, high school and college educations. They show very different patterns of wage growth (i.e., wages of college graduates tend to rise initially and for some extended period of time, whereas wages of those with elementary education change very little). These groups have very similar lifetime working profiles. This evidence suggests that there is little relationship between wages and work effort; rather men begin working when they finish schooling and reduce hours slightly when they get older. David Card, “Intertemporal Labor Supply: An Assessment,” in Christopher Sims, (ed.), Advances in Econometrics, Sixth World Congress, New York, Cambridge University Press, 1994. 83 Felix Reichling and Charles Whalen, Review of Estimates of the Frisch Elasticity of Labor Supply, Working Paper 2012-13. October 2012, http://www.cbo.gov/sites/default/files/cbofiles/attachments/10-25-2012-Frisch_Elasticity_of_Labor_Supply.pdf. 84 Laurence Ball, “Intertemporal Substitution and Constraints on Labor Supply: Evidence from Panel Data,” Laurence Ball, “Intertemporal Substitution and Constraints on Labor Supply: Evidence from Panel Data,” Economic
Inquiry, vol. 8, no. 4 (October 1990), pp. 706-724. , vol. 8, no. 4 (October 1990), pp. 706-724.
8185 Ali Elminejad, Toms Havrenek, and Roman Horvath, Ali Elminejad, Toms Havrenek, and Roman Horvath, Publication and Identification Biases in Measuring the
Intertemporal Subsitution of Labor Supply, ZBW, Leibnix Information Centre for Economics, Kiel Hamburg, April 9, , ZBW, Leibnix Information Centre for Economics, Kiel Hamburg, April 9,
2021, https://www.econstor.eu/bitstream/10419/232534/1/Frisch.pdf. 2021, https://www.econstor.eu/bitstream/10419/232534/1/Frisch.pdf.
8286 Isabel Z. Martinez, Emmanuel Saez, and Michael Siegenthaler, “Intertemporal Labor Supply Substitution? Evidence Isabel Z. Martinez, Emmanuel Saez, and Michael Siegenthaler, “Intertemporal Labor Supply Substitution? Evidence
from the Swiss Income Tax Holidays,” from the Swiss Income Tax Holidays,” American Economic Review, vol. 111, no. 2 (2021), pp. 506-546, , vol. 111, no. 2 (2021), pp. 506-546,
8387 This time endowment is effectively set by setting the shares of leisure and consumption in the utility function. Since This time endowment is effectively set by setting the shares of leisure and consumption in the utility function. Since
consumption and labor are known, this parameter sets the amount of leisure and the total time endowment. consumption and labor are known, this parameter sets the amount of leisure and the total time endowment.
~~84 Some models enter labor as part of a negative additive utility and there is no time endowment issue, but that is not~~
~~the case with the models in Table 4.~~
~~85 U.S. Department of Labor, American Time Use Survey, Table 3, http://www.bls.gov/news.release/atus.t03.htm.~~
~~Congressional Research Service~~

27

~~link to page 33~~ ~~Dynamic Scoring for Tax Legislation: A Review of Models~~

Congressional Research Service 27 link to page 35 Dynamic Scoring for Tax Legislation: A Review of Models choices are made with a utility function where individuals choose leisure and consumption, leisure demand has to be translated into labor supply, and the correspondence between those two drives the relationship.88 A larger time endowment, which allows a larger amount of leisure, causes all of the labor supply elasticities to be larger. If this measure is set independently, there are no obvious guides to how big it should be. A 40-hour workweek is 24% of the total hours in a week, and the leisure share is 76%. There is, however, a biological need to sleep. If a 40-hour workweek is assumed, and 8 hours per day are assigned to sleep, the share of leisure would be 64%. However, workers may have an embedded lunch hour, and spend some necessary time commuting (which is like working, in that it provides benefits such as lower housing prices), household activities, and care of family members. The American Time Use Survey indicates that the ratio of leisure to the sum of leisure and work is 43% for men aged 35 to 44 and 47% for women in the same age range. These numbers tend to be relatively steady throughout the primary working age of 25 to 54 for both groups.89 On average, men between the ages of 35 and 44 work 42 hours a week and women work 29 hours (reflecting some of those who are not in the work force). Women, however, spend much more time than men some of those who are not in the work force). Women, however, spend much more time than men
on housework and care of family members. on housework and care of family members.
Another way of considering this issue is that if it were assumed that the ratio of a leisure to hours Another way of considering this issue is that if it were assumed that the ratio of a leisure to hours
available for a full-time worker is 0.5, then that person would be effectively able to hold two jobs available for a full-time worker is 0.5, then that person would be effectively able to hold two jobs
(work 80 hours a week), which would imply 10- to 12-hour work days every day. Assuming up to (work 80 hours a week), which would imply 10- to 12-hour work days every day. Assuming up to
another half time job could be taken, then a ratio of 0.33 would be appropriate. another half time job could be taken, then a ratio of 0.33 would be appropriate.
The first study by Auerbach and Kotlikoff set the time endowment at 5,000 hours a year, which The first study by Auerbach and Kotlikoff set the time endowment at 5,000 hours a year, which
would lead to a leisure share of time at 0.6, assuming working for 40 hours for 50 weeks (2,000 would lead to a leisure share of time at 0.6, assuming working for 40 hours for 50 weeks (2,000
hours).hours).8690 In a 1993 study, Fullerton and Rogers set the time endowment at 4,000 hours, which In a 1993 study, Fullerton and Rogers set the time endowment at 4,000 hours, which
would suggest a share of 0.5.would suggest a share of 0.5.8791 According to current data, average hours are 42.5 for those who According to current data, average hours are 42.5 for those who
usually work full time and 38.5 for all workers.usually work full time and 38.5 for all workers.8892 Neither study had a discussion of the basis for Neither study had a discussion of the basis for
its choice. Current or recently used models range from a 0.3 to a 0.6 ratio of leisure to hours its choice. Current or recently used models range from a 0.3 to a 0.6 ratio of leisure to hours
available. available.
Comparing Empirical Estimates to Estimates in the Models
This section examines the estimates used in the models. To summarize the review, the evidence This section examines the estimates used in the models. To summarize the review, the evidence
suggests that suggests that
• the labor income elasticity is between 0.0 and minus 0.1, the labor income elasticity is between 0.0 and minus 0.1,
• the substitution elasticity between 0.0 and 0.3, the substitution elasticity between 0.0 and 0.3,
• total labor supply elasticity less than 0.3, total labor supply elasticity less than 0.3,
• the savings rate elasticity around zero but no more than 0.4 if positive, the savings rate elasticity around zero but no more than 0.4 if positive,
~~ the intertemporal substitution elasticity should be 0.2 or less, and~~
 88 Some models enter labor as part of a negative additive utility and there is no time endowment issue, but that is not the case with the models in Table 4. 89 U.S. Department of Labor, American Time Use Survey, Table 3, http://www.bls.gov/news.release/atus.t03.htm. 90 Alan J. Auerbach and Laurence J. Kotlikoff, Dynamic Fiscal Policy, Cambridge University Press, New York, New York, 1987. 91 Don Fullerton and Diane Lim Rogers, Who Bears the Lifetime Tax Burden, Washington, DC, The Brookings Institution, 1993. 92 U.S. Department of Labor, Household Data, Annual Averages, Table 19. Persons at Work in Agriculture and Non-Agriculture Industries by Hours of Work, 2012. Congressional Research Service 28 link to page 33 Dynamic Scoring for Tax Legislation: A Review of Models • the intertemporal substitution elasticity should be 0.2 or less, and • the Frisch elasticity close to zero. the Frisch elasticity close to zero.
Note that except for the intertemporal substitution elasticity, none of these estimates were Note that except for the intertemporal substitution elasticity, none of these estimates were
adjusted for publication bias, and thus would probably be smaller in absolute value. adjusted for publication bias, and thus would probably be smaller in absolute value.
Table 3 shows the values in the Solow models. The labor income and substitution elasticities in shows the values in the Solow models. The labor income and substitution elasticities in
all four of the models that report separate values are consistent with the empirical estimates noted all four of the models that report separate values are consistent with the empirical estimates noted
above. The Treasury study is low on the elasticities for labor income and substitution effects; it is above. The Treasury study is low on the elasticities for labor income and substitution effects; it is
also toward the high end on the savings elasticity. All of these estimates are close to the ranges also toward the high end on the savings elasticity. All of these estimates are close to the ranges
suggested above for labor supply, but the Tax Foundation has a large savings response (an infinite suggested above for labor supply, but the Tax Foundation has a large savings response (an infinite
savings elasticity means that the after tax return to its prior value). Note, however, that even a savings elasticity means that the after tax return to its prior value). Note, however, that even a
limited difference can have an impact, so that a change that cut marginal and average rates, the limited difference can have an impact, so that a change that cut marginal and average rates, the
same amount would have twice the effect in the CBO model as in the JCT model. Note also that same amount would have twice the effect in the CBO model as in the JCT model. Note also that
the JCT model is not a pure Solow model, but rather has an intertemporal model of consumption the JCT model is not a pure Solow model, but rather has an intertemporal model of consumption
over time. over time.

