Complex Models Determine Dynamic Scoring

The Congressional Budget Office and Joint Committee on Taxation use complex macroeconomic models for dynamic scoring.

The CBO, which estimates the effects of spending legislation, uses a Solow-type growth model and a life-cycle growth model. The tax committee, which analyzes tax proposals, uses a structural macroeconomic equilibrium growth model (MEG) and an overlapping generations model (OLG).

The CBO’s Solow model and JCT’s MEG model are viewed as somewhat similar. In a description of its Solow model, the CBO said it is built on the assumption that people base their decisions about working and saving primarily on current economic conditions including wage levels, interest rates and government policies. The model assumes that people respond to current developments as they have, on average, in the past, the agency said.

In a presentation earlier this year, Joint Tax said its MEG model provides for prices adjusting so that long run demand equals supply, but that in the short run less than full employment may exist.

By contrast, overlapping generations models assume that people are more forward-looking in their behavior. In a presentation about its life-cycle model, an overlapping generations model, the CBO said the tool assumes that people make choices about working and saving in response to both current economic conditions and their explicit expectations of future economic conditions. “The model requires specification of future fiscal policies that put federal debt on a sustainable path over the long run because forward-looking households would not hold government bonds if the households expected that debt as a percentage of GDP would rise without limit,” the CBO said.

Joint Tax said its overlapping generations model assumes that individuals and businesses forecast the entire future path of the economy, making decisions based on perfect foresight. “Perfect foresight means the model cannot solve if fiscal policy is not sustainable,” requiring an assumption about how fiscal policy will be made sustainable, the agency said.