-19-

b. Taxpayer Response to Increases in the Top Individual Tax
Rate

As part of the Omnibus Reconciliation Act of 1993, two new
individual income tax brackets of 36 percent and 39.6 percent
were added. In addition, new alternative minimum tax rates were
imposed and the limitation of itemized deductions and the
personal exemption phaseout were made permanent.

The estimation of the above described changes began with the
use of the individual income tax simulation model, described
previously, to calculate the change in tax liability resulting
from the proposed changes with no assumed behavioral change. The
model provides the forecast distribution of income which is
essential to the calculation and accounts for interactions
between the provisions.

The model output was then adjusted after considering certain
behavioral responses on the part of affected individuals. This
adjustment was particularly critical in this case because the
provisions affected high-income individuals who are generally
assumed to have greater access to information and greater ability
to rearrange their affairs to minimize the impact of the tax.

The types of taxpayer behavior taken into account include
the shifting from investments which yield interest and dividend
income taxed at the new higher rates into investments that
provide capital appreciation, which is taxed at unchanged lower
rates. Also considered were shifts from taxable to tax-exempt
assets, conversion to C corporation business form, conversion of
wage income into tax-deferred or tax-exempt fringe benefits, and
increased noncompliance and avoidance.

In making the determination of how much behavioral response
to include, the Joint Committee staff reviewed available studies
and consulted with the OTA staff. The final result was a
reduction in the estimate of increased fiscal year receipts of
$8.5 billion or a reduction of approximately 7 percent, for the
five-year period.

Because all revenue estimates assume fixed levels of
macroeconomic aggregates, the behavioral responses considered do
not include actions which would affect the overall output of the
economy such as a change in the supply of labor. While
macroeconomic effects were not included in the estimate, it is
not clear that they would have a significant impact on the
magnitude of the tax change. In the case of changes in the top
individual income tax rate, one would expect that the most
probable macroeconomic effect would be a change in the labor
supply of affected individuals.


FEB 15 1984

Honorable Bob Packwood
Page Two

It should be noted that these estimates are quite
sensitive to economic forecasts. For example, a ten percent
increase in the forecast for per capita incomes, increases
the projected revenue effects of a proposal of this type by
approximately 20 percent. The estimates shown above are
based on January, 1984, CBO economic projections.

It should also be noted that these numbers do not
represent actual revenue estimates, since taxing 100 percent
of anyone's income would force taxpayers to invest in tax
avoidance devices or simply encourage then not to earn income

in the first place.

Sincer.

David’ 8. Brockway


Congress of the Hrites Mtates

Jouer Coumrrrex on Taxation
Bastington, B.C. 20515 .

Honorable Bob Packwood
United States Senate Page 2

behavioral responses likely would have a significant effect on the
projected revenues. However, because a temporary 100-percent tax
rate is so vastly different from any other proposal we have
analyzed in the past, we are unable to quantify these factors with
the degree of confidence n ssary for us to provide a specific
revenue estimate at this time.

Should you so desire, it would be possible for us to
undertake a further review of the economic literature and consult
with outside experts in an effort to develop an acceptable method-
elogy for estimating the behavioral effects of your proposal.
However, because we expect to be breaking new ground, it is
unlikely we would be able to provide a specific revenue estimate
in the near future.

I cegret we are not at present able to provide the informa-
tion you have requested. If you would like to discuss further the
reasons for our inability to do so or what we believe we would
have to do in order to properly estimate the proposal, please let
ae now.

Sincerely,

Ronald A. Pearlman



-13-
in the absence of a rate reduction.?

The Joint Committee staff has long recognized that a change
in the rate of tax on capital gains will affect the level of
capital gains realizations by taxpayers.‘ Economists use the
term "elasticity" to describe the relative change in taxpayers’
decisions to realize capital gains that can be expected in
response to changes in the capital gains tax rate.
Mathematically, the realization elasticity is the percentage
change in realizations divided by the percentage change in tax
rates.

The Joint Committee staff estimate of the elasticity of
taxpayer response to a reduced capital gains tax rate was
developed after careful review of the major empirical and
theoretical studies by experts in government and the academic TM
community. The elasticities ultimately used, however, are not
those reported in any single study; nor are they derived by a
mechanical averaging of any group of studies. Rather, they
reflect the staff’s independent evaluation of the results of the
various studies, analyzed in the context of the historical
record.

3 The current methodology of the Joint Committee staff in
preparing distributional analysis of tax proposals, including
capital gains tax rate cut proposals, includes increased tax
revenue from the proposed changes for each of the five years of
the budget period. This would include the tax from induced
realizations in the case of a capital gains rate reduction.

* For example, in the General Explanation of the Revenue

Act of 1978 (P.L. 95-600), the revenue table included a separate
line item reflecting the increased revenues from induced capital
gains realizations.

5 For example, if a 10-percent reduction in the capital
gains tax rate were expected to result in a 10-percent increase
in realizations, the realization elasticity would be -1 (10
percent/-10 percent). An elasticity of -1.0 would mean that if
the capital gains tax rate were lowered, the percentage increase
in realizations would exactly offset the revenue loss from the
reduction in the rate, resulting in no net revenue effect. An
elasticity of -1.1 would mean that, if the capital gains tax rate
were lowered, the increase in realizations would produce more
revenues than the revenue loss occurring as a result of the lower
tax rate. Similarly, an elasticity of -0.9 would mean that the
increase in realizations from a reduction in the capital gains
tax rate would be less than the loss of revenues from the lower
rate.


Appendix I. Overview of the History and Operation of the
Joint Committee on Taxation

1. Establishment of the Joint Committee on Taxation

The Joint Committee on Taxation (the "Joint Committee") was
established by the Revenue Act of 1926. As originally conceived
by the House of Representatives, (a temporary) "Joint Commission
on Taxation" was to be created to "investigate and report upon
the operation, effects, and administration of the Federal system
of income and other internal revenue taxes and upon any proposals
or measures which in the judgment of the Commission may be
employed to simplify or improve the operation or administration
of such systems of taxes..."?°

The Senate expanded significantly the functions contemplated
by the House and transformed the proposed Joint Commission to a
Joint Committee with a permanent staff. The Senate was acting
largely in response to the findings of a select committee that
had been investigating misconduct and corruption at the Bureau of
internal Revenue (the earlier name of the Internal Revenue
Service). That select committee emphasized

"the need for the institution of a procedure by which the
Congress could be better advised as to the systems and
methods employed in the administration of the internal
revenue laws with a view to the needs for legislation in the
future, simplification and clarification of administration,
and generally a closer understanding of the detailed
problems with which both the taxpayer and the Bureau of
Internal Revenue are confronted. It is more properly the
function of the Senate Finance Committee and the House Ways
and Means Committee, jointly, to engage in such an
activity."

The Senate version was incorporated into the Revenue Act of 1926
and the Joint Committee on Taxation was created.

By statute, the Joint Committee is composed of 10 Members of
Congress: 5 Members from the Senate Committee’ on Finance (3
majority and 2 minority) and 5 Members from the House Committee

10° Revenue Act of 1926, House Report 1, 69th Cong., ist
Sess. (1925).

Revenue Act of 1926, Senate Report 52, 69th Cong., 1st
Sess., (1926).

* Revenue Act of 1926, House Report 356 (Conference
Report), 69th Cong., 1st sess. (1926); Revenue Act of 1926,
Public--No. 20--69th Cong. (44 Stat. 127).



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JAN 24 1983

Honorable Bob Packwood
United States Senate
Washington, D.C. 20510

Dear Senator Packwood:

This is in response to your request for revenue estimates of two
proposals to impose a 100 percent tax rate on income in excess of
$100,000. The first proposal applies this 100 percent tax to taxable
income in excess of $100,000; the second proposal coniputes the tax as
the larger of the present law tax or 100 percent of expanded income
over $100,000.

