Projecting results of tax policy

Opinion Journal:

Congress has a dreadful record predicting the economic impact of its policies, in part because it relies on computer models that are as reliable as tarot cards. So it's a good sign that before going on recess a majority of the Senate endorsed "dynamic scoring" of changes in tax law.

For decades the official forecasters at the Congressional Budget Office and Joint Committee on Taxation have assumed that changes in tax rates have little impact on how businesses and households behave or on the competitiveness of the U.S. economy. In this alternative universe, people work nearly as much at a 60% income tax rate as they do with a 30% rate, and investors don't care all that much if the tax on capital gains is 15% or 30%.

This often leads to crazy results. In January 2003, for example, the modelers predicted that capital gains revenues would be $68 billion in 2006 and $73 billion in 2007. In May 2003 Congress cut the capital gains tax rate to 15% from 20%, and in its revised budget forecast in August 2003 CBO estimated that the rate cut would reducerevenues to $65 billion in 2006 and $69 billion in 2007.

CBO wasn't even close. Actual capital gains revenue rose despite the lower tax rate to $109 billion in 2006 and $126 billion in 2007, thanks to faster economic growth and a greater incentive for investors to cash in their gains at the lower rate.

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This is more than a faculty-lounge argument. By always scoring tax rate reductions as losing huge amounts of revenues and tax increases as automatically lowering the deficit, the Beltway rules are stacked against sound tax policy. The issue is especially timely now, because enacting pro-growth tax reform depends on better real-world scoring.

Tax reform done right should be revenue neutral using standard CBO static analysis, but a dynamic model would predict a large revenue windfall from the overall increase in investment and economic efficiency. As part of a budget deal, those extra tax dollars that Democrats crave could be earmarked for deficit reduction. So it was disappointing that Finance Chairman Max Baucus, the Senate's main tax writer, was among the 48 Democratic "nos."

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This could be a real problem for Obama who does not seem to understand the concept, as do most Democrats not understand it.  But it should be hard to argue with the 2006 and 2007 actual results.