Consider a few of the more outrageous instances. One infamous episode occurred during the last major tax reform in 1986, when the tax rate on capital gains was increased from 20 percent to 28 percent. Congressional revenue estimators hugely overestimated capital gains revenues because their static analysis failed to take into account investors' behavioral response to the hike in the tax rate. Not only did capital gains revenues not increase as much as the Joint Committee on Taxation estimated, they actually declined.
The source of the error was the Congressional Budget Office's static assumption that the rate at which investors realized capital gains would not be adversely affected by the tax hike. As a result, CBO overestimated capital gains realizations by $527 billion between 1989 and 1992. By 1992, CBO's estimate of capital gains realizations was off by almost 60 percent annually, $287 billion vs. actual realizations of only $118 billion.
Congressional bureaucrats repeated their static-analysis fallacy in reverse when the Joint Committee on Taxation estimated the effects of the 1997 reduction of the top capital gains tax rate back down to 20 percent from 28 percent. The JCT projected that tax rate reduction would "cost" the government $21 billion over 10 years. In fact, capital gains tax revenue went through the roof, rising from $62 billion in 1996 to more than $100 billion in 1999.
The absurdity of static revenue analysis was best illustrated in 1988, when former Sen. Robert Packwood, R-Ore., then ranking Republican on the Senate Finance Committee, requested the JCT to estimate what would happen if the federal government levied a 100 percent tax on all income over $200,000 annually. The JCT revenue estimators cranked up their goofy static-revenue-estimating machine and concluded that such a confiscatory tax would raise $104 billion the first year, $204 billion the second year, $232 billion the third year, and $263 billion and $299 billion in the fourth and fifth years, respectively. Packwood pointed out the irrationality of the JCT's assumptions when he observed that the JCT's calculation "assumes people will work if they have to pay all their money to the government ... when clearly anyone in their right mind will not."
President Bush has started the ball rolling. I urge House Majority Leader John Boehner and Speaker Dennis Hastert to instruct the Congressional Budget Office and the Joint Committee on Taxation to scrap static analysis and replace it with a dynamic analysis that takes into account how people respond to incentives and disincentives to work, save, invest and take entrepreneurial risks.