State Budgets and Dynamic Scoring: Why Many States Fall Behind
Dec 06, 2016The author is an Economist at the Buckeye Institute. The views presented here are the views of the author. They may or may not reflect the views of the Buckeye Institute. The author can be contacted for comments at orphe@buckeyeinstitute.org
The general public, policy professionals, and lawmakers often ask the question: is the state government spending beyond its means? If so, by how much? Does waiting to make adjustments help or hurt?
Across the nation, many state governors are soon expected to release their biennial budget proposals. In the state of Oregon, Gov. Kate Brown released her 2017-19 budget proposing a mix of spending cuts and tax hikes in an attempt to address a growing fiscal imbalance. A fiscal imbalance is the difference between a government’s planned spending and projected revenues.
Despite a recent boom in economic activity and rising incomes in the state, the growth in government spending in Oregon has outpaced the boom-led boost in state revenues. It is this growing concern that prompted the governor to act now.
Governor Brown should be praised for attempting to correct a fiscal imbalance that would ultimately harm Oregon families. However, her approach is at odds with her good intentions. The bulk of empirical evidence and a large economics literature suggest that spending cuts should be accompanied with tax cuts and NOT tax hikes in order to boost investments that spur growth.
When tax reforms are introduced, economists calculate how much they will raise tax revenues for the state. Two very different types of calculations exist, "static scoring" and "dynamic scoring."
Static scoring assumes that a tax increase will have no effect on the economic behavior of individuals. Dynamic scoring adds to the calculations the predictable changes that a tax increase has on economic behavior. These additional calculations yield more precise estimates of projected tax revenues.
Higher taxes on labor and investment income no matter how small the increase, can have lasting negative effects on the state economy. This is because economic output crucially depends on investments that make capital available to the productive sectors of the economy. Taxes that penalize investment lower the available capital stock relative to trend, causing a slowdown in entrepreneurial and productive activity.
In addition, taxes on consumer goods and services raise the price of goods and services, thus lowering consumption because higher prices reduce the purchasing power of individuals. By choosing to raise taxes, the state government is opting to leave many families worse off.
While tax hikes may initially cause tax revenues to increase, the effect is short-lived because of the decline in economic activity that ensues. This is a perfect example for why dynamic and not static scoring should be used for policy analysis.
While a growing number of federal agencies and some states are already using dynamic scoring, most states lag far behind on this issue. To make our states great again, dynamic scoring should become the norm when crafting state policy.