~~86 Alan J. Auerbach and Laurence J. Kotlikoff, Dynamic Fiscal Policy, Cambridge University Press, New York, New~~
~~York, 1987.~~
~~87 Don Fullerton and Diane Lim Rogers, Who Bears the Lifetime Tax Burden, Washington, DC, The Brookings~~
~~Institution, 1993.~~
~~88 U.S. Department of Labor, Household Data, Annual Averages, Table 19. Persons at Work in Agriculture and Non-~~
~~Agriculture Industries by Hours of Work, 2012.~~
~~Congressional Research Service~~

28

~~Dynamic Scoring for Tax Legislation: A Review of Models~~

Table 3. Supply Elasticities in Solow Models
Joint
Committee
Congressional
Urban
on Taxation
Budget Office
Brookings Tax
Tax
Elasticity
(JCT)
(CBO)
Treasury
Policy Center
Foundation
Labor Income Labor Income
-0.10 -0.10
-0.05 -0.05
0.00 0.00
-0.05 -0.05
NA NA
Labor Labor
0.20 0.20
0.24 0.24
0.00 0.00
0.24 0.24
NA NA
Substitution Substitution
Total Labor Total Labor
0.10 0.10
0.19 0.19
0.00 0.00
0.19 0.19
0.3 0.3
Savings Savings
NA NA
0.20 0.20
0.40 0.40
0.20 0.20
Infinity Infinity
(Long Run) (Long Run)
Sources: Joint Committee on Taxation, “Overview of Joint Economic Committee Modeling, JCX 33-18,” April Joint Committee on Taxation, “Overview of Joint Economic Committee Modeling, JCX 33-18,” April
23, 2018, https://www.jct.gov/publications/2018/jcx-33-18/; Congressional Budget Office, “How CBO Analyzes 23, 2018, https://www.jct.gov/publications/2018/jcx-33-18/; Congressional Budget Office, “How CBO Analyzes
the Effects of Changes in Federal Fiscal Policies on the Economy,” November 2014, https://www.cbo.gov/sites/the Effects of Changes in Federal Fiscal Policies on the Economy,” November 2014, https://www.cbo.gov/sites/
default/files/113th-congress-2013-2014/reports/49494-FiscalPolicies.pdf, and “The 2013 Long Term Budget default/files/113th-congress-2013-2014/reports/49494-FiscalPolicies.pdf, and “The 2013 Long Term Budget
Outlook,” September 2013, p. 82, http://www.cbo.gov/sites/default/files/cbofiles/attachments/44521-Outlook,” September 2013, p. 82, http://www.cbo.gov/sites/default/files/cbofiles/attachments/44521-
LTBO2013_0.pdf; Robert Carrol , John Diamond, Craig Johnson, and James Makie III, “A Summary of the LTBO2013_0.pdf; Robert Carrol , John Diamond, Craig Johnson, and James Makie III, “A Summary of the
Dynamic Analysis of the Tax Reform Options Prepared for the President’s Advisory Panel on Federal Tax Dynamic Analysis of the Tax Reform Options Prepared for the President’s Advisory Panel on Federal Tax
Reform,” U.S. Department of the Treasury, Office of Tax Analysis, May 25, 2006, prepared for the American Reform,” U.S. Department of the Treasury, Office of Tax Analysis, May 25, 2006, prepared for the American
Enterprise Institute Conference on Tax Reform and Dynamic Analysis, May 2006; Benjamin R. Page and Kent Enterprise Institute Conference on Tax Reform and Dynamic Analysis, May 2006; Benjamin R. Page and Kent
Smetters, “Tax Policy Center, Dynamic Analysis of Tax Plans,” Tax Policy Center, April 5, 2017, Smetters, “Tax Policy Center, Dynamic Analysis of Tax Plans,” Tax Policy Center, April 5, 2017,
https://www.urban.org/sites/default/files/publication/89456/2001217-dynamic-analysis-of-tax-plans-an-update.pdf; https://www.urban.org/sites/default/files/publication/89456/2001217-dynamic-analysis-of-tax-plans-an-update.pdf;
and Stephen J. Entin, Huaqun Li, and Kyle Pomerleau, “Overview of the Tax Foundation’s General Equilibrium and Stephen J. Entin, Huaqun Li, and Kyle Pomerleau, “Overview of the Tax Foundation’s General Equilibrium
Model,” April 2018, https://files.taxfoundation.org/20180419195810/TaxFoundaton_General-Equilibrium-Model-Model,” April 2018, https://files.taxfoundation.org/20180419195810/TaxFoundaton_General-Equilibrium-Model-
Overview1.pdf?_gl=Overview1.pdf?_gl=
~~1*1oy7o6l*_ga*MjEyMzIxMDM0Mi4xNjcxODA3NDI1*_ga_FP7KWDV08V*MTY3ODgxOTEwNC4zMS4xLjE2N~~
~~zg4MTkxMTUuNDkuMC4w. It is not clear how long it takes to reach the long run.~~
~~Notes:~~ ~~The JCT model uses a life-cycle consumption approach to savings~~1. Notes: The JCT model uses a savings response consistent with that in a myopic Ramsey mode with an IES of 0.35; previously, it used with an IES of 0.35; previously, it used
an estimate of 0.25 and indicated that the long-run elasticity is 0.29. Presumably, the adjustment is more rapid an estimate of 0.25 and indicated that the long-run elasticity is 0.29. Presumably, the adjustment is more rapid
than in a standard Solow model. JCTthan in a standard Solow model. JCT, previously, and CBO also provide sensitivity analysis with labor supply elasticities. and CBO also provide sensitivity analysis with labor supply elasticities.
Their life-cycle elasticity appears to be slightly higher than that suggested in the meta-analysis. Their life-cycle elasticity appears to be slightly higher than that suggested in the meta-analysis.
As the table shows, there is no savings elasticity as such in the JCT model because savings is As the table shows, there is no savings elasticity as such in the JCT model because savings is
generated from intertemporal consumption, which in that respect is similar to an intertemporal generated from intertemporal consumption, which in that respect is similar to an intertemporal
elasticity of substitution. JCT’s value of 0.35 is slightly higher than the central tendency of the elasticity of substitution. JCT’s value of 0.35 is slightly higher than the central tendency of the
evidence. evidence.
Congressional Research Service 29 link to page 35 link to page 35 Dynamic Scoring for Tax Legislation: A Review of Models Some elasticities in the intertemporal model must be derived. The parameters that are directly Some elasticities in the intertemporal model must be derived. The parameters that are directly
entered into a model that has a utility function composed of leisure and consumption are the entered into a model that has a utility function composed of leisure and consumption are the
intertemporal elasticity of substitution (over time), the intratemporal substitution between leisure intertemporal elasticity of substitution (over time), the intratemporal substitution between leisure
and consumption, and leisure as a share of time (which is set by the value of coefficients on and consumption, and leisure as a share of time (which is set by the value of coefficients on
leisure and consumption in the utility function). leisure and consumption in the utility function).
In In ~~two~~three models referenced in this report models referenced in this report, —the JCT’s DSGEthe JCT’s DSGE ~~and OG-USA model,~~ , the new in-house JCT OLG model, and the OG-USA model—labor is entered labor is entered
separately in the utility function so that there is no intratemporal substitution elasticity. The JCT separately in the utility function so that there is no intratemporal substitution elasticity. The JCT
DSGE model is an infinite horizon model and the OG-USA model is an overlapping generations model. model is an infinite horizon model and the OG-USA model is an overlapping generations model.
According to the last JCT study, the Frisch elasticity is 0.2, which means that the labor income According to the last JCT study, the Frisch elasticity is 0.2, which means that the labor income
and substitution elasticity is -0.2 and 0.2, and the intertemporal substitution elasticity with respect and substitution elasticity is -0.2 and 0.2, and the intertemporal substitution elasticity with respect
to wages is less than 0.2 because 48% of agents do not respond to the interest rate. The to wages is less than 0.2 because 48% of agents do not respond to the interest rate. The
intertemporal substitution elasticity with respect to consumption is 0.47, but is smaller because of intertemporal substitution elasticity with respect to consumption is 0.47, but is smaller because of
~~Congressional Research Service~~

29

~~link to page 35 link to page 35 link to page 35~~ ~~Dynamic Scoring for Tax Legislation: A Review of Models~~

the share of workers that are non-savers.the share of workers that are non-savers.8993 The OG-USA model has an intertemporal substitution The OG-USA model has an intertemporal substitution
of elasticity for consumption of 0.33, and while leisure is an additive in the utility function, the of elasticity for consumption of 0.33, and while leisure is an additive in the utility function, the
Frisch elasticity depends on the share of the labor in the time endowment. They report a Frisch Frisch elasticity depends on the share of the labor in the time endowment. They report a Frisch
elasticity of 0.41, which is consistent with a labor share of about 60% of the time endowment.elasticity of 0.41, which is consistent with a labor share of about 60% of the time endowment.90
~~In the remaining models~~94 The new OLG model has an intertemporal substitution elasticity of one for a combination of consumption and housing, which is considerably larger than estimates from the literature and larger than those in other models. However, it also includes wealth in the utility function, which lowers the savings response because an increase in the rate of return means a growth in wealth that reduces saving via an income effect. The labor supply elasticity cannot be defined numerically, as labor is provided in discrete choices (full time employment, part time employment, and no employment). However, the labor supply elasticity appears to be small.95 In the remaining models (including the prior JCT OLG model), to convert leisure demand into labor supply, the substitution elasticity , to convert leisure demand into labor supply, the substitution elasticity
and income elasticity for leisure (which is one because of the nature of the utility function) must and income elasticity for leisure (which is one because of the nature of the utility function) must
be multiplied by the ratio of leisure to hours available (assuming there is no other nonlabor be multiplied by the ratio of leisure to hours available (assuming there is no other nonlabor
income).income).9196 The Frisch elasticity is the ratio of leisure to labor, multiplied by a weighted average of The Frisch elasticity is the ratio of leisure to labor, multiplied by a weighted average of
the intertemporal and the intratemporal substitution elasticities (with the weights the shares of the intertemporal and the intratemporal substitution elasticities (with the weights the shares of
leisure and consumption). The other intertemporal elasticity of labor supply (i.e., the change in leisure and consumption). The other intertemporal elasticity of labor supply (i.e., the change in
labor as the relative price of future consumption changes through changes in the rate of return) is labor as the relative price of future consumption changes through changes in the rate of return) is
the ratio of leisure to labor, multiplied by the intertemporal substitution elasticity. the ratio of leisure to labor, multiplied by the intertemporal substitution elasticity.
Table 4 reports both these direct and derived elasticities for the reports both these direct and derived elasticities for the prior JCT, CBO, and Treasury models, JCT, CBO, and Treasury models,
along with assumptions in the EY Quest, the Diamond-along with assumptions in the EY Quest, the Diamond- Zodrow OLG model, and the Penn Zodrow OLG model, and the Penn
~~Wharton Budget Model. Note that only one model in Table 4 is a Ramsey model (the Treasury~~
~~model), although it has a utility function similar to the OLG models.92~~Wharton Budget Model. Note that only one model in Table 4 is a Ramsey model (the 93 JCT, Macroeconomic Analysis Of H.R. 6760, The “Protecting Family And Small Business Tax Cuts Act Of 2018” As Reported By The Committee On Ways And Means, JCX-79-18, September 26, 2018, https://www.jct.gov/publications/2018/jcx-79-18/. 94 Jason DeBacker, Richard W. Evans, and Kerk L. Phillips, “Integrating Microsimulation Models of Tax Policy into a DGE Macroeconomic Model,” Public Finance Review, vol. 47, no. 2 (2019), pp. 207-275. 95 For a detailed description of the general model, see Rachel Moore and Brandon Pecoraro, “Macroeconomic Implications of Modeling the Internal Revenue Code in a Heterogeneous-Agent Framework,” Economic Modelling, vol. 87 (May 2020), pp. 72-91. This version of the model is slightly different from the one in use by the JCT, as the JCT model has wealth in the utility function. 96 The values change slightly with income used for consumption, which raises the substitution elasticity and lowers the income elasticity. For example, the JCT implied elasticity would be 0.17 if 25% of consumption came from other sources and the incomes elasticity would be 0.27 rather than 0.30. See CRS Report RL31949, Issues in Dynamic Revenue Estimating, by Jane G. Gravelle, for the conversion formulas. Congressional Research Service 30 link to page 35 Dynamic Scoring for Tax Legislation: A Review of Models Treasury model), although it has a utility function similar to the OLG models.97 Also note that two of the Also note that two of the
models, CBO and Penn Wharton, have uncertainty, which tends to lead to precautionary savings models, CBO and Penn Wharton, have uncertainty, which tends to lead to precautionary savings
and a smaller effect of the rate and a smaller effect of the rate of return on savings. Penn Wharton also reports that the savings return on savings. Penn Wharton also reports that the savings