We have estimated the revenue impact of these proposals,
assuming an effective date of January 1, 1983-as follows:

(Billions of Dollars)

Calendar Year or: Fiscal Year

100% tax on 1983 1984 1985 1986 1987
taxable income. over .
$100,000 cy 22.6 28.2 35.3 44.1 55.2
FY 9.1 24.9 31.2 38.9 48.6
expanded income over
$100,000 cy 59.7 75.6 95.6 120.9 152.9
- PY 24.1 66.1 83.7 105.8 133.8

These revenue numbers are somewhat higher than was the case for
similar estimates made in previous years. There are two reasons for
this. First, the 1981 tax cuts, particularly the cut in the top -
marginal tax rate from 70 percent to 50 percent, provided substantial tax
relief to high-income individuals, thereby increasing the revenue gain
from taxing 100 percent of their income. For example, income which was
in the 70-percent bracket under prior law would have experienced a
30-percentage-point tax increase if the tax rate were raised to 100
percent. Today, that income is taxed in the 50-percent bracket and would
experience a 50-percentage-point. tax increase if taxed at 100 percent.
This increase from 30 percentage points to 50 percentage points increases
the revenue gain from confiscatory taxation of that income by two-thirds.



~4-

. To estimate the revenue effects of most proposed changes in
the individual income tax, the Joint Committee staff first uses
the individual income tax model to calculate the tax liability
for each of the sample returns in the model on the basis of
present law. The model then recalculates the tax for each of the
returns incorporating the parameters contained in the proposed
legislation. In so doing, the model accounts for the interaction
of all variable components of a taxpayer’s return. For example,
a 10-percent increase in the personal exemption does not
necessarily increase the revenue loss associated with the
personal exemption by 10 percent. Some returns will become
nontaxable as a result of the increase, while other returns will
shift to a different marginal rate bracket. The model will take
these changes into account. After statistically weighting the
present-law and proposed-law tax payments to adjust the results
to reflect outcomes for the more than 110 million U.S. individual
tax returns, the model calculates the difference in total
revenues between present law and the proposal. This result
obtained from the model is often only the first step in
estimating the revenue effect associated with a proposal. For
example, as discussed below, the Joint Committee staff often must
make further adjustments to account for changes in taxpayer
behavior, to reflect interaction among a package of proposals, or
to reflect fiscal year budget reporting.”

In addition to the individual tax model, microsimulation
models based on SOI data developed by the Joint Committee staff
and the OTA staff include a corporate tax model, a partnership
model, and an estate and gift tax model.

2. Other Models

In addition to the large microsimulation models based upon
large samples of tax returns, the Joint Committee staff has
developed a variety of econometric models to estimate the revenue
impact of changes in tax laws relating to business investment and
depreciation, natural resources and energy, employee benefits and
other issues. The information needed to calculate the revenue
effects of a proposal may not be available from tax return data

? To be useful tools in budget analyses, estimates must be
presented in a form consistent with the Federal government's
cash-flow accounting system. Under this system, amounts received
by the Treasury are accounted for at the time of receipt and
disbursements are accounted for during the period when paid out.

To be consistent with the cash-flow measure of budget
receipts, revenue estimates are shown in a format that
corresponds to fiscal-year receipts of the Treasury Department.
Because taxes are most often calculated on a calendar-year basis,
the translation of changes in calendar-year tax liabilities into
changes in the fiscal-year receipt of taxes is necessary.


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Wasmingtom. OC 20618-6489

(202) 228-3621
Honorable Bob Packwood

MAR 21 1990
United States Senate

259 Senate Russell Office Building
Washington, DC 20510

Dear Senator Packwood:

This is in response to your request for revenue estimates of
proposals imposing a 100-percent tax rate on income above $100,000
and $200,000. Specifically, the proposal would compute the tax
under present law for individual returns, but would impose a tax
of 100 percent on income (1) over $100,000 or (2) over $200,000.

Assuming an effective date of January 1, 1990, and subject to
the qualifications noted below, we have estimated this proposal to
have the following effect on fiscal year budget receipts:

Fiscal Years
TBillions of Dollars]
Item . 1990 1991 1992 1993 1994 1990-94

100% tax on income

over $100,000....... 194.1 378.9 429.6 486.9 $52.2 2,041.7
100% tax on income

over $200,000....... 122.3 237.7 267.2 300.4 337.7: 1,265.3

These estimates do not account for any behavioral response
{tax avoidance, compliance, change in work effort and savings
behavior, etc.) that would result from the imposition of a
100-percent tax rate. Accordingly, they should not be given the
same weight as an estimate that does take behavioral response into
account. However, if the Looopercent tax rate were to be in
effect for a substantial period of time, so that taxpayers would
have no rational hope of avoiding or evading the 100-percent tax
in the outyears by deferring income to lower rate years or using
other tax avoidance or deferral plans, then in our judgment there
would be a substantial reduction in income-producing activity in
the ecgnoay and, thus, a significant reduction in tax receipts to
the Federal government.

I hope this information is helpful to you. If we can be of
further assistance, please let me know.

Sincerely,

Ronald A. Pearlaan


~20-

IV. ISSUES RELATING TO ESTIMATING THE
MACROECONOMIC EFFECTS OF PROPOSED LEGISLATION

A. In General

As indicated earlier in this testimony, under current
revenue estimating methodology, a revenue estimate predicts how
Federal receipts will increase or decrease relative to the
baseline projections if a proposed change in the tax law is
enacted. However, although a revenue estimate under current
estimating methodology may incorporate anticipated behavioral
responses to a proposed change in the tax law, the estimate does
not take into account the potential effect, if any, the proposal
may have on aggregate economic growth, interest rates, or other
macroeconomic variables. Thus, a current methodology revenue
estimate does not predict the positive or negative effects, if
any, a proposal might have on the overall economy.

It has been suggested that in making revenue estimates of a
tax proposal the Joint Committee staff should take into account
the projected macroeconomic effects that would result from that
particular tax proposal.

B. Issues to be Considered Concerning the Possibility of
Incorporating Macroeconomic Effects in Revenue Estimates

There are a number of important issues which need to be
analyzed in considering whether to modify the current estimating
methodology applicable to proposed tax policy changes. Many of
these are discussed in the document released last week by the
Congressional Budget Office entitled "Budget Estimates: Current
Practices and Alternative Approaches." While we will not repeat
a discussion of each of those considerations, we would highlight
the following:

e Inclusion of macroeconomic effects in estimates of
revenue proposals but not spending proposals could
create a serious inconsistency in overall budget
analysis.

e Most revenue proposals are likely to have little or no
macroeconomic consequences.

e Because of the complexity and lack of consensus as to
the measurement of such macroeconomic effects,
attempting to take macroeconomic consequences into
account could undermine the credibility of the


-26-

so complex and highly technical that the staff economists must
rely on the technical expertise and experience of the staff
attorneys and accountants to analyze the potential effects of
proposed tax legislation. From time to time during consideration
of health reform legislation during 1994, the Congressional
Budget Office (CBO) economists estimating the outlay effects of
the legislation also drew upon the expertise of the Joint
Committee staff’s attorneys to assist in the interpretation of
tax provisions in the health reform legislation.

4. Work of the Joint Committee on Taxation revenue
estimating staff

Revenue estimate requests

The Congressional Budget Act of 1974** requires the Joint
Committee on Taxation to provide revenue estimates for all tax
legislation considered by either the House or the Senate. Such
estimate are the official Congressional estimates for reported
tax legislation.*” In addition, under the Budget Enforcement Act
of 1990, any proposed reduction in taxes must be "paid for" with
either an offsetting tax increase or a direct spending
(entitlement) decrease.

