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Role of the 25 Percent Revenue Offset in Estimating the Budgetary Effects of Legislation 1 (January 2009)

handle is hein.congrec/cbo8355 and id is 1 raw text is: A series of issuze summaries from the Congressional Budget Office JANUARY 13, 2009 The Role of the 25 Percent Revenue Offset in Estimating the Budgetary Effects of Legislation When excise taxes, customs duties, and other types of indirect taxes are imposed on goods and services, they tend to reduce income for workers or business owners in the taxed industry and for others throughout the econ- omy. Consequently, revenue derived from existing direct tax sources-such as individual and corporate income taxes and payroll taxes-will also be reduced. To approximate that effect, the Congressional Budget Office (CBO), the Joint Committee on Taxation (JCT), and the Treasury Department's Office of Tax Analysis (OTA) apply a 25 percent offset when estimating the net revenue that legislation imposing some form of indirect tax is expected to generate. In other words, the estimated pro- ceeds from the indirect tax are reduced by 25 percent to account for the resulting reductions in income and pay- roll taxes. The offset is made in addition to accounting for behavioral responses to the new tax. Although applying the 25 percent offset for budget esti- mates is a longstanding convention, proposals to address global climate change have created greater public aware- ness of that practice. Because tradable emission permits would have economic effects that are identical to those of a tax on emissions, which would be an indirect tax, CBO applies the offset when calculating the revenue that such policies might generate. For example, if the issuance of emission permits was estimated to generate $100 billion in revenues in a given year, the estimate would also reflect an offsetting reduction of $25 billion in income and pay- roll taxes, for a net revenue gain of $75 billion. This brief explains that estimating convention-its rationale, appli- cation, and implications for policy decisions. Why an Offset Is Needed More than 90 percent of federal revenue comes from income and payroll taxes-what economists generally refer to as direct taxes. Much of the remainder is gener- ated by excise taxes, tariffs, and a variety of governmental fees and assessments that are all thought of as indirect forms of taxation.1 The distinction stems from the way in which total income and total production are measured in the econ- omy. In the absence of taxes, all that is spent on goods and services in the economy becomes income for those who produce, or supply the means to produce, those goods and services. Proceeds from that spending are used to provide compensation-in the form of wages, profits, rent, and interest-to those who supply the labor, machines, buildings, and other inputs that are needed to produce those goods and services. Taxes imposed on that compensation are considered direct. Taxes imposed at an intermediate stage of production and sale are indirect. Because the prices of goods and services must reflect all the costs of production, imposing an indirect tax would divert some of the proceeds from spending on those goods and services that otherwise would be available for compensation to those firms or individuals that provide the productive inputs. 1. That classification is in contrast to the way that direct and indirect taxes are distinguished under law. Under the legal definition, indi- rect taxes are imposed on an action or event, such as importing, manufacturing, buying a good, paying for a service, or transferring an asset. Direct taxes are imposed on objects, such as property or wealth. Under that classification scheme, income and payroll taxes are also considered indirect taxes. f

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