The JCT’s “Experiment” Doesn’t Tell Us Much

October 16, 2012 J

By Jason Hughey

On October 11, Thomas Barthold, chief of staff of the Joint Committee on Taxation (JCT) sent a letter to Senators Max Baucus and Orrin Hatch.  The letter detailed a hypothetical tax policy experiment that Barthold designed in which a number of tax credits and deductions were eliminated along with simultaneous decreases in the personal income rates.  The goal of the experiment was to answer the question of whether it would be possible to reform the tax code by offsetting decreases in revenue from lower marginal tax rates with eliminations of deductions and credits.

The results?

Barthold concluded that the elimination of credits and deductions could only be accompanied by a 4% across the board reduction in personal income tax rates.  Any further reduction in marginal tax rates would decrease revenue to the federal government, and thus, would add to the federal deficit.

The problem?  The experiment that Barthold conducted was based on a number of questionable assumptions.  The first of these assumptions was that, under such a plan, the 2001 and 2003 reduction to the tax rates would be allowed to expire and that capital gains would be taxed at the higher income tax rate.  Such a proposal doesn’t fit with the type of conservative tax policy reforms we’ve seen in the past, nor with one that we will likely see in the future, making this experiment an “apples vs. oranges” comparison to the type of tax reforms that have been discussed until this point.

Furthermore, the experiment only includes some deductions and credits, but it excludes other significant deductions and credits.  Among those excluded are the earned income tax credit, the child credit, the exclusion of employer provided self-employed health benefits, and deductible retirement and healthcare savings account contributions.  While the simulation did include other major deductions, such as the mortgage interest deduction and charitable deductions, its failure to include other tax credits and deductions casts a certain level of doubt on the overall robustness of its results.

Finally, and perhaps most importantly, Barthold’s experiment assumes the archaic method of static scoring.  Instead of taking the real world behavior of individuals reacting to new tax policy into account, the experiment simply “crunches the numbers” on expected changes in tax rates while assuming that people’s behavior will remain the same.  Thus, this experiment precludes the possibility of an increase in revenue due to higher economic growth as a result of lower taxes.  This alone may be the most prohibitive factor affecting our ability to predict what the effects of tax reform would like based upon this experiment.

Although the JCT had the right idea in trying to determine what an across the board cut in rates coupled with the removal of deductions and credits, the methodology that it used in this experiment cannot be at all thought to be a definitive forecast of such tax reform.  Additional analysis is needed before we conclude what the effects of conservative tax proposals would look like.

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