elasticity is 0.5 (although it allows users to set their own targets). elasticity is 0.5 (although it allows users to set their own targets).
All of the intertemporal elasticities are large compared with the empirical evidence. As indicated All of the intertemporal elasticities are large compared with the empirical evidence. As indicated
iin Table 4, in contrast to the Solow models, the implied labor substitution elasticities are higher in contrast to the Solow models, the implied labor substitution elasticities are higher
than those empirically estimated in the CBO, the Treasury Ramsey model, and the Penn Wharton than those empirically estimated in the CBO, the Treasury Ramsey model, and the Penn Wharton
model. A part of the reason for this high elasticity is the large leisure share of time, although they model. A part of the reason for this high elasticity is the large leisure share of time, although they
also tend to have larger substitution elasticities. All of the income elasticities are too large in also tend to have larger substitution elasticities. All of the income elasticities are too large in
absolute value and all of the models, except CBO and the Penn Wharton model, have a backward absolute value and all of the models, except CBO and the Penn Wharton model, have a backward
bending labor supply (in contrast to the Solow models). The largest absolute values are in the bending labor supply (in contrast to the Solow models). The largest absolute values are in the
Treasury Ramsey and Penn Wharton models, with the lowest in the Treasury Ramsey and Penn Wharton models, with the lowest in the prior JCT, EY, and Diamond JCT, EY, and Diamond
models. Since the form of the utility function forces the income elasticity of demand for leisure to models. Since the form of the utility function forces the income elasticity of demand for leisure to
be one, these values are driven by the leisure share of time. Compared with empirical estimates, be one, these values are driven by the leisure share of time. Compared with empirical estimates,
the Frisch elasticity is too high in almost all the models, but is particularly high in the Penn the Frisch elasticity is too high in almost all the models, but is particularly high in the Penn
Wharton and Treasury Ramsey models. Finally, the last elasticity, the intertemporal labor supply, Wharton and Treasury Ramsey models. Finally, the last elasticity, the intertemporal labor supply,
response to the interest rate should probably be close to zero because there is no evidence response to the interest rate should probably be close to zero because there is no evidence
supporting any response. They are largest in the Penn-Wharton and Treasury models. supporting any response. They are largest in the Penn-Wharton and Treasury models.

~~89 JCT,~~ ~~Macroeconomic Analysis Of H.R. 6760, The “Protecting Family And Small Business Tax Cuts Act Of 2018” As~~
~~Reported By The Committee On Ways And Means, JCX-79-18, September 26, 2018, https://www.jct.gov/publications/~~
~~2018/jcx-79-18/.~~
~~90 Jason DeBacker, Richard W. Evans, and Kerk L. Phillips, “Integrating Microsimulation Models of Tax Policy into a~~
~~DGE Macroeconomic Model,” Public Finance Review, vol. 47, no. 2 (2019), pp. 207-275.~~
~~91 The values change slightly with income used for consumption, which raises the substitution elasticity and lowers the~~
~~income elasticity. For example, the JCT implied elasticity would be 0.17 if 25% of consumption came from other~~
~~sources and the incomes elasticity would be 0.27 rather than 0.30. See CRS Report RL31949,~~ ~~Issues in Dynamic~~
~~Revenue Estimating, by Jane G. Gravelle, for the conversion formulas.~~
92 Table 4. Elasticities and Parameters in Intertemporal Models EY Quest Study of Diamond Penn JCT, The Tax Study of Wharton OLG Treasury Treasury Cuts and Inflation Budget Parameter or (Prior CBO, Ramsey OLG Jobs Act Reduction Model Elasticity Model) OLG Model Model OLG Act OLG OLG Intertemporal 0.40 0.33 0.25 0.35 0.40 0.50 0.625 Substitution Elasticity Intratemporal 0.60 1.00 0.80 0.60 0.60 0.80 1.00 Substitution Elasticity Leisure Share 0.40 0.39 0.60 0.50 0.0 0.30 0.54 Implied Labor 0.24 0.39 0.48 0.30 0.24 0.24 0.54 Substitution Elasticity Implied Labor -0.40 -0.39 -0.60 -0.5 -0.40 -0.30 -0.54 Income Elasticity Implied Frisch 0.35 0.50 0.71 0.48 0.35 0.30 0.97 (Intertemporal Labor Supply With Respect to Wages Holding Interest Rates Constant) 97 As discussed in the working paper, parameters of the CBO Ramsey model suggest its principal difference from the As discussed in the working paper, parameters of the CBO Ramsey model suggest its principal difference from the
CBO OLG model was assuming a leisure share of hours of 0.5, rather than 0.4, which increases the elasticities. See CBO OLG model was assuming a leisure share of hours of 0.5, rather than 0.4, which increases the elasticities. See
Maria I. Marika Santoro, Maria I. Marika Santoro, The CBO Infinite-Horizon Model with Idiosyncratic Uncertainty and Borrowing Constraints, ,
Working Paper 2009-3, October 2009, http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/106xx/doc10683/2009-Working Paper 2009-3, October 2009, http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/106xx/doc10683/2009-
03.pdf. 03.pdf.
Congressional Research Service Congressional Research Service

3031

link to page 35 link to page 35 Dynamic Scoring for Tax Legislation: A Review of Models

