Wednesday, March 04, 2015

No Way to Avoid It

In my column on dynamic scoring, I wrote:
[A]ccurate dynamic scoring requires more information than congressional proposals typically provide. For example, if a member of Congress proposes a tax cut, a key issue in estimating its effect is how future Congresses will respond to the reduced revenue. 
This raises important questions for which we have no easy answers. In the coming years, will these Congresses respond quickly to the revenue shortfall, or will they let budget deficits fester? When they act to close the budget gap, will they increase taxes, or will they cut spending? If they cut spending, will it be on consumption items, such as health care for the elderly, or on growth-promoting investments, such as education for the young? The impact of the initial tax cut depends crucially on the answers to these questions, but budget analysts usually have little to go on but speculation.
On this passage, John Cochrane comments:
Greg also opined on the second round effects, how policy might change economic outcomes which might change future policy. Here I'll go with the old fashioned approach -- let's not go there!

I understand the desire not to go there.  The problem is, you cannot avoid going there. 

Dynamic scoring requires the solution of a general equilibrium model.  To solve a dynamic GE model, you need to specify how the government is going to satisfy its present-value budget constraint. You might be tempted to ask the model what happens if the government cuts taxes and never does anything else. But you won't get very far. The model will tell you that the government has to do something else eventually, and it won't tell you what will happen if the government tries to do something impossible.