Use Dynamic Analysis In Revenue Estimation

"The conservative Arkansas Policy Foundation, which last year supported a cut in the grocery tax, called on state economists to use a process known as "dynamic scoring" where the impacts of the tax cuts on economic growth are estimated."
-- Associated Press, December 4, 2007

Dynamic analysis is an attempt to measure the full impact of fiscal policy revisions, including tax proposals, on revenue estimates. It can also provide legislators with more information when considering fiscal proposals.

One example is the 2008 increase in the severance tax. The state revenue estimate was based on an $8 natural gas futures contract price on the NYMEX. But a study by the Univ. of Arkansas Center for Business and Economic Research cited an average $6.21 price for forecast investments to occur, and the contract currently trades at a lower price.

Dynamic analysis has evolved from theoretical to practical since the Policy Foundation first recommended the idea in 1998. The American Economics Association and National Bureau of Economic Research have published papers on the issue in the last five years. Arkansas is able to conduct dynamic analysis of major fiscal policy proposals. The state has access to trained experts and an econometric model that attempts to measure dynamic effects of policy changes at the level of the national (U.S.) economy. This should also be applied to the state (Arkansas) level.

Legislators have implicitly recognized tax rates affect individual economic behavior by crafting a border city exemption for citizens of Texarkana, which borders a state that does not levy an individual income tax. Measuring individuals' behavioral response to tax rate revisions is an important part of dynamic analysis.

A common question posed by legislators and the citizens they represent is, What is the impact of tax proposals on revenues?' Subjecting fiscal proposals to dynamic scoring will give them more information. One important detail: If this analysis is used the non-commercial methods used to develop revenue estimates should be transparent and subject to disclosure under the Arkansas Freedom of Information Act so the public interest is protected. This includes assumptions about variables used in the analysis.