Distribution analysis

To accompany revenue estimates prepared by the Joint
Committee staff, data are often prepared on the estimated changes
in the benefit or burden by income class that result from
adoption of a given proposal. Distributional analyses attempt to
measure the changes in taxpayers’ economic welfare that result
from changes in the tax law. The distributional analysis is
consistent with the five-year budget horizon used for revenue
analysis.

Tax expenditure analysis

The Joint Committee on Taxation staff prepares and publishes
annually a list of tax expenditures, which are submitted to the
House Committees on Ways and Means and Budget and the Senate
Committees on Finance and Budget. Tax expenditures are defined
under the Congressional Budget and Impoundment Control Act of
1974 as reductions individual and corporate income tax
liabilities that result from special tax provisions or
regulations that provide tax benefits to particular taxpayers.

*6 Section 201(g), as amended by the Balanced Budget and

Emergency Deficit Control Act of 1985 (Gramm-Rudman-Hollings),
P.L. 99-177, 99 Stat. 1037.

wv Id.


-22-

For example, in addition to providing a revenue estimate for
a large increase in the cigarette tax, the Joint Committee staff
could provide information explaining that the cigarette tax
increase may be expected to reduce demand for cigarettes
significantly, resulting in a long-run decline of the tobacco
industry. Similarly, in addition to providing a revenue estimate
for a "neutral cost recovery" depreciation system, the Joint
Committee staff could provide information explaining how such a
system could be expected to increase investment and economic
growth in the long run.

For many proposals, the potential economic impact will be
well known by both proponents and opponents of the proposals and
additional information from the Joint Committee staff may be
unnecessary. Most revenue proposals would likely have an
immeasurably small effect on the economy. However, in cases in
which the effects of a revenue estimate may not be well
understood, Congressional decision making might be enhanced by
the additional information that might be provided by the Joint
Committee staff. It should be noted that, in some cases, this
type of analysis may be difficult or impossible for a variety of
reasons, e.g., lack of data, complexity of interactions within
the proposals, differences of views within the economic
community, etc.

In addition, it may be appropriate for the Congress to
direct the utilization of resources to develop reliable
macroeconomic models that might be used to assist in the
measurement of potential macroeconomic effects of certain
proposed legislation. It may be difficult to determine the types
of proposals for which the macroeconomic effects should be
measured, but guidelines could be established to assist in this
determination.

The Joint Committee staff is always interested in exploring
ways to improve the accuracy of our revenue estimates. The Joint
Committee staff’s goal in producing revenue estimates is now, as
it always has been, to provide the Congress with an accurate and
unbiased assessment of the impacts of tax legislation on Federal
receipts. The Joint Committee staff views the constant updating
and revision of revenue estimating methodology as a necessary
process for achieving that goal, and the Joint Committee staff is
looking forward to studying the feasibility of any suggested
improvements. In addition, the Joint Committee staff bélieves
that the Congress should have as much information as is
reasonably possible about the revenue estimates we prepare.

We appreciate the opportunity to appear before you today to
explain our existing revenue estimating methodology and look
forward to your comments and the comments of the experts that you
have assembled.


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Wasmmeten. OC 20618-6453
(202) 228-9621

, MAR 15 1999

Honorable Bob Packwood
United States Senate
Washington, DC 20510

Dear Senator Packwood:

This is in response to your letter of March 6, 1990, as
modified by your letter of March 7, 1990, requesting a revenue
estimate for the proposals described below.

The first proposal would raise the rate of tax on income over
$100,000. For the years 1990-1992, the tax rate on such income
would be 100 percent; for years after 1992, the rate would be 50
percent. The second proposal would apply these tax rates to
incomes over $200,000.

During 1989, we provided you the “static® estimates of these
Proposed rate changes, and we have been asked to update those
estimates to reflect our 1990 baseline. These estimates are:

Piscal Years
B ons of Dollars
Itea 1990 1991 1992 1993 1994 Total

1008 tax on income
over $100,000......... 194.1 378.9 429.6 486.9 5$$2.2 2,041.7

100% tax on income
over $200,000......... 122.3 237.7 267.2 300.4 337.7 1,265.3

As os know, a static estimate is merely a mathematical
calculation of the increased revenues the Federal Government would
receive assuming enactment of a tax legislative proposal and
further assuming no behavioral response to the tax law change. In
the case of your proposals, the static estimates represent the
upper bound of possible Federal Government receipts.

As your letter suggests, we vould expect there to be a very
substantial behavioral cesponse to a temporary tax rate of 100
percent. Indeed, we assume taxpayers would atteapt to avoid
completely the effects of the 100-percent rate (e.9., by deferring
income to lower-rate years, by expanding the non-taxable portion
of their incomes, by inaccurate reporting, or otherwise). These

§

e


-17-

the National Marine Manufacturers Association shows that the
boating industry was in a recession two years prior to the
enactment of the luxury tax. Beginning in 1989, the boating
industry began to experience a significant decline in sales for
both luxury and nonluxury boats. Between 1988 and 1990, sales of
luxury and nonluxury boats declined by about one-third.é This
decline continued through 1993. It has been asserted that
several factors contributed to the decline in sales. Several
sources cited the lack of consumer confidence due to the oncoming
recession, the luxury tax, State sales taxes, and a large used
boat market from which lower priced substitutes were available,
as reasons for the decline in boat sales between 1988 and 1993.
In 1993, anticipated repeal of the luxury excise tax caused a
delay in the planned purchases of boats until the 1994 season.
The imposition of a luxury excise tax on boats logically would be
expected to result in a reduction of luxury boat sales. The
Joint Committee estimate of the luxury excise tax on boats took
account of such a reduction in sales on top of an already
declining industry.

3. Proposals to Increase the Top Individual Income Tax Rate
a. 100-Percent Rate on Income Above Certain Levels

Considerable attention has recently been directed to reports
of Joint Committee revenue estimates of a 100-percent marginal
tax rate applied to income over $100,000 or $200,000. For many
years, Senator Bob Packwood (R-OR) has asked the Joint Committee
staff to prepare an analysis of the theoretical revenue that
would be generated under such a hypothetical rate. Senator
Packwood’s purpose in requesting this analysis has not been to
determine the precise revenue consequences if such a proposal
were actually enacted. Rather, his purpose was to illustrate
that a confiscatory tax rate would not produce the levels of tax
that some have mistakenly asserted. The responses that have been
provided to Senator Packwood have been used incorrectly as
evidence of the flaws in the Joint Committee staff's revenue
estimating methodology. For example, in a recent article that
appeared in the Wall Street Journal, incorrectly asserting that
Joint Committee estimating methodology does not take into account
behavioral changes, it was asserted:

"Thus, when Sen. Bob Packwood (R. Ore.), incoming
chairman of the Finance Committee, asked the JCT
to calculate the revenue effects of raising the
top tax rate to 100% on everyone making more than
$200,000 in 1989, he was told that this tax change
would raise $204 billion in 1990, rising to

® GAO Report - Tax Policy and Administration: Luxury excise
tax issues and estimated effects, February 1992; GAO/GGD-92-9.


-9-

reporting generates compliance revenue by changing taxpayer
perceptions of the risks of noncompliance and by assisting them
in identifying the income they have received. In addition, the
information reporting document could be of use to the IRS in the
generation of enforcement revenues, either in the matching or
audit process.

Revenue estimates of so-called "compliance" provisions do
not always recognize both compliance and enforcement effects.
The realization of compliance revenues in the example above
requires only that the proposed change of law be expected to
change taxpayer behavior. Thus, compliance revenues are included
in the estimate. Downstream enforcement revenues, however, are
dependent upon specific actions by the IRS, which May or may not
occur depending on resource allocation decisions. Using the
assumption of a constant baseline level of enforcement, such
revenues would be "counted" only in the event of specific
resource allocations and not merely because of a change in law.
Thus, in the above example, only the compliance revenue
attributable to taxpayer behavior would be counted unless there
were adequate resource allocations to justify counting the
enforcement revenues.

D. Behavioral Effects and Macroeconomic Aggregates

1. Overview

The extent to which behavioral effects are taken into
account in calculating the revenue effects of proposed tax
legislation seems to cause the greatest confusion concerning the
current estimating process: As discussed above, the Joint
Committee staff does take many behavioral responses into account
in preparing revenue estimates.

Revenue estimates often mistakenly are referred to as
"static" because traditional estimating conventions utilized by
the OTA staff and the Joint Committee staff assume no overall
effect on economic aggregates such as gross domestic product,
i.e., the forecast of total employment, investment, and other
economic aggregates are assumed to remain unaffected by tax
proposals. However, economists preparing revenue estimates
assume that the components of these variables may change among
sectors or industries, depending on the nature of the legislative
proposal. For example, when the deduction for business meals was
reduced, the revenue estimating methodology assumed some job
displacement in the restaurant industry. However, it was assumed
that this displacement was generally absorbed in other
industries.

Ordinarily the growth of the following economic variables,


Congress of the Bnited States

JOINT Committed on Taxanon
Mespagten, BC 20515-4453

MAR - 9 1993

WOEMORAND ON
TOs Lindy Paull
FROM: Harry L. Gutman

SUBJECT: Revenue Rstimates

In response to your request dated March 4, 1993, we are
providing information concerning taxpayers with taxable incomes
over $100,000 and over $200,000.

You asked for a revenue estimate for a hypothetical 100-
percent tax imposed on taxpayers with taxable incomes over
$100,000 and over $200,000. We are unable to provide an estimate
for this provision. our estimating models and methodol,
incorporate behavioral effects based oa available empirical
evidence to produce reliable estimates of the effects of tax rate
changes in general. As a proposed tax rate nears 100 percent,
however, we lack historica experience on which to base an
estimate of the behavioral aspects. While we can provide a
purely static tabulation of the revenue collected a@ 100-
percent Cax, this figure does not reflect the behavioral response
of taxpayers that likely would occur.

You also asked for a tabulation of the amounts of taxable
income over $100,000 of taxable income and the amount of taxable
income over $200,000 of taxable income. Our model indicates thac
for 1994 the amount of taxable income over $100,000 of income is
$386.6 billion, and the amount. of taxable income over $200,000 of
Caxable income is $248.7 billion.



-29-

Appendix II. Compilation of Letters to
Senator Bob Packwood (R-OR) Relating to
100-Percent Tax Rate on Certain Income

The following letters represent a compilation of letters
that have been sent to Senator Bob Packwood in response to his
request for certain analysis concerning a 100-percent individual
income tax rate with respect to income in excess of certain

levels. These letters have been included with the consent of
Senator Packwood. .



once included in the tax law), taxpayer response may be estimated
statistically. For example, sufficient data is available to
permit revenue estimates for proposals to change the excise tax
on cigarettes to account for the expected change in demand for
cigarettes.

Occasionally, reliable data will not be available to predict
how taxpayers will respond to a proposed change. In such cases,
the Joint Committee staff makes an informed judgment, relying on
relevant economic theory and other relevant sources, to assess
possible behavioral responses.

The following examples demonstrate the ways in which the
Joint Committee staff accounts for possible taxpayer behavior in
preparing revenue estimates:

e When Congress limited the ability of taxpayers to
deduct passive losses, the Joint Committee staff
estimating methodology assumed that investment patterns
would change and corporations would claim a portion of
the losses no longer freely available to individuals.
Thus, the Joint Committee staff estimated that the
limitation on passive losses of individuals included in
the Tax Reform Act of 1986 would raise $36 billion from
individuals for the period 1987 to 1991, but would lose
$12.6 billion from corporations during the same period.

e When the Tax Reform Act of 1986 made it less attractive
for property and casualty insurance companies to invest
in tax-exempt bonds, the Joint Committee staff assumed
that these companies would shift partially from
investments in tax-exempt bonds to higher yielding
taxable investments and that other corporations and
individuals would acquire the tax-exempt bond holdings
that insurance companies previously held. This
phenomenon of investment shifting is an example of what
are collectively referred to as "portfolio effects."

e Changes in excise taxes are expected to have an effect
on the quantity of the taxed items purchased. For
example, the estimate of revenues to be gained from
imposing the so-called "luxury tax" on boats, cars,
airplanes, furs and jewelry assumed reductions in
purchases of these items.

e Changes in the taxation of capital gains are assumed to
affect how rapidly capital assets are sold. A proposed
decrease in capital gains taxation will speed up the
sale of capital assets, which moves some revenue into
the budget window. Some of the speed up is assumed to
be permanent; that is, it is assumed that some capital
assets that might otherwise have been held until the


-5-

or may be available only for a limited number of potentially
affected taxpayers. In these instances, the Joint: Committee staff
must look beyond the SOI data files and construct a model that
relies on such alternative sources of data.

Frequently, data may be available from other government
agencies, such as the Department of Commerce, the Department of
Transportation, the Department of Labor, the Department of Health
and Human Services, the Social Security Administration, and the
Federal Reserve Board. For example, the Current Population
Survey conducted by the Bureau of the Census of the Department of
Commerce provides useful and otherwise unavailable data relating
to pension plan participation by income class.

In the absence of Federal or State government data sources,
Joint Committee staff must locate other reliable sources, such as
that available from leading economists, CBO, the General
Accounting Office ("GAO"), private consulting or research
organizations, or affected taxpayers.

C. Key Factors Impacting the Preparation of Revenue Estimates

After a microsimulation model produces a preliminary
estimate of the revenue effect of a proposal, the Joint Committee
staff often must make further adjustments to address issues that
cannot be answered by directly applying the simulation models.
These adjustments may be necessary to account for such things as
changes in taxpayer behavior (in addition to taxpayer behavioral
effects calculated directly from the model), the interaction of
various proposals, and issues relating to taxpayer compliance.

1. Anticipated Behavioral Responses

One of the most significant elements of Joint Committee
staff revenue estimates is the assumed effect of taxpayer
behavior. Although the microsimulation models used by the Joint
Committee staff account for certain taxpayer behavior, additional
adjustments are often necessary. In general, a revenue estimate
prepared for any proposal that increases or reduces the
deductibility or excludability of an item of expense or income,
or that changes the rate of tax on certain types of income or
consumption, will incorporate an analysis of potential behavioral
responses. Thus, revenue estimates prepared by the Joint
Committee staff are not static, as has been frequently suggested.
The Joint Committee staff’s estimates are dynamic to the extent
they take account of the direct behavioral responses that can be
expected from proposed changes in the tax laws.

In many cases, empirical research can offer guidance as to
how taxpayers will respond to a proposed change in tax law. If
adequate historical data exists (e.g., if a similar proposal was


-18-

$299 billion by 1993! Such a result is obviously
ridiculous, yet is totally consistent with
established JCT procedures."®

In fact, the information that has been provided to Senator
Packwood represents a simple mathematical calculation derived
from the Joint Committee’s individual income tax model of the
amount of taxable income above $100,000 (or $200,000) reduced by
the current Federal income tax attributable to such income.
Thus, the response shows the amount of tax that could be raised
by such a change if there were no behavioral responses to the
100-percent tax rate.

However, the Joint Committee has consistently stated to
Senator Packwood that it is impossible to provide a complete
analysis of a proposal to impose a 100-percent marginal tax rate
on income above certain levels. In a letter to Senator Packwood
dated October 12, 1994, the Joint Committee on Taxation staff
stated as follows:

",..f{wle are unable to provide a complete analysis
of the proposal outlined. Our estimating models
and methodology incorporate behavioral effects
based on available empirical evidence to produce
reliable estimates of the effects of tax changes
in general. Even when tax rate changes are
relatively small, our analyses include significant
changes in behavior to account for portfolio
shifts and the timing of income realizations. At
a proposed tax rate of 100 percent, however, we
lack historical experience on which to base an
estimate of the significant behavioral effects.
One may speculate that these effects would be
extraordinary. If the 100-percent tax rate were
to be in effect for a substantial period of time,
so that taxpayers would have no rational hope of
avoiding or evading the 100-percent tax in the out
years by deferring income to lower rate years or
using other tax avoidance or deferral plans, then
in our judgment there would be a substantial
reduction in income-producing activity in the
economy and, thus, a significant reduction in tax
receipts to the Federal government."

Copies of a number of letters to Senator Packwood on this
issue are included in Appendix II. All contain similar caveats.

° Bruce Bartlett, "Static Scoring Gets It Wrong", Wall
Street Journal (December 14, 1992).


When one proposal would modify two or more provisions within
the Internal Revenue Code, the result of the combination of
changes often produces a greater or lesser revenue effect than
the sum of the revenue effects of each proposal if enacted
separately. If this interaction is ignored, the analysis is
incomplete; if the interaction is assigned to any one element of
a proposal, the revenue estimate for that proposal may be
misleading.

The proper interpretation of the revenues attributed to
specific proposals and the accompanying interaction are
determined by the "stacking order" of the analysis. There are
two principal methods of presenting these results in line-by-line
revenue tables, and it is important to note that the numbers in
each type of presentation may appropriately answer different
questions but reflect the same estimated revenue effect.

The first of these methods provides a revenue estimate for
each proposal in isolation against present law, assuming none of
the other proposals is adopted. A separate line on the revenue
table displays interactions among proposals. This procedure is
usually the most efficient when only a few proposed changes are
involved. Under this method, deleting a proposal from the
package may have a greater or lesser revenue effect than the
effect shown on the specific line for that proposal.

A second method requires that each proposal be estimated as
if all other proposals have already been enacted with a separate
line again used to display interactions among proposals. The
Joint Committee staff utilized this second method to analyze the
Tax Reform Act of 1986. This method showed the revenue impact of
adding or deleting specific proposals from the total tax reform
package (rather than the revenue impact relative to present law
of that single change without making any of the other changes
contained in the package).

3. Compliance and Enforcement

Implicit in all Joint Committee staff revenue estimates are
assumptions concerning compliance and enforcement. The revenue
yield of any provision is dependent on the extent of compliance
by taxpayers from both voluntary behavior and enforcement
{including penalties assessed by the IRS). In general, levels of
enforcement are assumed to remain unchanged as a result of most
legislative proposals. However, many estimates do take into
account changes in taxpayer compliance. This represents another
aspect of taking into account behavioral effects.

Certain changes in tax law are specifically designed to
improve compliance and also have the potential to affect
enforcement. An example is the extension of information
reporting to previously uncovered income sources. Information


Soathy

~24-

on Ways and Means (3 majority and 2 minority).¥

The statutorily prescribed duties of the Joint Committee are
to: (1) investigate the operation and effects of internal revenue
taxes and the administration of such taxes; (2) investigate
measures and methods for the simplification of such taxes; (3)
make reports to the House Committee on Ways and Means and the
Senate Committee on Finance (or to the House and the Senate) on
the results of such investigations and studies and to make
recommendations;** and (4) review any proposed refund or credit
or income or estate and gift taxes in excess of $1,000,000.35

Under Internal Revenue Code section 8021, the Joint
Committee is empowered to: (1) obtain and inspect tax returns and
return information (as specified in sec. 6103(f)); (2) hold
hearings, require ‘attendance of witnesses and production of
books, administer oaths, and take testimony; (3) procure printing
and binding; and (4) make necessary expenditures. In addition,
section 8023 authorizes the Joint Committee (or the Chief of
Staff), upon approval of the Chairman or Vice-Chairman, to secure
tax returns, tax return information or data directly from the
Internal Revenue Service or any other executive agency for the
purpose of making investigations, reports, and studies relating
to internal revenue tax matters, including investigations of the
Internal Revenue Service’s administration of the tax laws.

2. Role of the Joint Committee on Taxation in the legislative
process

The staff of the Joint Committee on Taxation is closely
involved in every aspect of the tax legislative process. Among
other things, the Joint Committee staff (1) prepares hearing
pamphlets for the use of the House Committee on Ways and Means
and the Senate Committee on Finance, (2) writes the first drafts
of all committee reports and conference reports (statements of
managers) for all tax legislation, (3) assists the office of
legislative counsel in the drafting of statutory language, (4)
assists Members of Congress with the development and analysis of

* Section 8002 of the Internal Revenue Code of 1986. The
statutory authority relating to the Joint Committee on Taxation
is contained in sections 8001-8005 and 8021-8023 of the Internal
Revenue Code of 1986, and predecessor sections of the Internal
Revenue Code of 1954, the Internal Revenue Code of 1939, and
preceding Revenue Acts dating back to the Revenue Act of 1926.
These legislatively prescribed duties are essentially unchanged
since the Revenue Act of 1926.

** Section 8022 of the Internal Revenue Code of 1986.

*% Section 6405 of the Internal Revenue Code of 1986.



WRITTEN TESTIMONY
OF THE STAFF OF THE JOINT COMMITTEE ON TAXATION
REGARDING THE REVENUE ESTIMATING PROCESS

FOR
THE JOINT HEARING
OF THE HOUSE AND SENATE BUDGET COMMITTEES
OF
THE 104TH CONGRESS
ON
JANUARY 10, 1995

PRESENTED
BY
KENNETH J. KIES
CHIEF OF STAFF
JOINT COMMITTEE ON TAXATION
U.S. CONGRESS

JCX-1-95

January 9, 1995


-11-

that the affected industry comprises a significant portion of a
regional economy, such as tobacco in North Carolina, Virginia and
Kentucky or luxury boats in New England, the reduced demand for
labor could result ina locally situated economic downturn. The
resulting increased unemployment could generate additional
Federal expense in the form of increased payments of unemployment
compensation, food stamps, and other transfer Payments. Joint
Committee staff estimates do not reflect these effects.

Similarly, some tax incentives, such as empowerment zones
and targeted jobs tax credits, target specific segments of the
population likely to be receiving transfer payments from the
Federal government. The budgetary effects of the revenue loss
from these proposals may be offset by a reduction in Federal
transfer payments, as well as by increased income and payroll
taxes on any additional earned income. The Joint Committee staff
does not attempt to account for these outlay effects in
estimating such proposals.

The Joint Committee would not, in any case, attempt to
Measure such increases or decreases in transfer Payments because
they affect outlays for which CBO provides estimates.

III. ESTIMATING METHODOLOGY RELATING TO CERTAIN
PROPOSALS WHICH HAVE GENERATED CONTROVERSY OR CONFUSION

A. Overview

A few revenue proposals for which the Joint Committee staff
has provided revenue estimates in recent years have generated
both some controversy and confusion concerning the current
estimating methodology.

In an effort to further understanding of the complex issues
involved in revenue estimating and to dispel popular
misconceptions regarding certain of the Joint Committee staff's
estimates, the estimating methodology and issues relating to the
following proposals are discussed below:

(1) Proposals to reduce the rate of tax on capital gains.

(2) The 10-percent luxury excise tax on boats, airplanes,
jewelry, and fur enacted in 1990 and repealed in 1993.

(3) Proposals to increase the top rate of tax on
individuals.

