A Bias Towards Tax Increases In NY Times, CBO, JTC Budget Calculators

New York Times' readers, bloggers, economists and others are having fun with the NY Times, "You Fix The Budget" interactive budget calculator. Unfortunately, there are hidden assumptions and biases in the calculations that lead readers to favor tax increases and to understate the extent of the cuts needed to government program spending to close the short and long-term budget gaps.

The most significant bias in the calculator is that it assumes changes in tax rates do not affect the growth rate of the US economy (GDP).

The calculations assume a 'static' as opposed to a 'dynamic' economy. In reality, many tax increases will lower capital investment, the growth of the economy, labor force participation and hours worked. These changes can affect unemployment levels, tax revenue and government program participation rates, which will understate the projected costs and overstate the budgetary effects of program cuts in the budget calculators.

The NY Times calculator is based on the model of economists Alan Auerbach and William Gale mentioned in their paper "DÉJÀ VU ALL OVER AGAIN: ON THE DISMAL PROSPECTS FOR THE FEDERAL BUDGET." The economists' paper and model use CBO's projections of the President's budget. CBO does not model tax revenues. It uses the projections of the Joint Committee on Taxation (JCT). JCT uses a static model of the economy when modeling the effects of tax rates on tax revenue. JCT assumes individuals and corporations minimize taxes and modify behavior, but tax law changes do not change the projected growth rates of the US economy.

From page 19 of "Inside the JCT Revenue Estimating Process" CBO JCT states:

"Macroeconomic" Revenue Estimates

• standard JCT estimate incorporates behavioral responses in projecting tax revenues, but assumes that these tax and behavioral changes do not in turn ‘move the needle' of the entire US economy
• This is termed the "Fixed GNP Constraint"
• Generally assumes that total labor supply and investment are fixed
• For example, we assume that a surtax on labor income will not cause taxpayers to retire early, or simply to work less hard

Many of the proposed changes that NY Times readers' input into the interactive budget calculator will not in real life close the budget gap. Many tax increases will not produce the revenue inputted into the calculation. Many tax and program changes will increase individual, household and family participation rates in government programs, which will drive up program expenses faster than anticipated in the calculator's model.

The budget calculator appears to work similarly to JCT and CBO's calculation, but the inputted tax and program changes will not in real life produce the anticipated benefits.

Tax increases will produce lower amounts of revenue than anticipated even if tax rates are further increased. Program costs will be higher than expected.

The result is that program cuts will need to be deeper than planned unless the US economy grows much faster than currently projected.

Congress will be able to pass a package of tax increases and program cuts than that produce a CBO projection of a closed budget gap. Unfortunately, as the years roll out, it will become clear that the budget gap will not disappear due to negative economic effects from the plan and another round of cuts and tax increases will be required.