A Small Step For Dynamic Tax Analysis

PRESIDENT BUSH has budgeted “an additional $513,000 for the Treasury Department’s Office of Tax Analysis to create a new division of dynamic analysis,” according to Bruce Bartlett. Ho hum.

Actually, this is a big deal. It goes to the heart of the supply-side theory of marginal tax rates that has been the intellectual foundation of the Reagan and the Bush tax cuts. And let us be clear about this.

The reason that the Reagan tax cuts of 1983 and the Bush tax cuts of 2003 have resulted in gangbuster growth is that both were focused upon broad tax rate cuts.

By contrast, Democrats still believe that the way to jumpstart the economy is with “targeted” tax cuts.

The Reagan tax cuts in 1983 lowered the top income tax rate from 70 percent to 50 percent, and the tax bill of 1986 lowered the top rate from 50 percent to 28 percent. The result? The share of taxes paid by the rich went up.

The Bush tax cuts of 2003 cut the top rate on dividends and capital gains to 15 percent. The result? The economy took off like a rocket.

But guess what? The government’s official estimate of the effects of these tax rate cuts, the so-called “scoring” of tax changes, make no allowance for the idea that people might change their behavior when tax rates are cut.

That’s what the $513,000 is all about. To advance the adoption of “dynamic” economic analysis in forecasting tax revenues.

The first attempt to cut tax rates occurred in 1978 when the Steiger Amendment cut the top capital gains rate to 25 percent. Writes Bartlett:

After Congress cut the capital-gains tax in 1978, the Treasury Department studied the effect and concluded the tax cut had indeed raised federal revenue. There was also a huge jump in venture capital financing that many economists credit for starting the high-tech revolution of the last 25 years.

Tax experts eventually determined that there was a reflow effect of about 35 percent. That is, if you reduced a tax rate and crudely assumed that the revenue would be reduced by the same amount, you would be wrong. The loss in revenue would be 35 percent less than you estimated. Equally, if you raised taxes, the increased take would be about 35 percent less than you expected.

The new office of dynamic analysis will be tasked with getting more accurate revenue estimates after tax rate changes. That can’t happen soon enough.

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Christopher Chantrill blogs at www.roadtothemiddleclass.com. His Road to the Middle Class is forthcoming.