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123 IRET Congressional Advisory 1 (2001)

handle is hein.taxfoundation/iretcgadv0120 and id is 1 raw text is: December 10, 2001 No. 123 FEDERAL REVENUE AND EXPENDITURE ESTIMATING: A FLAWED PROCESS THAT LEADS TO BAD FISCAL POLICY Summary Although most private sector forecasting models recognize that changes in tax rates or other features of the tax code affect the aggregate economy in various ways, government revenue estimators at the Treasury and the Joint Committee on Taxation (JCT) deliberately ignore tax-driven effects on the aggregate economy when attempting to measure the revenue consequences of proposed tax changes. Government revenue estimators claim their models are dynamic because they sometimes allow for modest changes in which products are produced, where income is earned, and how income is spent as a result of tax changes. But because the models assume that tax changes never affect total production, total employment, total earnings, total saving and investment, economic growth, or any other features of the aggregate economy, government revenue estimation models are essentially static. When tax changes improve production incentives at the margin, output and incomes rise, which expands the tax base and yields positive revenue feedbacks. When tax changes worsen marginal production incentives, they yield negative revenue feedbacks. By ignoring these effects, the Treasury and the JCT deliver highly misleading revenue estimates, and highly misleading advice to the Congress and the Administration. Tax reforms with large positive work and saving incentives - such as an across-the-board cut in tax rates, a lower capital gains tax rate, faster capital cost recovery allowances, and elimination of the alternative minimum tax - would have much smaller revenue costs than government estimators claim. Spending increases that have no positive incentive effects, or transfer payments that discourage work or saving, would decrease GDP, not add to it, and would cost more than initially forecast by reducing government revenues. Government revenue estimates could, and should, be more accurate: Government revenue estimation models should include dynamic macroeconomic effects. The dynamic effects in the models should be based on behavioral changes motivated by price signals (i.e., the microeconomic price and incentive effects of tax and spending changes), not on theoretically unsound and empirically discredited Keynesian theories of demand management. The models should recognize that we live in a global economy. Taxing U.S.-sited capital less heavily can quickly attract large amounts of domestic and foreign saving to finance additional investment in the United States. The assumptions and equations that government estimators use in their models should be made public so that people outside the government may judge whether the models are reasonable. The JCT is moving too slowly toward new estimation methods, and the Treasury has not even begun. They must be urged, respectively, to move faster and to get started for the good of the country. Institute for Research on the Economics of Taxation IRET is a non-profit, tax exempt 501 c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote economic growth and efficient operation of the free market economy. 1730 K Street, N.W., Suite 910, Washington, D.C. 20006 Voice 202-463-1400 9 Fax 202-463-6199 0 Internet www.iret.org

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