What can a donut shop teach us about Tax Reform? Maybe quite a bit. Would the federal government have all of the money it needed if Congress just kept raising taxes? Possibly, but after a while, higher tax rates would actually bring in less money for the government. The same is true of a business. If you were making a little bit of money selling donuts at $1 a piece, would you make 300 times as much money by changing your price to $300 per donut? Probably not.
When it comes to evaluating tax changes, the most common way is to assume that no matter how different the tax code is in the future, the economy will continue to behave as if nothing had happened — Americans will keep working and investing in the exact same way. Using this “static,” or unchanging, view of the economy, however, gives us a distorted idea of what the future is going to look like.
The Tax Foundation uses a sophisticated economic model to measure the dynamic effects of tax policy changes. We believe that this approach gives lawmakers a more realistic picture of the effects of tax changes on the economy and federal finances.
Imagine that you own a sweet donut shop.
And say you sell 100 donuts every day at $1 each. You’d make $100 a day, right?
Now say you raised the price of your donuts to $5 each. Would you make $500 a day?
But maybe people wouldn’t buy as many donuts at five dollars each.
So what if you lowered the price of the donuts to fifty cents each?
Yes, you’d make less money per donut, but you’d probably have a lot more customers.
Seems like a simple part of economics, right?
Well, simple or not, it’s not how the government views taxes.
Whenever Congress is trying to calculate how much money they’ll get from taxes, they use what some people call, ‘Static Scoring.’
That means that according to Congress’ estimates, every tax cut means lost revenue.
And every tax hike means more money for the government.
Which isn’t always true. Just like every increase in the price of donuts doesn’t mean more money for the donut shop.
After all, who’s going to buy a $300 donut?
All of this matters because, in a weird way Congress’ over-simplified model is holding us back.
Because if you don’t estimate the economic effect of taxes, you can’t make good policies.
Well, there IS a better model. But Congress isn’t using it.
A Dynamic scoring model focuses more on economic growth.
A Dynamic model calculates the broader effects of tax policy on the things that produce economic growth — such as how tax policy affects the cost of labor and the cost of capital investment.
Higher taxes on labor means fewer jobs at lower wages. Lower taxes on labor mean more of those jobs at higher wages.
Higher taxes on capital such as buildings and ovens mean less investment in those things
And lower taxes mean more.
Well, more capital and more labor mean more growth and better living standards for American families.
And after all, isn’t the point of tax reform to grow our economy so Americans can have more opportunities?
Critics of dynamic scoring resist it because economists don’t always agree on the details.
But isn’t trying dynamic scoring better than using a model we know is wrong?
After all, this isn’t a donut shop, we’re talking about.
It’s our country.
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