The Administration, led by the Office of the United States Trade Representative, is actively negotiating a free trade agreement with 11 countries, known officially as the Trans-Pacific Partnership (TPP). The TPP would open markets and expand trade among countries that constitute approximately 40 percent of global gross domestic product (GDP).
Assuming the successful completion of these negotiations, the TPP would go into force after the implementing legislation is passed by Congress and signed into law by the President. The implementing legislation would be considered by the Ways and Means Committee in the House and the Committee on Finance in the Senate before being considered by the full House and Senate.
Further, the implementing legislation would be subject to the various rules regarding scoring by the Congressional Budget Office (CBO) that previous implementing bills have faced. Central to the analysis by the CBO will be its estimate of the budgetary cost to the federal government of implementing the agreement. The budgetary cost to the government of trade agreements is primarily the amount of tariff revenue that is lost as the United States reduces or eliminates tariffs on imports of products from the other TPP countries. In preparing previous estimates of the budgetary costs of trade agreements, the CBO has produced estimates that do not take the impact of the macroeconomic effects of the agreement on the U.S. economy into account.
In keeping with congressional rules and statutory requirements, Congress will likely have to also enact other provisions that would offset or “pay for” the lost tariff revenue to ensure that the implementation of the agreement does not increase the deficit. This is where the new rule established by the House of Representatives, which requires a macroeconomic analysis of major legislation, comes into play. Specifically, the new House rule requires the CBO to incorporate into its analysis “the budgetary effects of changes in economic output, employment, capital stock and other macroeconomic variables resulting from the legislation.” Among congressional policymakers this analysis is often referred to as “dynamic scoring.”
That the TPP agreement will have an impact on the overall level of economic activity in the United States is really beyond question. Therefore, the real questions are: How big is that macroeconomic impact? and How could the analysis of the macroeconomic impact factor into congressional consideration of the agreement?
The enactment of this new rule on dynamic scoring garnered considerable media attention and some criticism. Much of the media attention was focused on potential impact of dynamic scoring on efforts to enact tax reform. However, it is quite possible that Congress will enact the TPP before it enacts tax reform. Therefore, the TPP could be the first opportunity for the CBO to use dynamic scoring under the new House rule. Criticisms of the rule generally focused on assertions that dynamic scoring is less precise, or even technically impossible to implement. Those criticisms are ill-founded, particularly as they relate to the ability of the CBO to analyze the macroeconomic effects of the TPP.
In a few cases where the CBO or the Joint Committee on Taxation have produced dynamic scores—such as the Senate immigration bill in the 113th Congress or the analysis of the tax reform discussion draft released by former Ways and Means Chairman Dave Camp—they have included a wide range of results. However, with regard to analysis of the macroeconomic effects of the TPP, policymakers have the advantage of the expertise of the U.S. International Trade Commission (ITC).
The ITC is an independent agency tasked with enforcing U.S. trade laws and providing non-partisan, expert analysis of trade policy to Congress and the Administration. One of the regular types of analysis the ITC has produced are detailed economic reports on the impact of free trade agreements on the U.S. economy. These reports include the results of the ITC’s macroeconomic analysis of the trade agreements on the U.S. economy.
The ITC produced this analysis for each of the last four free trade agreements implemented by the United States, specifically the trade agreements with Panama, Peru, Colombia, and South Korea. The ITC’s analysis of the agreements with Peru, Colombia, and South Korea each included a quantitative estimate of the impact of the agreement on U.S. GDP growth.
Furthermore, in each of these cases, the ITC’s analysis produced estimates of the impact on U.S. GDP that were quite specific. For example, in the case of the U.S.–Korea trade agreement, the ITC found that the agreement would increase U.S. GDP by between $10.1 billion and $11.9 billion. For the U.S.–Peru agreement that estimate was $2.1 billion. For the U.S.–Colombia agreement the estimate was $2.5 billion. Thus, the ITC has already demonstrated the ability to produce specific estimates of the impact of trade agreements on U.S. GDP growth.
