Friday, July 23, 2010

WSJ vs. The Joint Committee On Taxation

The issue of federal and, for that matter, state and local tax policy is one as old as the income tax amendment. Ronald Reagan was excoriated for wanting to cut taxes, yet his tax cuts spurred a 20-year US economic expansion.

Thus, a recent battle in the editorial pages of the Wall Street Journal is noteworthy. In answer to an earlier staff editorial, director of the Congressional Joint Committee on Taxation, Thomas Barthold, fired back in a letter published in Wednesday's edition of the paper. The Journal responded with its lead staff editorial that day, in which these passages appeared,

The director of the Joint Committee on Taxation, Thomas Barthold, takes us to task in a nearby letter for exaggerating the revenue impact and economic benefits of the investment tax cuts of 2003. (See "The Obama Tax Trap," July 2.) This is a debate we're delighted to have, and Members of Congress should want to have it too if they ever want to cut taxes again.

In a 2005 paper "Dynamic Scoring: A Back-of-the-Envelope Guide," Harvard economists Greg Mankiw and Matthew Weinzierl looked at the revenue feedback effects of tax cuts. They concluded that in all of the models they considered "the dynamic response of the economy to tax changes is too large to be ignored. In almost all cases, tax cuts are partly self-financing. This is especially true for cuts in capital income taxes." We could cite other evidence that squares with what happened after tax cuts in the 1960s, 1980s and in 2003.

So how well did Joint Tax do when it predicted a giant revenue decline from the 2003 investment tax cuts? Not too well. We compared the combined Congressional Budget Office and Joint Tax estimate of revenues after the 2003 tax cuts were enacted with the actual revenues collected from 2003-2007. (See the nearby table.)

In each year total federal revenues came in substantially higher than Joint Tax predicted—$434 billion higher than forecast over the five years. We readily admit that some of this extra revenue flowed from the housing bubble. When that mania turned to panic and the economy went into recession, revenues collapsed. But the 2003-07 growth spurt wasn't all housing related, any more than the late-1990s stock boom was all phony merely because the bubble later burst. The last decade saw growth in technology (Google, the iPod), energy, professional services, biotech and even manufacturing.

As for capital gains tax receipts, they nearly tripled from 2003 to 2007, even though the capital gains tax rate fell to 15% from 20%. (See the second table.) Yet the behavioral models that Mr. Barthold celebrates predicted that the capital gains cuts would cost the government just under $10 billion from 2003-07 when the actual capital gains revenues over five years were $221 billion higher than JCT and CBO predicted.

Mr. Barthold also claims it is a "non sequitur" to say that the $786 billion, or 44%, rise in federal revenues from 2003-07 was at least partially a result of the tax rate reductions. Why? Because, he says, "in normal economic times, general economic growth and inflation will lead to an increase in revenues from one year to the next with no changes in tax policy."

True enough, but the revenue growth from 2003-07 was anything but "normal." The 44% increase in revenues compares with a 25% average over the last 30 years. Tax revenues increased by 12% in 2006, the second largest single year gain in revenues in 25 years. The highest was 15% in 2005.

Joint Tax now says that rescinding the Bush investment tax cuts will raise about $500 billion in revenue over the next five years. So on January 1 we will enact one of the largest tax increases in history, coming out of one of the deepest recessions in a century, because computer models that we know are wrong are telling Congress that this will raise far more revenue than the increases will raise in reality.

That last statement from the committee regarding the effects of letting the Bush tax cuts lapse is troubling, isn't it? Does anyone believe economic growth will be enhanced through higher taxes?

As it is, the committee has made horrendous estimation errors, in the wrong direction, on prior tax policy effect on tax revenues.

Further, Barthold's letter of reply was a qualitative, shoot-from-the-hip sort of thing, with none of the sensible basic analysis which appeared in the Journal's staff editorial reply. For example, comparing growth in tax revenues in a certain year or period with the long-run average, to assess whether it was really inevitable, or an extraordinary growth rate.

From the exchange, Barthold appears to be both naive and sloppy. Not to mention simply wrong in his and his staff's lack of understanding of the need for dynamic modeling of consumer and investor reactions to tax rate changes.

No comments: