The Congressional Budget Office (CBO) and the Joint Committee on Taxation (JCT) recently released macroeconomic analyses of extending the individual provisions of the Tax Cuts and Jobs Act (TCJA), set to expire at the end of 2025. This analysis offers valuable insights into their modeling approaches and the likely outcomes of next year’s tax debates.
JCT Finds Economic Growth, CBO Highlights Crowd-Out
JCT, utilizing three macro models (MEG, OLG, and DSGE), predicts that permanently extending the TCJA’s individual provisions would stimulate the economy, increasing GDP by 0.2% to 0.9% over the 2025-2034 period. This aligns with our own findings, which estimate an initial GDP boost of 0.7% in 2026, gradually declining to 0.6% by the end of the forecast window.
Conversely, CBO’s analysis emphasizes a significant crowd-out effect, where increased deficits offset the TCJA’s pro-growth impacts. While CBO acknowledges initial GDP growth (around 0.3%), it predicts a decline of 0.4% by 2034 due to this crowding out.
Understanding Crowd-Out
CBO defines crowd-out as the reduction in private investment due to increased federal deficits. Their past research, while acknowledging uncertainty, suggests a significant crowd-out effect, particularly for deficit-financed spending increases. However, several studies, including some cited by CBO, find minimal or even negligible crowd-out effects for tax cuts, especially when considering private saving responses and foreign capital inflows.
Key Differences in Modeling
- Crowd-Out Effect: CBO’s model assumes a substantial crowd-out effect, while JCT’s models incorporate varying degrees of this effect.
- Tax vs. Spending: CBO’s model appears to emphasize the negative incentive effects of income taxes without explicitly differentiating the crowd-out impacts of tax cuts versus spending increases.
- Open Economy: CBO’s analysis may not fully account for the mitigating effects of a globalized economy, where foreign demand for U.S. assets can partially offset domestic crowding out.
Policy Implications
The differing conclusions highlight the importance of robust economic modeling and a nuanced understanding of the factors influencing economic growth and fiscal sustainability.
- Pro-Growth Tax Cuts: Lawmakers should consider pro-growth tax cuts, particularly those that incentivize investment and labor supply.
- Spending Reforms: To offset the potential impact of tax cuts on the deficit, policymakers should prioritize spending reforms, including reductions in unnecessary spending and addressing entitlement programs.
- Addressing the Deficit: While acknowledging the need to address the long-term fiscal trajectory, policymakers should recognize that spending cuts are generally more effective than tax increases in stabilizing the debt while minimizing economic damage.
Conclusion
The analyses by JCT and CBO provide valuable insights into the potential economic consequences of extending the TCJA. While the differing conclusions underscore the complexities of economic modeling, they highlight the critical need for a balanced approach that considers both economic growth and fiscal responsibility.