It is possible that the CBO would choose to conduct its own macroeconomic analysis of the TPP agreement, although such a step would raise questions about why the CBO would try to duplicate analysis performed by an agency with considerably more expertise in analyzing trade policy, but even if it did, there is little reason to think that the results of the CBO’s analysis would be significantly different than the analysis conducted by the ITC.
Assuming that the CBO either relies on the expert analysis from the ITC or performs an analogous analysis, the CBO can extend that macroeconomic analysis to incorporate the impact of the additional GDP growth on the amount of federal revenue collected. This additional analysis is something that the CBO does on a regular basis and is most certainly not breaking new ground.
As a routine matter, the CBO includes analysis of how faster or slower GDP growth would impact the amount of revenue collected by the federal government in its annual Budget and Economic Outlook. For example, in its just released 2015 Budget and Economic Outlook, the CBO included an analysis of the impact on federal revenues if GDP growth were 0.1 percentage point higher or lower than its baseline estimate. The CBO determined that this change in GDP growth would increase or reduce the amount of revenue collected by $288 billion over the 10 years of the budget window. Thus, the CBO has routinely demonstrated that it has the analytical capacity to extend a macroeconomic analysis of the impact of policy changes on U.S. GDP growth to also generate a dynamic revenue estimate.
This brings us back to the real question of how this additional analysis can be used. While the dynamic revenue effect is not specifically listed in the new House rule as one of the variables that the CBO is required to report, it certainly falls within the category of “other macroeconomic variables resulting from such legislation.” Assuming that Congress requests and that the CBO provides analysis that includes a dynamic revenue feedback estimate, Congress will be able to incorporate this information in determining which other policies need to be included to ensure that the legislation does not add to the deficit.
Exactly how this could work is best demonstrated by example. As noted, the ITC found that, once fully implemented, the U.S.–Korea trade agreement would increase GDP by between $10.1 billion and $11.9 billion, or roughly 0.1 percent of GDP when it completed the report in 2011. Using its conventional scoring methodology, that is, assuming that GDP is fixed, the CBO determined that the cost associated with implementing the U.S.–Korea trade agreement was about $7 billion.
In its 2011 Budget and Economic Outlook (the same year that the ITC published its macroeconomic estimate of the U.S.–Korea trade agreement), the CBO reported that if GDP growth had been 0.1 percentage points higher each year than its baseline assumptions, federal revenues would have been $266 billion higher. The CBO reported that the annual increase in revenue from 0.1 percentage points of faster GDP growth ranged from $1 billion in the first year to $55 billion in the 10th year, as the benefits of faster growth in the early years of the budget window compounded over time.
Thus, a conservative and overly simplistic approach to this analysis shows that, if we assume that the TPP agreement has a one-time, short-term impact of increasing GDP growth by 0.1 percentage point, the corresponding estimate of dynamic revenue growth would be about $1 billion in additional revenue. This would be enough to offset about one-seventh of the CBO’s conventional estimate of the budgetary costs of implementing the TPP.
The example above is based on simplified rules of thumb that the CBO regularly publishes, and uses the ITC’s analysis of the U.S.–Korea trade agreement as a benchmark. The TPP is likely to have a larger impact on the U.S. economy and GDP growth than the U.S.–Korea agreement, and the CBO has more sophisticated analytical tools available to it for estimating the macroeconomic effects, including the dynamic revenue effect. The CBO has used these more sophisticated methods to analyze the dynamic revenue effects of other major policy proposals, for example, S. 744 of the 113th Congress—the Border Security, Economic Opportunity, and Immigration Modernization Act.
Thus, the first opportunity that Congress may have to consider legislation under the new dynamic scoring rules also has the benefit of well-established analysis by independent, non-partisan experts that address many of the criticisms leveled against dynamic scoring. With this robust analysis available to it, Congress will have the opportunity to implement dynamic scoring in a manner that will allow it to more accurately determine the real impact of the agreement on the federal budget as it considers legislation to implement the TPP.
