Location:
BUDGET, STATE; TAXATION;

OLR Research Report


August 1, 2012

 

2012-R-0326

FORECASTING THE REVENUE IMPACT OF TAX CUTS

 

By: Judith Lohman, Assistant Director

You asked whether any states, when forecasting the revenue impact of tax reductions, consider potential revenue increases that could result from the cuts. Forecasts that include such considerations use so-called “dynamic scoring” methods because they take account of changes in people's behavior and the broader economy that tax changes produce.

According to a June 2012 journal article on this topic, 36 states use dynamic revenue estimating models in preparing fiscal notes on proposed tax changes, at least some of the time. The article, which is based on a survey of all 50 states, provides an overview of how states estimate the revenue effects of proposed tax changes and how the estimates are incorporated into the legislative process (Mikesell, John L., “Revenue Estimating/Scoring by States: An Overview of Experience and Current Practices with Particular Attention to the Role of Dynamic Models,” Public Budgeting & Finance, Vol. 32, No. 2, Summer 2012, pp. 1-24).

Mikesell identifies three methods for making such estimates and lists states in five categories according to the methods or combinations of methods they use. We briefly summarize the three methods below. A copy of the article is attached.

1. Static scoring is based on the assumption that a proposed tax change will have no impact on the behavior of households or businesses. “Estimators use this approach when they lack a basis for making behavioral adjustments with sufficient confidence” or when the proposed change is “small and insufficient to induce a discernable behavior change,” Mikesell says (p. 9).

2. Microdynamic scoring assumes that those subject to a tax change will alter their behavior in response, and adjusts the estimated tax base accordingly. For example, if a tax on a certain item, such as gasoline or cigarettes, decreases, microdynamic scoring assumes that people will buy more of it, offsetting some of the revenue loss from the lower rate. “The underlying logic of the microdynamic model is universally accepted,” Mikesell comments (p. 10).

3. Macrodynamic scoring seeks to estimate all revenue effects, both direct and indirect, that a particular tax change is likely to produce in a state's economy. Estimates using macrodynamic scoring rely on complicated computer models of a state's economy and the factors that affect it, including any increases in economic activity that may offset a revenue loss from a tax reduction. Macrodynamic scoring is the “broadest and most complete approach” to revenue estimating, according to Mikesell (p. 11).

Table 1 shows Miksell's listing of states by the types of methods they use to estimate the revenue impact of proposed tax changes (p.13). The table shows a scoring continuum from states that use only static scoring (right-hand column) to those that regularly use macrodynamic models (left-hand column). The states in the middle columns (the majority) use various combinations of the static and dynamic methods.

Table 1: State Scoring Methods for Proposed Tax Changes

STATIC


DYNAMIC

Static Scoring

Only

Static Scoring Generally; Microdynamic Scoring Sometimes

Microdynamic Scoring Regularly

Maintain, But Rarely Use, Macrodynamic Scoring Model

Regularly Use Macrodynamic Scoring Model

Arizona

Alabama

California

Florida

Tennessee

Illinois

Arkansas

Delaware

Georgia

Texas

Michigan

Colorado

Hawaii

Iowa

 

Missouri

Connecticut

Indiana

Massachusetts

 

Minnesota

Mississippi

Idaho

Nebraska

 

New Mexico

Nevada

Kansas

Oregon

 

Oklahoma

North Carolina

Kentucky

Rhode Island

 

Pennsylvania

North Dakota

Louisiana

Vermont

 

South Dakota

South Carolina

Maine

   

West Virginia

Utah

Maryland

   

Wyoming

 

Montana

   
   

New Hampshire

   
   

New Jersey

   
   

Virginia

   
   

Washington

   
   

Wisconsin

   

JL:ro