Federal developments

TCJA and dynamic scoring

Extending TCJA’s tax cuts will be a key issue in the coming session of Congress. Deficit financed tax cuts have been the central tenet of Republican fiscal policy – one of the few consistent points of policy agreement in their coalition – since Reagan was first elected. But the current level of federal debt makes continuing down that path less and less tenable. The interest on the ever-growing debt creates a fiscal vise on the budget, as debt held by the public rises to an all-time high relative to the size of the economy.

Aside: The high level of debt is mostly due to Republicans’ tax cutting success, helped along by their failure to cut spending, some Dem-fueled spending increases not offset by adequate tax increases, and bi-partisan pandemic relief spending. So, the soup they’re in is largely of their own making, in my view.

Finding spending cuts and tax offsets is politically painful. So, the first line of attack is to minimize the score. The smaller the offsets needed the better.

Putting aside the head-in-the-sand approach (a/ka/ current policy baseline) favored by Senator Crapo, the standard way to do that is through dynamic scoring, i.e., the hypothesis that tax cuts stimulate overall economic growth to partially offset their cost. I have posted about this before and it’s down-in-the-weeds stuff. The scorekeeping is done by congressional staff economists using complicated econometric models. It’s the economist’s version of looking at chicken entrails (pages of equations driven by over-simplified assumptions about human behavior) to divine the future. So, getting into the minds of the voodoo high priests is crucial.

Last week, the Brookings Institute posted an explainer revealing that the two relevant groups of congressional economists are not of one mind on this with regard to making TCJA permanent, How do JCT and CBO differ in modeling expiring TCJA tax provisions? (1/15/2025). The piece was based on a Brookings roundtable in December at which the congressional economists made presentations. JCT refers to the Joint Committee on Taxation and CBO to the Congressional Budget Office. JCT staff estimate the effects of tax changes, while CBO estimates the effects of other budget changes (spending etc.).

If, like me, you’re into this sort of thing, it’s worth reading. The conclusion:

JCT finds that extending the TCJA individual provisions would increase GDP, capital investment, and labor supply, while CBO projects that these stimulative effects would be offset by crowding-out effects. One difference between their analyses is how JCT and CBO model deficits and their impact on private investment. CBO estimates a significant crowding-out effect from the deficit increases resulting from extending these provisions, leading to reduced private investment and long-term GDP growth. Conversely, JCT projects minimal crowding out and instead shows positive capital accumulation over the budget window for two of their models.

My takeaways

First, the GOP is fortunate that JCT, rather than CBO, scores tax bills – it appears to be about a $300 billion advantage. This is, of course, a purely hypothetical case. Your mileage may differ, depending upon the precise configuration of the TCJA extension (i.e., which provisions are included, for how long, what the offsets are, etc.). If they rely heavily on tariffs as an offset, much the savings will evaporate, I assume.

Second, it’s obvious that dynamic scoring is more art than science to the extent that economics is ever science. JCT’s methodology (gory details in 27 slides), as described by the Brookings piece:

The  [static] estimates are then used as inputs to three different macroeconomic models that JCT maintains. The three models differ in their assumptions about taxpayer behavior, the response of the Federal Reserve, and the level of foresight they attribute to individuals and businesses.

JCT evaluates the strengths and weaknesses of each macro model relative to the policy proposal and assigns weights to their outputs accordingly. For the illustrative analysis JCT demonstrated at the roundtable, JCT applied equal weights to each model. However, weights may vary in official analyses depending on the specific policy context.

Third, given the split decision, ignoring dynamic estimates in this context seems to be the prudent thing to do – i.e., for the hypothetical exercise of making TCJA’s expiring provisions permanent. I do think it makes sense to do the analyses, though, simply because more information is useful to the policymaking process. If there is a consensus, getting that into the public debate is important.

IRS commissioner

IRS Commissioner Danny Werfel has announced that he is resigning his position on inauguration day (Politico), despite having years left on his term. Trump’s designated replacement is questionable in my view.

I wished that Werfel had continued to serve, requiring Trump to fire him. The IRS commissioner serves at the will of the President. 26 U.S. Code § 7803. So, Trump would not have had to state a reason (cause) for firing him, but it would have been nice to see how he might justify it. (When Trump fired James Comey as FBI director in his first term, he cooked up various reasons for doing so – one example.) I understand Werfel’s likely desire to avoid focusing undesirable controversy on the Service. I also will be surprised if Long’s nomination does not go through after modest pushback from the Dems.

Direct file temporary reprieve

At the confirmation hearings for the Secretary of the Treasury, Scott Bessent, the nominee, said the Direct File program would remain for the 2025 filing season. My guess is that it is on life support after that. If so, the investment in what is  proving to be a popular program allowing filers to pay for private tax preparation software will be abandoned.

Hiring freeze

One of the Trump administration’s many first-day executive orders is a freeze on hiring federal civilian employees. The freeze took effect instantly (i.e., noon on inauguration day). I’m sure there are some new hires who were scheduled to start today, tomorrow, etc. who have suddenly found their job offers are (at best) on a temporary hold. Thoughtful management this is not.

There are a variety of exemptions (political appointees of course, as well as border enforcement, public safety, etc.). The freeze expires in 90 days, but not for the IRS, which must get special clearance from DOGE (the Elon Musk quasi-government operation) per the order:

Within 90 days of the date of this memorandum, the Director of the Office of Management and Budget (OMB), in consultation with the Director of OPM and the Administrator of the United States DOGE Service (USDS), shall submit a plan to reduce the size of the Federal Government’s workforce through efficiency improvements and attrition.  Upon issuance of the OMB plan, this memorandum shall expire for all executive departments and agencies, with the exception of the Internal Revenue Service (IRS).  This memorandum shall remain in effect for the IRS until the Secretary of the Treasury, in consultation with the Director of OMB and the Administrator of USDS, determines that it is in the national interest to lift the freeze.

That does not look like a positive development to me for those of us concerned about IRS service quality and compliance. One could take the optimistic view that it will allow expiry for IRS earlier than 90 days, because the agency is exempt from the general OPM rule. The use of “shall remain in effect” certainly suggests that’s not what they had in mind. Instead, it looks like singling the IRS for harsher treatment. I hope all the temporary tax season workers have been hired. Somehow, I doubt that’s the case.

The presumed goal is to save money. A freeze on IRS hiring will have the opposite effect, so the actual goal must be to reduce outlays without regard to revenue collection. That is consistent with Republican political talking points about the IRS, not common-sense fiscal management. I fear dark days are ahead for federal tax administration and enforcement with ramification for compliance, including SALT compliance and enforcement.

TCJA shopping list

The NY Times has provided a 50-page list of budget items used by Ways & Means for a TCJA extension bill. This includes a plethora of direct spending changes, as well as tax changes, that go in both directions (i.e., some have positive and others negative effects on the budget balance).

Some of these have the potential for dramatic negative effects on the Minnesota state budget, such as the proposal to let the Medicaid matching formula (FMAP) drop below 50%. The description:

This option would lower the floor and allow all states’ FMAPs to be set according to the formula. This option would primarily
impact high-income states, like California and NewYork. p. 19.

Of course, Minnesota is also a high-income tax. I have no idea how far Minnesota would drop below its current 50% match. CBO’s description says it would affect 13 states. Similarly, a proposal would apply the same matching rate to the ACA expansion, which is currently 90%. This would not affect those red states that have not opted into ACA’s Medicaid expansion.

To my political light, some version of this stuff would be high on the list a Republican Congress would opt to use because it will hit blue states hard.