~~Table 4. Elasticities and Parameters in Intertemporal Models~~
EY Quest
Study of
Diamond
Penn
JCT, The Tax
Study of
Wharton
OLG Treasury
Treasury
Cuts and
Inflation
Budget
Parameter or
~~JCT,~~(Prior
CBO,
Ramsey
OLG
Jobs Act
Reduction
Model
Elasticity
~~OLG~~Model)
OLG
Model
Model
OLG
Act OLG
OLG
~~Intertemporal~~
~~0.40~~
~~0.33~~
~~0.25~~Implied 0.27 0.21 0.38 0.35 0.27 0.253 0.73 Intertemporal Labor Supply Elasticity With Respect to Prices Holding Wage Rate Constant Sources: The JCT prior OLG model was used to estimate the effect of the Tax Cuts and Jobs Act of 2017. The
~~0.35~~
~~0.40~~
~~0.50~~
~~0.625~~
~~Substitution~~
~~Elasticity~~
~~Intratemporal~~
~~0.60~~
~~1.00~~
~~0.80~~
~~0.60~~
~~0.60~~
~~0.80~~
~~1.00~~
~~Substitution~~
~~Elasticity~~
~~Leisure Share~~
~~0.40~~
~~0.39~~
~~0.60~~
~~0.50~~
~~0.0~~
~~0.30~~
~~0.54~~
~~Implied Labor~~
~~0.24~~
~~0.39~~
~~0.48~~
~~0.30~~
~~0.24~~
~~0.24~~
~~0.54~~
~~Substitution~~
~~Elasticity~~
~~Implied Labor~~
~~-0.40~~
~~-0.39~~
~~-0.60~~
~~-0.5~~
~~-0.40~~
~~-0.30~~
~~-0.54~~
~~Income Elasticity~~
~~Implied Frisch~~
~~0.35~~
~~0.50~~
~~0.71~~
~~0.48~~
~~0.35~~
~~0.30~~
~~0.97~~
~~(Intertemporal~~
~~Labor Supply With~~
~~Respect to Wages~~
~~Holding Interest~~
~~Rates Constant)~~
~~Implied~~
~~0.27~~
~~0.21~~
~~0.38~~
~~0.35~~
~~0.27~~
~~0.253~~
~~0.73~~
~~Intertemporal Labor~~
~~Supply Elasticity~~
~~With Respect to~~
~~Prices Holding~~
~~Wage Rate~~
~~Constant~~
~~Sources:~~ ~~The~~ Joint Committee reported increased elasticities for the OLG model in its analysis. Joint Committee reported increased elasticities for the OLG model in its analysis.
Macroeconomic Analysis of the “Tax Reform Act of 2014,” JCX-22-14, February 26, 2014, https://www.jct.gov/Macroeconomic Analysis of the “Tax Reform Act of 2014,” JCX-22-14, February 26, 2014, https://www.jct.gov/
publications.html?func=startdown&id=4564. Formerly the elasticities (in order as listed inpublications.html?func=startdown&id=4564. Formerly the elasticities (in order as listed in Table 4) were 0.25, were 0.25,
0.50, 0.30, 0.15, -0.30, 0.18, and 0.11. See Macroeconomic Analysis Of Various Proposals To Provide $500 Bil ion 0.50, 0.30, 0.15, -0.30, 0.18, and 0.11. See Macroeconomic Analysis Of Various Proposals To Provide $500 Bil ion
In Tax Relief, JCX-4-05, March 01, 2005, at https://www.jct.gov/publications.html?func=startdown&id=1189; In Tax Relief, JCX-4-05, March 01, 2005, at https://www.jct.gov/publications.html?func=startdown&id=1189;
Shinichi Nishiyama and Felix Reichling, “The Costs to Different Generations of Policies That Close the Fiscal Shinichi Nishiyama and Felix Reichling, “The Costs to Different Generations of Policies That Close the Fiscal
Gap,” Congressional Budget Office, Working Paper 2015-10, December 2015, at https://www.cbo.gov/Gap,” Congressional Budget Office, Working Paper 2015-10, December 2015, at https://www.cbo.gov/
publication/51097. For Treasury studies, see Robert Carrol , John Diamond, Craig Johnson, and James publication/51097. For Treasury studies, see Robert Carrol , John Diamond, Craig Johnson, and James ~~Makie~~Mackie III, III,
“A Summary of the Dynamic Analysis of the Tax Reform Options Prepared for the President’s Advisory Panel on “A Summary of the Dynamic Analysis of the Tax Reform Options Prepared for the President’s Advisory Panel on
Federal Tax Reform,” U.S. Department of the Treasury, Office of Tax Analysis, May 25, 2006, prepared for the Federal Tax Reform,” U.S. Department of the Treasury, Office of Tax Analysis, May 25, 2006, prepared for the
American Enterprise Institute Conference on Tax Reform and Dynamic Analysis, May 2006. EY Quest model is American Enterprise Institute Conference on Tax Reform and Dynamic Analysis, May 2006. EY Quest model is
from Brandon Pizzola, Robert Carrol , and James Mackie, “Analyzing the macroeconomic impacts of the Tax from Brandon Pizzola, Robert Carrol , and James Mackie, “Analyzing the macroeconomic impacts of the Tax
Cuts and Jobs Act on the US economy and key industries,” https://assets.ey.com/content/dam/ey-sites/ey-com/Cuts and Jobs Act on the US economy and key industries,” https://assets.ey.com/content/dam/ey-sites/ey-com/
en_gl/topics/growth/growth-pdfs/ey-tax-reform-projected-to-grow-us-economy.pdf The academic studies are en_gl/topics/growth/growth-pdfs/ey-tax-reform-projected-to-grow-us-economy.pdf The academic studies are
from John Diamond and the Penn Wharton Budget Model. The estimates are based on the latest application by from John Diamond and the Penn Wharton Budget Model. The estimates are based on the latest application by
John Diamond, John Diamond, “Macroeconomic Effects of the Inflation Reduction Act,Macroeconomic Effects of the Inflation Reduction Act,” August 4, 2022, August 4, 2022,
https://www.bakerinstitute.org/research/macroeconomic-effects-inflation-reduction-act. Also reported are https://www.bakerinstitute.org/research/macroeconomic-effects-inflation-reduction-act. Also reported are
estimates for the Camp plan. The estimates for the Penn Wharton Model were provided to the author. estimates for the Camp plan. The estimates for the Penn Wharton Model were provided to the author.
Formulas for converting the first three parameters in supply elasticities are in CRS Report RL31949, Formulas for converting the first three parameters in supply elasticities are in CRS Report RL31949, Issues in
Dynamic Revenue Estimating, by Jane Gravelle, 2007, Appendix C, https://www.everycrsreport.com/files/, by Jane Gravelle, 2007, Appendix C, https://www.everycrsreport.com/files/
20070426_RL31949_788e1e67fd8aaa2e827bd090f203b1616d4eb84c.pdf. Note that some of the information 20070426_RL31949_788e1e67fd8aaa2e827bd090f203b1616d4eb84c.pdf. Note that some of the information
used to obtain estimates was provided directly by the authors and does not appear in the publications. This table used to obtain estimates was provided directly by the authors and does not appear in the publications. This table
~~Congressional Research Service~~

31

~~link to page 35~~ ~~Dynamic Scoring for Tax Legislation: A Review of Models~~

does not include the Global-Gaidar model (see Seth G. Benzell, Laurence J. Kotlikoff, Guil ermo LaGarda & does not include the Global-Gaidar model (see Seth G. Benzell, Laurence J. Kotlikoff, Guil ermo LaGarda &
Victor Yifan Ye, “Simulating Business Cash Flow Taxation,” NBER Working Paper 23675, August 2017, Victor Yifan Ye, “Simulating Business Cash Flow Taxation,” NBER Working Paper 23675, August 2017,
https://www.nber.org/papers/w236750), where economic effects are dominated by international capital flows, but https://www.nber.org/papers/w236750), where economic effects are dominated by international capital flows, but
the intertemporal and intratemporal substitution elasticity is 0.25 and 0.4, respectively. No leisure share is the intertemporal and intratemporal substitution elasticity is 0.25 and 0.4, respectively. No leisure share is
reported, but the original Auerbach Kotlikoff model had a leisure share of 0.6. If so, elasticities in rows 4-6 reported, but the original Auerbach Kotlikoff model had a leisure share of 0.6. If so, elasticities in rows 4-6
would be 0.24, 0.4, and 0.47. would be 0.24, 0.4, and 0.47.
Notes: Implied labor substitution and income elasticities are calculated assuming only wage income. If capital Implied labor substitution and income elasticities are calculated assuming only wage income. If capital
income exists, the substitution elasticity elasticities would be higher. The labor substitution elasticity is the share income exists, the substitution elasticity elasticities would be higher. The labor substitution elasticity is the share
of leisure times the substitution elasticity; the labor income elasticity is the share of leisure times -1; The Frisch of leisure times the substitution elasticity; the labor income elasticity is the share of leisure times -1; The Frisch
elasticity is the ratio of leisure to labor times a weighted average of the share of leisure times the intertemporal elasticity is the ratio of leisure to labor times a weighted average of the share of leisure times the intertemporal
elasticity and the share of labor times the intratemporal elasticity; and the elasticity of labor with respect to the elasticity and the share of labor times the intratemporal elasticity; and the elasticity of labor with respect to the
interest rate is leisure divided by labor times the intertemporal elasticity, assuming the interest rate and the interest rate is leisure divided by labor times the intertemporal elasticity, assuming the interest rate and the
savings rate are equal. The last measure would be multiplied by the interest rate over the saving rate if they are savings rate are equal. The last measure would be multiplied by the interest rate over the saving rate if they are
different. different.
Is it possible to make choices that would lead to better elasticities? It would require using the time Is it possible to make choices that would lead to better elasticities? It would require using the time
endowment as a tool to fit the model to evidence, as suggested by Ballard. For example, set the endowment as a tool to fit the model to evidence, as suggested by Ballard. For example, set the
intertemporal elasticity at 0.2, consistent with the evidence. Set the intratemporal substitution intertemporal elasticity at 0.2, consistent with the evidence. Set the intratemporal substitution
elasticity at 1.5 and the leisure share of hours at 0.15. Then the labor substitution elasticity would elasticity at 1.5 and the leisure share of hours at 0.15. Then the labor substitution elasticity would
be 0.225, the income elasticity would be -0.15, and there would be a slight positive elasticity of be 0.225, the income elasticity would be -0.15, and there would be a slight positive elasticity of
total labor supply. The Frisch elasticity would be 0.23 (using labor and leisure shares as proxies total labor supply. The Frisch elasticity would be 0.23 (using labor and leisure shares as proxies
Congressional Research Service 32 link to page 35 link to page 35 Dynamic Scoring for Tax Legislation: A Review of Models for shares of consumption and leisure), at the low end, but reasonable considering publication for shares of consumption and leisure), at the low end, but reasonable considering publication
bias, and the elasticity of labor with response to price change would be 0.026, small enough not to bias, and the elasticity of labor with response to price change would be 0.026, small enough not to
be very troubling. be very troubling.
Note that the CBO and Penn Wharton models are models with uncertainty. As noted above, Note that the CBO and Penn Wharton models are models with uncertainty. As noted above,
generally, uncertainty should lead to precautionary savings that is not sensitive to the interest rate, generally, uncertainty should lead to precautionary savings that is not sensitive to the interest rate,
and a lower savings response.and a lower savings response.9398
Conclusion: Are Intertemporal Models Helpful or Harmful In
Determining Feedback Effects?
Economists were attracted to intertemporal models because they were dissatisfied with the ad hoc Economists were attracted to intertemporal models because they were dissatisfied with the ad hoc
treatment of savings in Solow models. However, intertemporal models are far less transparent, treatment of savings in Solow models. However, intertemporal models are far less transparent,
and modelers appear in some cases to make little attempt to connect the elasticities associated and modelers appear in some cases to make little attempt to connect the elasticities associated
with labor supply to the ones found in empirical evidence. The JCT model used in the past has with labor supply to the ones found in empirical evidence. The JCT model used in the past has
come close but,come close but,9499 as illustrated, it is possible to come even closer to matching the empirical as illustrated, it is possible to come even closer to matching the empirical
evidence, while at the same time minimizing “shooting in the dark” with a labor supply response evidence, while at the same time minimizing “shooting in the dark” with a labor supply response
to the interest rate. JCT also incorporates life-cycle elements in its MEG model that do not to the interest rate. JCT also incorporates life-cycle elements in its MEG model that do not
involve labor supply responses to rates of return. Nevertheless, the assumption of equal involve labor supply responses to rates of return. Nevertheless, the assumption of equal
substitution elasticities between consumption across far apart periods means that these models substitution elasticities between consumption across far apart periods means that these models
still rest on unproven, and probably unreasonable assumptions about the elasticity of substitution still rest on unproven, and probably unreasonable assumptions about the elasticity of substitution
between consumption amounts that are 10 or 20 years apart. There is a question of whether between consumption amounts that are 10 or 20 years apart. There is a question of whether
intertemporal models do more harm than good, at least with respect to the feedback effects during intertemporal models do more harm than good, at least with respect to the feedback effects during
the budget horizon, especially when parameter choices may induce a large labor supply response the budget horizon, especially when parameter choices may induce a large labor supply response
to the rate of return. to the rate of return.

