WASHINGTON (Reuters) - The holy grail of conservative tax policy - the theory that lower tax rates will generate stronger revenues by turbo-charging economic growth - has sprung back to life and is stirring controversy again in Washington.
The so-called “dynamic scoring” theory, disputed by many independent economists, has formed the basis of Republicans’ defensive line on negotiations over the year-end “fiscal cliff” of looming tax hikes and automatic spending cuts.
They have put new revenues on the table, but not any that come from Americans paying more in taxes. Instead, what Republicans in the House of Representatives are offering is new revenue generated by a cleaner, simpler tax code, with fewer deductions and lower rates.
“Long-term revenue that results from economic growth, that’s fine,” said Representative Jim Jordan, who heads the conservative Republican Study Committee caucus. “If it’s revenue ... that increases the tax burden, I think that’s a real problem.”
Conservative Republicans, saying that their re-election gave them at least an equal mandate to President Barack Obama‘s, intend to dig in on growth revenues for the time being. A common refrain is that they weren’t re-elected to raise taxes.
Their adherence to this theory could present a major hurdle for House Speaker John Boehner in winning passage for any deficit deal.
Obama, showing that he is just as adept with wonky budget terms, fired back during his news conference on Wednesday.
“What I will not do is to have a process that is vague, that says we’re going to sort of, kind of, raise revenue through dynamic scoring or closing loopholes that have not been identified,” Obama said.
He said he is concerned that such revenues will not materialize, prompting cuts to programs that aid middle-class families or to government-funded research.
Obama is instead seeking some $1.6 trillion in increased tax revenues to help reduce deficits, largely by allowing tax rates to rise for the wealthiest.
The origins of dynamic scoring can be traced to the 1970s and supply-side economist Arthur Laffer, whose D-shaped Laffer curve represents the relationship between tax rates and the revenue they generate.
It postulates that raising tax rates beyond a certain point would be counterproductive and raise less revenue, and vice versa, but estimating the optimal rate is tricky.
Some of these concepts were adopted by the Reagan administration’s supply-side economics policies and tax cuts in the 1980s.
The dynamic scoring argument surfaced during last year’s debt ceiling talks, went into hibernation for several months, then reappeared in Mitt Romney’s presidential campaign, which used it to back a 20 percent tax cut and reform plan.
Boehner says the version he is offering will produce a “gusher” of growth and revenue, but in return, Republicans want cost-cutting reforms to entitlement programs like Social Security and Medicare.
“We’re willing to work with the administration to get tax reform, but not tax reform that raises taxes on people,” said Representative Scott Garrett, the No. 2 Republican on the House Budget Committee.
Congress has about seven weeks to craft a solution to deal with the year-end expiration of Bush-era tax cuts and the launch of automatic spending cuts. If left unchecked, these would suck about $600 billion out of the U.S. economy next year and lead to a new recession, according to the nonpartisan Congressional Budget Office.
In addition to the year-end deadlines, Congress also by early next year must raise the federal borrowing limit and come up with a plan to shrink deficits by enough to satisfy credit ratings agencies and financial markets.
In cutting any deal with Obama and Democrats emboldened by gains in the U.S. Senate, Boehner will need to appease the conservatives in order for any plan to win House approval. They still hold substantial sway, despite Democrats gaining about seven seats in the chamber.
The Republican offer of growth-only revenues from tax reform has been widely chided by Democrats. Senator Charles Schumer has likened it to the straw-to-gold scheme at the center of the Rumpelstiltskin fairy tale.
On Tuesday, Treasury Secretary Timothy Geithner said it was “magical thinking” to believe that by merely eliminating tax deductions, credits and preferences, Congress could produce enough revenue to cut deficits.
“I don’t see how you do this without higher rates. I just don’t see how you feasibly, realistically, do it.”
Economists have expressed skepticism too. The tax-cut revenue growth argument received a thorough airing last year during the fiscal debates over raising the debt limit.
“Dynamic scoring in this context is an illusion - just a way to turn wishful thinking into numbers. It is not serious and should be taken off the table,” said Simon Johnson, a former chief economist at the International Monetary Fund who is now a professor at Massachusetts Institute of Technology.
Generally, economists cite a lack of empirical evidence that past tax rate cuts have produced significant growth, much less revenue. Bruce Bartlett, who held economic policy jobs in the Reagan and George H.W. Bush administrations, says any effect on long-term growth rates from tax reform could be measured in the tenths of a percentage point.
“The idea that tax reform will jump-start an economy suffering from the after-effects of a cyclical downturn is nonsense,” he said in a recent New York Times opinion piece on Romney’s tax plan.
But not all House Republicans are drawing a line in the sand over growth-only revenues. Mindful that Democrats have a strong hand to play with the ability to simply let tax rates rise back to pre-2001 levels, some are willing to trust Boehner to get the best deal possible from Obama.
“The real question is, can they reach a deal that both of them can sell to their respective groups,” said Representative Tom Cole, a moderate Republican from Oklahoma who sits on the House Budget and Appropriations committees.
“If the speaker comes back and tells me, ‘This is the best deal we can negotiate or we go over the fiscal cliff,’ I’d be inclined to go with the speaker’s deal,” Cole said.
Reporting by David Lawder; Editing by Fred Barbash and Stacey Joyce