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Rejecting Imaginary Budget Numbers

December 1, 2014 in Economics

By Richard W. Rahn

Richard W. Rahn

Would you make an effort to find ways to reduce your tax burden if your tax rate was suddenly raised 50 percent? The higher one’s income, the more incentive a person has to find ways to minimize his tax burden — which is why very high tax rates on the rich always fail to produce the projected revenue.

The new Republican Congress is going to make a couple of critical personnel decisions within the next few weeks. The Congressional Budget Office has the responsibility for scoring the cost and economic effects of spending bills, and the Joint Committee on Taxation (JTC) has the responsibility for scoring and gauging the effects of tax bills. The staff directors of these committees are of great importance because conclusions they make regarding the impact of tax and spending bills greatly influence decisions of Congress. Historically, these number-crunchers relied on “static” models, which largely ignore changes in behavior as a result of changes in tax rates or government spending. The alternative approach is to use what are commonly referred to as “dynamic” models, which incorporate expected changes in behavior. Critics of the dynamic model approach argue that it is difficult to project changes in behavior, and it is easier to calculate changes in expected tax revenues if no change in behavior is assumed. In other words, the advocates of the static approach believe it is better to be precisely incorrect than approximately accurate.

Reliance on static models leads to an overestimation of tax revenues from any tax rate increase and an overestimation of the tax revenue loss from any tax rate reduction. This bias leads to higher levels of taxation and spending than is best for economic growth and job creation. The current JTC tax model now includes some dynamic estimates, but the committee has not revealed the assumptions and interactions within the model, thus keeping outside economists from being able to review it.

Upgraded economic models factoring in taxpayer behavior would improve accuracy.”

The errors in the tax and spending models in the past have been considerable, and destructive for policymakers. For example, there have been a number of changes to the capital gains tax rates over the years. In 1978, 1981, 1986 and 1996, the Joint Committee on Taxation not only produced grossly inaccurate numbers but did not even get the direction of the sign correct. That is, it scored what turned out to be a revenue gain as loss and vice versa because it largely ignored the “unlocking …read more

Source: OP-EDS

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