~~93 Engen, Gravelle, and Smetters included a comparison of a myopic OLG model with fixed labor with and without~~
~~uncertainty. Introducing uncertainty reduced the effects by more than half. However, that may not be similar with~~
~~endogenous labor. See Eric Engen, Jane Gravelle, and Kent Smetters, “Dynamic Tax Models: Why They Do the~~
~~Things They Do,” National Tax Journal, vol. 50, September 1997, pp. 657-682.~~
~~94 Table 4’s notes summarize these estimates.~~
~~Congressional Research Service~~

32

~~link to page 35~~ ~~Dynamic Scoring for Tax Legislation: A Review of Models~~

Intertemporal modelers presenting the background on their models sometimes report the first two Intertemporal modelers presenting the background on their models sometimes report the first two
values ivalues in Table 4 but no measure of the leisure share of time, which makes it impossible to but no measure of the leisure share of time, which makes it impossible to
evaluate on the basis of their published work.evaluate on the basis of their published work.95100 Sometimes even the minimal information on Sometimes even the minimal information on
elasticities is not provided. (JCT and CBO report all their relevant assumptions.) Without the elasticities is not provided. (JCT and CBO report all their relevant assumptions.) Without the
parameters to understand the models (and particularly without information on the time parameters to understand the models (and particularly without information on the time
endowment), these models become impossible to evaluate or compare. endowment), these models become impossible to evaluate or compare.

95 98 Engen, Gravelle, and Smetters included a comparison of a myopic OLG model with fixed labor with and without uncertainty. Introducing uncertainty reduced the effects by more than half. However, that may not be similar with endogenous labor. See Eric Engen, Jane Gravelle, and Kent Smetters, “Dynamic Tax Models: Why They Do the Things They Do,” National Tax Journal, vol. 50, September 1997, pp. 657-682. 99 Table 4’s notes summarize these estimates. 100 Even accomplished modelers Diamond and Zodrow do not always report this value. See John W. Diamond and Even accomplished modelers Diamond and Zodrow do not always report this value. See John W. Diamond and
George R. Zodrow “Promoting Growth, Maintaining Progressivity, and Dealing with the Fiscal Crisis: CGE George R. Zodrow “Promoting Growth, Maintaining Progressivity, and Dealing with the Fiscal Crisis: CGE
Simulations of a Temporary VAT Used for Debt Reduction,” Simulations of a Temporary VAT Used for Debt Reduction,” Public Finance Review, vol. 41, no. 6, November 2013, , vol. 41, no. 6, November 2013,
pp. 852-884. They chose a value of 0.4 for the IES and 0.8 for the intratemporal substitution elasticity. pp. 852-884. They chose a value of 0.4 for the IES and 0.8 for the intratemporal substitution elasticity.
Congressional Research Service Congressional Research Service

33 33

Dynamic Scoring for Tax Legislation: A Review of Models

Appendix. A Simple Model of Feedback Effects
Consider a model that incorporates a labor supply based on an estimated elasticity of E. In that Consider a model that incorporates a labor supply based on an estimated elasticity of E. In that
case, with L as labor, W as wages, and t as the tax rate on wages (denoting a “d” as a change, so case, with L as labor, W as wages, and t as the tax rate on wages (denoting a “d” as a change, so
that dL is a small change in L and dL/L is a percentage change in L), the labor supply can be that dL is a small change in L and dL/L is a percentage change in L), the labor supply can be
defined asdefined as:
(1) dL/L = E(dW/W –dt/(1-t)) (1) dL/L = E(dW/W –dt/(1-t))
This model assumes that E is positive, so labor rises with an increase in W and falls with an This model assumes that E is positive, so labor rises with an increase in W and falls with an
increase in t. Also note that the response is not to a percentage change in t, but to a percentage increase in t. Also note that the response is not to a percentage change in t, but to a percentage
change in the after tax share, (1-t). change in the after tax share, (1-t).
With this information, a simple revenue feedback effect can be estimated. Revenue from the tax is With this information, a simple revenue feedback effect can be estimated. Revenue from the tax is
tWL and the change in revenue istWL and the change in revenue is:
(2) d(tWL) = dt(WL) + tW(dL) (2) d(tWL) = dt(WL) + tW(dL)
Holding wages constant (this assumption will subsequently be relaxed), and substituting from (1) Holding wages constant (this assumption will subsequently be relaxed), and substituting from (1)
into (2), the ratio of the second term in (2) to the first (the feedback effect) isinto (2), the ratio of the second term in (2) to the first (the feedback effect) is:
(3) (tWdL)/((dt)WL) = -Et/(1-t) (3) (tWdL)/((dt)WL) = -Et/(1-t)
Assuming a tax rate of 25% and a labor supply elasticity of 0.1 to 0.2, the feedback effect ranges Assuming a tax rate of 25% and a labor supply elasticity of 0.1 to 0.2, the feedback effect ranges
from 3.3% to 6.6%. The feedback effect is larger the larger the initial tax and the larger the from 3.3% to 6.6%. The feedback effect is larger the larger the initial tax and the larger the
elasticity. elasticity.
A decrease in labor supply looking at only the labor market would be expected to raise wages, A decrease in labor supply looking at only the labor market would be expected to raise wages,
which would affect the wage base and also have a feedback effect on labor. The rise in wages and which would affect the wage base and also have a feedback effect on labor. The rise in wages and
the contraction in labor would also increase the rate of return to capital. This in turn could cause the contraction in labor would also increase the rate of return to capital. This in turn could cause
an increase in the capital stock (either from savings or from capital flows from abroad). To an increase in the capital stock (either from savings or from capital flows from abroad). To
address these effects in the short run, the model would also require a production function that address these effects in the short run, the model would also require a production function that
shows how labor and capital can be combined. shows how labor and capital can be combined.
Every model has a “numeraire” or a fixed value since economic effects depend on relative, rather Every model has a “numeraire” or a fixed value since economic effects depend on relative, rather
than absolute, values. A sensible numeraire for this model is the overall price level, P. Changes in than absolute, values. A sensible numeraire for this model is the overall price level, P. Changes in
prices are a weighted average of the wage and rate of return depending on their share of income. prices are a weighted average of the wage and rate of return depending on their share of income.
Setting the share of capital income as a, and denoting the rate of return as R and the capital stock Setting the share of capital income as a, and denoting the rate of return as R and the capital stock
as K (to keep the model simple, depreciation is not included and income shares reflect net as K (to keep the model simple, depreciation is not included and income shares reflect net
product): product):
(4) dP/P = a(dR/R) + (1-a) dW/W = 0 (4) dP/P = a(dR/R) + (1-a) dW/W = 0
Finally consider a common production function (a Cobb Douglas) that has the characteristic that Finally consider a common production function (a Cobb Douglas) that has the characteristic that
income shares are fixed, so that a is a constant andincome shares are fixed, so that a is a constant and:
(5) RK/WL = a/(1-a) (5) RK/WL = a/(1-a)
When this equation is differentiated to convert it into percentage changes; When this equation is differentiated to convert it into percentage changes;
(6) dR/R +dK/K-dW/W-dL/L= 0 (6) dR/R +dK/K-dW/W-dL/L= 0
If K is constant, substitute from (4) to eliminate dR/R. From equation (1) If K is constant, substitute from (4) to eliminate dR/R. From equation (1):
(7) (td(WL))/(dtWL) = [E(1-a)t]/[(1-t)(1+aE)] (7) (td(WL))/(dtWL) = [E(1-a)t]/[(1-t)(1+aE)]
The feedback response from the labor tax, assuming a is 0.25, is smaller. Rather than 3.3% to The feedback response from the labor tax, assuming a is 0.25, is smaller. Rather than 3.3% to
6.6%, it is 2.4% to 4.8%. 6.6%, it is 2.4% to 4.8%.
Congressional Research Service Congressional Research Service

34 34

link to page 22 link to page link to page 22 link to page 2223 Dynamic Scoring for Tax Legislation: A Review of Models

If capital income is also subject to tax, then the effects of the rise in R needs to also be calculated If capital income is also subject to tax, then the effects of the rise in R needs to also be calculated
and taken into account. If taxed at the same rate, the result is [Eat]/[(1-t)(1+aE)], which is 0.8% to and taken into account. If taxed at the same rate, the result is [Eat]/[(1-t)(1+aE)], which is 0.8% to
1.6%. Adding both responses = [Et]/[(1-t)(1+aE)]. As this example indicates, with an across the 1.6%. Adding both responses = [Et]/[(1-t)(1+aE)]. As this example indicates, with an across the
board tax the feedback effects are not much different incorporating these general equilibrium board tax the feedback effects are not much different incorporating these general equilibrium
effects (3.2% and 6.4% rather than 3.3% and 6.6%). effects (3.2% and 6.4% rather than 3.3% and 6.6%).
These results can also be used to show increases in output. In the case where the capital stock is These results can also be used to show increases in output. In the case where the capital stock is
fixed, the percentage change in labor for a given percentage change in the after tax share is the fixed, the percentage change in labor for a given percentage change in the after tax share is the
same as the feedback effect in (3) but since labor is only a part of output, it would be multiplied same as the feedback effect in (3) but since labor is only a part of output, it would be multiplied
by the output share (0.75). The result is the same as the ratio in (7). Thus a 20% decrease in the by the output share (0.75). The result is the same as the ratio in (7). Thus a 20% decrease in the
tax rate would increase output, with an elasticity of 0.1, by 2.4% times 0.2, or 0.5%. For the 0.2 tax rate would increase output, with an elasticity of 0.1, by 2.4% times 0.2, or 0.5%. For the 0.2
elasticity, the result would be 1%. elasticity, the result would be 1%.
The previous short run model had a fixed capital stock and three variables, the rate of return R, The previous short run model had a fixed capital stock and three variables, the rate of return R,
the wage rate W and the labor supply, L. A Solow growth model allows (if it is a closed economy) the wage rate W and the labor supply, L. A Solow growth model allows (if it is a closed economy)
growth over time in capital and feedback effects. In the long run, that permits a change in capital. growth over time in capital and feedback effects. In the long run, that permits a change in capital.
Capital can grow not only because of a change in savings rate but also because increased labor Capital can grow not only because of a change in savings rate but also because increased labor
income generates capital to go along with it even if the savings rate does not change. income generates capital to go along with it even if the savings rate does not change.
In the long run steady state, additional variables, output (Q) and the savings rate (s) have to be In the long run steady state, additional variables, output (Q) and the savings rate (s) have to be
added. added.
(8) dQ/Q = adK/K +(1-a)dL/L (8) dQ/Q = adK/K +(1-a)dL/L
which indicates that the percentage change in output is a weighted average of the percentage which indicates that the percentage change in output is a weighted average of the percentage
changes in capital and labor. changes in capital and labor.
In addition, the savings rate is determined by the after tax return, where tk is the tax rate on capital In addition, the savings rate is determined by the after tax return, where tk is the tax rate on capital
income. income.
(9) ds/s = Es (dR/R-dtk/(1-tk)) (9) ds/s = Es (dR/R-dtk/(1-tk))
Finally, in the steady state savings equals investment, Finally, in the steady state savings equals investment,
(10) gK = sQ (10) gK = sQ
where g is a constant exogenous growth rate of population and technology. Thus, where g is a constant exogenous growth rate of population and technology. Thus,
(11) dK/K = ds/s + dQ/Q (11) dK/K = ds/s + dQ/Q
These results are shown in These results are shown in Table 1 and Table 2, for various elasticities. for various elasticities.
The feedback effects, which all have the same denominator: 1+aE+(1-a)Es, and are all multiplied The feedback effects, which all have the same denominator: 1+aE+(1-a)Es, and are all multiplied
by t/(1-t) have the following numerators: by t/(1-t) have the following numerators:
(A) Labor tax change with general income tax in place: E(1+Es) (A) Labor tax change with general income tax in place: E(1+Es)
(B) Capital income tax change with general income tax in place: Es(1+E) (B) Capital income tax change with general income tax in place: Es(1+E)
(C) Income tax change (on capital and labor): (1-a)E(1+Es) +aEs(1+E) (C) Income tax change (on capital and labor): (1-a)E(1+Es) +aEs(1+E)
Output effects can also be calculated for the solutions to the change in labor and capital as (1-a) Output effects can also be calculated for the solutions to the change in labor and capital as (1-a)
dL/L+adK/K. dL/L+adK/K.
Congressional Research Service Congressional Research Service

35 35

Dynamic Scoring for Tax Legislation: A Review of Models

Author Information

Jane G. Gravelle Jane G. Gravelle

Senior Specialist in Economic Policy Senior Specialist in Economic Policy

Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan
shared staff to congressional committees and Members of Congress. It operates solely at the behest of and shared staff to congressional committees and Members of Congress. It operates solely at the behest of and
under the direction of Congress. Information in a CRS Report should not be relied upon for purposes other under the direction of Congress. Information in a CRS Report should not be relied upon for purposes other
than public understanding of information that has been provided by CRS to Members of Congress in than public understanding of information that has been provided by CRS to Members of Congress in
connection with CRS’s institutional role. CRS Reports, as a work of the United States Government, are not connection with CRS’s institutional role. CRS Reports, as a work of the United States Government, are not
subject to copyright protection in the United States. Any CRS Report may be reproduced and distributed in subject to copyright protection in the United States. Any CRS Report may be reproduced and distributed in
its entirety without permission from CRS. However, as a CRS Report may include copyrighted images or its entirety without permission from CRS. However, as a CRS Report may include copyrighted images or
material from a third party, you may need to obtain the permission of the copyright holder if you wish to material from a third party, you may need to obtain the permission of the copyright holder if you wish to
copy or otherwise use copyrighted material. copy or otherwise use copyrighted material.

Congressional Research Service Congressional Research Service
R43381 R43381 · VERSION 810 · UPDATED
36 36