The Political Philosophy of Karl Schmitt
A Little Bit of Bad Inflation News...

Jason Furman on the Cost of Tax Cuts

Jason Furman takes a step back:

Do Revenue Surprises Tell Us Much about The Cost of Tax Cuts?, 7/18/06: by Jason Furman: The best answer to the question posed by the title of this paper is probably “no,” revenue surprises do not tell us much about the cost of tax cuts. The reason is that revenues are extremely volatile and move up and down in response to a variety of factors that have nothing to do with tax policy. Indeed, the impacts on revenue levels that the most optimistic dynamic-scoring models predict are trivial in comparison to the unexpected swings in revenue levels that regularly occur for other reasons, whether taxes are cut, raised, or left unchanged.

Another key point about drawing lessons based on revenue surprises is that if one wanted to use revenue surprises — i.e., how actual revenue levels differ from predicted revenue levels — in order to draw conclusions about the dynamic effects of tax cuts, one would need to use data on revenue levels for more than just a single year or a couple of years. Data for just one or two years often are quite ambiguous and can tell conflicting stories.... [T]his analysis uses every annual forecast made by CBO since January 1981, in order to assess what revenue surprises can tell us about the costs of tax cuts. The story that these data tell is an intriguing one: on average, revenues have fallen below expectations in the years that have followed tax cuts, which, if anything, might indicate that tax cuts have had overall negative economic effects that produced larger-than-expected revenue losses. In addition, revenues have tended to exceed expectations in years following tax increases, which might suggest that tax increases have strengthened the economy, resulting in even larger revenue gains....

[I]f one believes that revenue surprises do tell an important story and seeks to use them, it ought to be noted that the revenue surprises over the past quarter century lead to the opposite conclusion from that which tax-cut supporters propound. To come up with data that appear to support their rosy conclusions about tax cuts generating powerful economic effects, tax-cut proponents have been citing data on actual revenue levels from only one or two years, as well as particular revenue forecasts from one or two carefully selected years, rather than using revenue levels and revenue forecasts for all recent years and letting the chips fall where they may....

An examination of how CBO’s revenue forecasts have compared with actual revenue levels since 1981 yields some interesting results. First, the CBO estimates are essentially unbiased.... Second, the average forecast error in these 24 estimates — the average amount by which CBO either overestimated or underestimated the following year’s revenue level, regardless of whether the error was an overestimate or underestimate — is very large... the equivalent of more than $150 billion in 2006.... Third, the overestimates and underestimates have tended to follow certain patterns. The period that followed the 1990 and 1993 tax increases... [saw] revenues came in an average of 0.1 percent higher than forecast.[6] In contrast, revenue levels generally were disappointing in the Reagan years and under the current administration — i.e., in years following tax cuts — falling an average of 4.0 percent below projections....

[T]o the degree that dynamic-scoring analyses by economists do differ modestly from conventional cost estimates of tax legislation, even the “sign” of this difference is ambiguous. Research tends to find that if reductions in income taxes are not paid for, the resulting increase in the national debt will hurt the economy more over the long term than the tax cuts otherwise will help it, so that the net long-term effect of the tax cuts on the economy is likely to be negative. Conversely, estimates of the long-term economic effects of tax increases generally produce results consistent with the conclusion that income tax-increases can improve long-term economic growth if the savings from the revenue-raising measures are used to reduce the debt.

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