B. Discussion of Specific Estimates


-~10-

as supplied by CBO, is assumed to be unchanged by proposed tax
law changes for revenue-estimating purposes:

--Gross Domestic Product

--Aggregate investment

--Interest rates

--Overall price index

--Total level of State and local taxes

Although these aggregate levels are fixed in the CBO
baseline, the composition of the variables underlying these
aggregates may be assumed to vary as a result of legislative
proposal. Examples of elements of economic forecasts that may be
reallocated include the following:

--Shifts between corporate and noncorporate income

--The mix of employee compensation between cash and

nontaxable fringe benefits

--Relative prices

2. Behavioral Effects Not Generally Included in Revenue

Estimates

The Joint Committee staff generally does not attempt to
estimate the possible effects of a tax change on the baseline
forecasted growth of GDP. Use of a fixed revenue baseline means
that, in developing revenue estimates, the Joint Committee staff
does not take into account macroeconomic or "feedback" effects,
if any.

Thus, for example, with respect to tax changes that are
likely to affect the return to capital, such as capital gains
relief, investment tax credits, and accelerated depreciation, the
fixed GDP forecast assumption means that the Joint Committee
staff does not attempt to estimate growth in income resulting
from the increased productivity, if any, caused by increases in
investment. It also means the Joint Committee estimate does not
account for any net increase in entrepreneurial activity
generated by the incentives.

Similarly, the Joint Committee staff does not attempt to
forecast changes in labor supply resulting from changes in income
tax or payroll tax rates. At some income levels, the reduced
disposable income resulting from an increase in tax rates could
lead to an increase in labor supply by individuals seeking to
maintain consumption levels. At other income levels, increases
in tax rates may reduce labor supply as the marginal value of
extra hours worked decreases. Hence, consideration of labor
supply effects could increase or decrease the revenues to be
anticipated from a tax increase, depending on whom the tax
increase is affecting.

Some tax changes may affect the demand for labor. For
example, excise tax increases that reduce demand for a product
may result in layoffs in the affected industry. To the extent


Congress of the Anite States

Joint COMMITTEE ON TAXATION
Gashington, B.C. 20515

OCT 12 1905

Honorable Bob Packwood Page Two
United States Senate

years or using other tax avoidance or deferral Plans, then in our
judgment there would be a substantial reduction in income-
producing activity in the economy and, thus, a significant
reduction in tax receipts to the Federal government.

I hope this information is helpful to you. If we can be of
further assistance, please let me know.

Sincerely,

John L. Buckley



SS Congress of the Wnited states ee
vee. wontam een ATEROWER, _
Sa SS roc stati re REE
1016 LONGWORTH HOUSE OFFICE BUILDING
‘Wamenaten, OC 206 16-6463
(202) 228-3621

OCT 12 1994

Honorable Bob Packwood
United States Senate
Washington, DC 20510-6200

Dear Senator Packwood:

This is in response to your letter of September 30, 1994,
for revenue estimates of imposing a 100-percent tax on all income
over $100,000, and alternatively, income over $200,000. We are
unable to provide a revenue estimate for these options for the
reasons given below. However, the following table, which gives
the amount of taxable income above those levels reduced by the
current Federal income tax attributable to such income shows the
amount of tax that could be raised by such change assuming no
behavioral or macroeconomic responses.

{Billions of Dollars]
iten 1225 1296 _1997 1998 1999 1999-95

After tax income in
excess of:

$100,000......... 289.1 314.4 342.8 370.1 399.6 1,716.2
$200,000......... 182.3 195.5 212.6 227.0 243.5 1,061.9

As mentioned above, we are unable to provide a complete
analysis of the proposal outlined. Our estimating models and
methodology incorporate behavioral effects based on available
empirical evidence to produce reliable estimates of the effects
of tax changes in general. Even when tax rate changes are
relatively small, our analyses include significant changes in
behavior to account for portfolio shifts and the timing of income
realizations. At a proposed tax rate of 100 percent, however, we
lack historical experience on which to base an estimate of the
significant behavioral effects. One may speculate that these
effects would be extraordinary. If the 100-percent tax rate were
to be in effect for a substantial period of time, so that
taxpayers would have no rational hope of avoiding or evading the
100-percent tax in the outyears by deferring income to lower rate



2.

-7-

death of the owner, thereby avoiding capital gains
taxation entirely, are sold within the budget window as
a result of a capital gains tax decrease. These
changes result in increases in revenue, which offset
much of the decrease from the tax cut.

Other changes in the taxation of capital to provide
specific incentives to acquire certain types of assets,
such as targeted investment tax credits and accelerated
depreciation, are also generally expected to affect
investment decisions. These incentives are expected to
speed up and, for some proposals, increase investment
in the types of capital benefiting from the incentives.
Investment in assets not entitled to the incentives is
assumed to decline.

Changes in individual income tax rates are assumed to
affect portfolio management decisions of individuals.
For example, an increase in the top individual income
tax rate is assumed to result in increased holdings of
tax-exempt bonds and reduced holdings of taxable
investment instruments. To the extent that increasing
the rate of tax on ordinary income reduces the taxation
of capital gains relative to such ordinary income, it
is assumed that individuals will shift portfolios so
that they receive less current income as dividends and
More as capital gains. Both of these assumptions
reduce the estimated revenue gain from an increase in
the top individual income tax rate.

Changes in the deductibility of various expenses, such
as home mortgage interest payments, business meals, or
contributions to tax-deferred savings plans, are
assumed to affect the rate at which such expenses
occur. A decrease in the deductibility of business
meals, for example, is assumed to reduce the total
amount spent on business meals.

Finally, for changes in tax law that may be difficult
to enforce or administer, some efforts by taxpayers to
avoid taxation are assumed. One such example is the
provision included in the Energy Policy Act of 1992 to
include in income the value of employer-provided
parking to the extent that it is greater than $155 per
month. The Joint Committee staff estimate assumed that
there would be a tendency for taxpayers to take steps

-to reduce or underestimate the value of employer-

provided parking so as to avoid income inclusion under
this provision.

Interaction


-21-

estimating process and render estimates less reliable.
The uncertainty of monetary policy further contributes
to this problem.

e Given the fact that most of the discussion associated
with proposals to take macroeconomic effects into
account has focused on proposals which are viewed, at
least by some, as having the potential for positive
macroeconomic effects, taking such effects into account
could reduce the pressure to further reduce the
deficit. Moreover, to the extent that an estimate
overstates the positive macroeconomic effects of a
proposed change, the result could be an increase in the
deficit.

V. CONCLUSION

There are difficult practical and theoretical hurdles to
overcome prior to including macroeconomic effects in Joint
Committee staff revenue estimates. That does not mean that it is
not appropriate to improve the revenue estimating process and, at
the same time, to begin the steps necessary to overcome these
hurdles.

As a first step, it is clear that the Joint Committee staff
must act to rectify the perceived inadequacies with the existing
revenue estimating process. The Joint Committee staff can do
this by (1) continuing to improve the methodology employed in
preparing revenue estimates and (2) doing a better job of
informing the Congress about the revenue estimates it prepares.

Much of the confusion surrounding revenue estimates could be
alleviated through increased disclosure of the underlying
assumptions used by the Joint Committee staff in deriving these
estimates. Thus, the Joint Committee staff could provide
additional information about specific proposals. This type of
additional analysis is done intermittently now by the Joint
Committee staff and, in some cases, by other governmental
organizations (such as the Congressional Research Service) or by
private consulting. A more systematic approach to disclosure may
be warranted.

This disclosure could have two components. First, the Joint
Committee staff could provide additional information to the
Congress as to the methodology that it has employed in preparing
a revenue estimate, with particular emphasis placed on the types
of taxpayer behavioral responses assumed in preparing an
estimate. Further, the Joint Committee staff could provide
information as to the likely effects a proposal might be expected
to have on the economy.


Congress of the Hrited States

dort Commerrrex on TAXATION

Bashington, B.C. 20515

NOV 15 1988

Honorable Bob Packwood
United States Senate Page Two

I hope this information will be helpful to you. If we
can be of any further assistance to you, please do not
hesitate to let me know.

Sincerely,

(signed) Ronald A. Pearlman
Ronald A. Pearlman


. tweens mc nsso 4 Goncom
stmare mount Sure Cnet oF Stare
ane

— ‘cme  — Congress of the United States - en aan
mamas Sore 0. tee war, . Jour Commrrter on Taxaniow
‘eve stwTeen, TEX ovat 4 Waar, Tem. 1018 LONGWORTH HOUSE OFFICE SURLDING
ashington, B.C. 20515
Honorable Bob Packwood FEB i 5 84

‘taited States Senate
Wasnington, D.C. 20510

Attn: John Colvin

Dear Senator Packwood:

This is in response to a request from John Colvin to
reestimate the effects on individual income tax liability of
a proposal to impose a 100 percent tax on income in excess of
selected thresholds. Under this proposal, tax liability
would be computed as the larger of the present-law tax or 100
percent of income over the selected threshold.

The revenue impact of this proposal has been estimated
using two different income concepts for the application of
the 100 percent tax rate--either expanded income or a more
broadly-defined measure of income. Expanded income is
@efined as adjusted gross income plus excluded capital gains
and various other tax preference items, less investment
interest to the extent of investment income. The
broadly-based income measure includes everything in expanded
income plus the two-earner deduction and other statutory
adjustments, tax-exempt interest, excluded life and health
insurance payments paid by employers, and presently untaxed
social security, veteran, AFDC and SSI benefits.

The estimated revenue effects for calendar year 1984,
under the various specifications, are as follows:

(Billions of Dollars)

Income Concept 100% Tax Applied Against Income Over:
$20,000 $30,000 $50,000 $100,000

372.1 165.7 74.1
81.5

expanded income 658.4
broadly-based income 793.5 450.2 190.7



-27-

These special tax provisions can take the form of exclusions,
credits, deductions, preferential tax rates, or deferrals of tax
liability.

Tax expenditures are considered to be analogous to direct outlay
programs, and the two can be viewed as alternative means of
accomplishing similar budget policy objectives. Tax expenditures
are most similar to those direct spending programs that have no
spending limits, and that are available as entitlements to those
who meet the stuatutory criteria established for the programs .?°

Estimates of tax expenditures are prepared for use in budget
analysis. They are a measure of the economic benefits that are
provided through the tax laws to various groups of taxpayers and
sectors of the economy. The estimates also may be useful in
determining the relative merits of achieving specified public
goals through tax benefits or direct outlays.

Requests for data or estimating methodology

Members occasionally request that the Joint Committee staff
provide background material relating to proposed changes in the
tax laws, such as an analysis of changes in the Federal tax
burdens over a period of time or an analysis of the extent to
which proposed legislation exacerbates or reduces the so-called
marriage penalty.

In addition, Members may request information as to the
methodology employed by the Joint Committee staff in preparing a
particular revenue estimate. If a Member wishes to obtain
additional information regarding an estimate, the Joint Committee
staff attempts to respond to the Member’s request. This most
often entails meeting with the Member or the Member’s staff to
review the relevant assumptions employed. If warranted, the
Joint Committee staff also produces documents or letters
describing a particular estimating methodology in detail. For
example, in 1990, the Joint Committee staff published a pamphlet
that provided extensive detail on the methodology employed to
estimate the effects of President Bush’s proposed reduction in
the tax rate on capital gains.

Volume of requests received by the Joint Committee on Taxation

18 There are a few tax expenditures that have spending
limits. One example is the tax credit for low-income rental
housing. This credit is available only to those who have
received credit allocations from State housing authorities.
There are statutory limits on the total amounts of credit
allocations that can be issued in any given year.



=3-

nominal gross domestic product ("GDP"), inflation rates, interest
rates, and employment levels. For modeling purposes, a number of
elements of the CBO forecast are disaggregated to match specific
tax-related variables. For example, the aggregate forecast of
wages and salaries paid is statistically matched to various types
of taxpayers, e.g., by income class.

In contrast, the reference point for revenue estimates
prepared by the Treasury Office of Tax Analysis ("OTA") is an
alternative set of economic forecasts generated by the
Administration. Differences in resulting revenue estimates
prepared by the Joint Committee staff and by the OTA staff often
can be traced to differences between the economic forecasts of
CBO and the Administration.

As mandated by the Congressional Budget Act, revenue
estimates published by the Joint Committee staff generally
provide a fiscal year budget impact for the period ending five
years following the current fiscal year (total of six fiscal
years).

B. Econometric and Statistical Simulation Tax Models

1. Models Based on Statistics of Income Data

For most income tax revenue estimates, the Joint Committee
staff relies on large computerized models of the Federal income
tax system and the economy. These models have been developed by
economists on the Treasury OTA staff, the Joint Committee staff,
and in private economic consulting organizations. In simple
terms, these models contain two components: (1) a calculator,
which computes taxes paid under present law and under the
proposal for which a revenue estimate is prepared and (2) tax
return or other data. The primary data source for most models is
the tax returns filed by individuals, corporations, and
fiduciaries with the Internal Revenue Service ("IRS") and
provided to the Joint Committee by the IRS Statistics of Income
Division ("SOI"). The models combine the most recently available
taxpayer information with forecasts of the aggregate level of
national income provided by CBO.

The largest microsimulation model employed by the Joint
Committee staff is the individual income tax model, which
contains a random sample of approximately 200,000 individual
income tax returns. This data’ is also matched with data from the
Current Population Survey to account for individuals who do not
file income tax returns. Once this match is complete, the file
sample contains approximately 250,000 records. This sample is
then statistically weighted to represent the entire filing and
nonfiling population.


-14-

Consistent with current estimating methodology, the Joint
Committee staff does not take into account the possible effects
of a capital gains tax cut on GDP (i.e., the macroeconomic or so-
called "feedback" effects) in preparing revenue estimates of
capital gains tax cut proposals. With respect to the effects of
a capital gains tax cut, feedback effects on GDP, if any, would
be expected to come from increases in productivity resulting from
changes in the capital stock. Such productivity growth would
occur slowly at first, with most of the effects outside the
budget window. In theory, increased entrepreneurial activity
utilizing otherwise unemployed labor could generate short-run
increases in GDP.

2.. Estimates of the Luxury Excise Tax

The luxury excise tax enacted as part of the Omnibus Budget
Reconciliation Act of 1990 imposed a 10-percent excise tax on the
value of automobiles in excess of $30,000, the value of boats in
excess of $100,000, the value of personal-use aircraft® in excess
of $250,000, and the value of furs and jewelry in excess of
$10,000. The tax was effective for sales occurring on or after
January 1, 1991. As part of the Omnibus Budget Reconciliation
Act of 1993, the tax on boats, personal-use aircraft, furs, and
jewelry was repealed. The repeal was effective for purchases of
boats, jewelry, furs, and personal-use aircraft occurring on or
after January 1, 1993. The 10-percent tax on automobiles was
indexed periodically for inflation such that, in 1994, the tax
applied only to the value of automobiles in excess of $32,000.

The methodology used to estimate excise tax proposals
generally involves several steps. Once the initial tax base is
determined, the base is adjusted to account for changes in
consumption patterns (elasticities of demand and supply) that
result from the imposition of the tax. The base is also adjusted
to account for any significant compliance problems in the
administration of the proposed tax. The tax rate is then applied
to the adjusted tax base to yield the expected gross revenues
from the tax.

One of the most fundamental components of any revenue
estimate is the construction of the tax base. Estimation of the
luxury excise tax proposal required information on units of each
item sold at a given price. Because no single data source
contained all the information necessary for the estimates,
several data sets were used to derive the revenue estimates of
the tax.

At the time of the legislative consideration of the luxury

® Aircraft for which 80 percent of use was for nonpersonal
activities were excluded from the tax.


-16-

IRS LUXURY EXCISE TAX RECEIPTS
COMPARED TO JCT ESTIMATES’
Fiscal Years
[Millions of Dollars]

Items 1991 (a) 1992
Airplanes over $250,000:

IRS Actual Receipts.. 0.1 0.4

JCT Estimate......... : : 1.0 4.0

Shortfall.................... -0.9 -3.6
Boats over $100,000:

IRS Actual Receipts 7.3 12.4

JCT Estimate......... : : 4.0 9.0

EXC@SS........-..44-- . . 3.3 3.4
Automobiles over $30,000:

IRS Actual Receipts 151.5 296.5

UCT Estimate......... : : 27.0 69.0

EXCESS... eee eee eee eee 124.5 227.5
Furs over $10,000:

IRS Actual Receipts 0.3 0.7

JCT Estimate. : : . : (*) 1.0

Shortfall.............-...00. 0.0 -0.3
Jewelry over $10,000:

IRS Actual Receipts 9.2 15.8

JCT Estimate......... : . 1.0 3.0

EXC€SS... 2... eee eee eee 8.2 12.8
Total:

IRS Actual Receipts.. . . 168.4 325.8

JCT Estimate.............200- 33.0 87.0

Total Excess................-0-000- 135.4 238.8

{a) Year contains only 9 months of receipts.
(*) Gain of less than $1 million.

Since the enactment of the luxury excise tax, there has been
much debate about its effect on the boating industry. Data from

7 The Joint Committee staff estimates provided in this
table are the original estimates used in the Omnibus Budget
Reconciliation Act of 1990 presented on a gross basis. IRS tax
collection data represents gross fiscal-year excise tax
collections. The net revenue estimates usually produced by the
Joint Committee staff must be shown on a gross basis to produce
any meaningful comparison.


-2-

legislative proposals. This portion of the testimony will also
discuss possible approaches for improving the current estimating
process.

II. REVENUE ESTIMATING METHODOLOGY

A. Overview of The Joint Committee Staff’s
Current Revenue Estimating Methodology

1. The Basic Calculation of All Revenue Estimates

Revenue estimates measure the anticipated changes in Federal
receipts that result from proposed legislative changes to the
Internal Revenue Code or related statutes. The following
discussion outlines the major elements involved in revenue
estimating methodology currently employed by the Joint Committee
staff.

Requests for revenue estimates range from those affecting
broad groups of taxpayers (e.g., proposals to exclude all
interest and dividends from gross income or to adopt a value-
added tax) to those affecting a narrow class of taxpayers (e.g.,
a proposal applicable only to the banking industry). Each
proposal is estimated using essentially the same methodology. In
simple terms, two calculations are required. First, one must
determine the revenue projected to be collected under present
law. Second, one must estimate the revenue yield that will
result from the tax law after it is modified. The difference
between these two amounts is the revenue estimate.

2. The Revenue Baseline and Macroeconomic Forecasts

The reference point for a revenue estimate prepared by the
Joint Committee staff is the Congressional Budget Office ("CBO")
five-year projection of Federal receipts, referred to as the
revenue baseline.* The revenue baseline serves as the benchmark
for measuring the effects of proposed tax law changes. The
baseline assumes that present law remains unchanged during the
five-year budget period. Thus, the revenue baseline is an
estimate of the Federal revenues that will be collected over the
next five years in the absence of statutory changes.

The revenue baseline is based upon CBO forecasts of
macroeconomic variables such as the annual rate of growth of

* The revenue baseline is a component of the budget
baseline prepared by CBO, which includes expenditures as well as
receipts.


Eres Dene — Congrens of the Cinited States -*
ome (OUT veseen st, eaCeAR Joerr Cousarrrss on Taxaniom

1018 LONGWORTH MOUSE OFFICE BULDENS
‘Weehington, OC 206 18-6463
(202) 226-3621

NOV 15 1988

Honorable Bob Packwood
United States Senate
Washington, DC 20510

Dear Senator Packwood:

This is in response to the request by Lindy Paull of the
Senate Finance Committee Staff for revenue estimates of
proposals imposing a 100 percent tax rate on income above
$100,000 and $200,000. Specifically, the proposal would
compute the tax as under present law for individual returns,
but would impose a tax of 100 percent on income (1) over
$100,000 or (2) over $200,000.

Assuming an effective date of January 1, 1989, and
subject to the qualifications noted below, we have estimated
this proposal to have the following effect on fiscal year
budget receipts:

Fiscal Years
(Billions of Dollars)

Item 1989 1990 1991 1992 1993

100% tax on income over
$100,000... .seeveceeeees 166.7 326.6 372.7 425.3 485.4

100% tax on income over
$200, 000.....eeereceee 104.6 204.3 232.1 263.6 299.3

These estimates do not account for any behavioral
response (tax avoidance, compliance, change in work effort
and savings behavior, etc.) that would result from the
imposition of a 100 percent tax rate. Accordingly, they
should not be given the same weight as an estimate that does
take behavioral response into account.



-25-

legislative proposals, (5) assist Members of Congress in
addressing constituent issues and problems, (6) prepare revenue
estimates of all revenue legislation considered by the Congress,
(7) review proposed large income tax refunds, and (8) initiate
investigations of various aspects of the Federal tax system. If
the Joint Committee on Taxation staff does not perform these
functions, the staffs of the Ways and Means and Finance
Committees would have to be expanded to pick up these
responsibilities.

3. The Joint Committee on Taxation staff

In general

The professional staff of the Joint Committee on Taxation
currently includes lawyers, certified public accountants (CPAs),
economists, and computer specialists. Most of the lawyers and
accountants have substantial tax experience before coming to work
for the Joint Committee, including private practice experience
with law firms or Big 6 accounting firms or experience with the
Internal Revenue Service.

The Joint Committee on Taxation revenue estimating staff

The Joint Committee staff economists all have advanced
degrees. These economists have substantial experience with
economic modelling, much of it obtained working for other
Government agencies, including the Office of Tax Analysis in the
Treasury Department, the Department of Agriculture, the Internal
Revenue Service, and State governments. Some of the economists
have significant private sector experience working for economic
consulting firms or accounting firms.

The Joint Committee revenue estimating staff is responsible
for the data collection and modelling necessary to estimate the
revenue effects of proposed changes in the Internal Revenue Code.
These economists draw on the professional expertise of other
Joint Committee staff (i.e., the staff attorneys and
accountants), other tax professionals, and academic literature on
the economics of taxation to assist them in their analyses. In
particular, the Joint Committee economists rely heavily on the
staff's tax lawyers and accountants to describe and interpret the
specifics of the other technical proposals within the broader
context of the tax system.

Some proposals to reorganize the operations of the Congress
have proposed merging the Joint Committee on Taxation revenue
estimating staff with the Congressional Budget Office. Sucha
move would seriously impair the unique relationships that permit
the Joint Committee’s lawyers and economists to work together to
provide the best possible assistance to the Members of Congress
with respect to revenue legislation. The Federal tax system is



I. INTRODUCTION

My name is Ken Kies. I am the Chief of Staff of the Joint
Committee on Taxation. It is my pleasure to present the
testimony of the Joint Committee on Taxation at this joint
hearing of the House Committee on the Budget and the Senate
Committee on the Budget concerning the revenue estimating process
and how that process might be improved.

At the outset, let me make one observation concerning the
overall philosophy of the Joint Committee estimating function.
This philosophy has three guiding principles. First, the
objective of the estimating process is to consistently produce
accurate estimates that can be reasonably relied upon by Members
of Congress in making legislative decisions. Second, the Joint
Committee on Taxation staff ("Joint Committee staff") is
dedicated to continually improving its estimating methodology to
enhance the accuracy of its work product. Third, the Joint
Committee staff is highly sensitive to the need that the
estimating process be viewed as fair and impartial. In that
spirit, we believe this hearing offers a welcome opportunity to
explain and discuss the estimating process.

The Joint Committee staff plays an integral role in
virtually every stage of the tax legislative process. One aspect
of this role involves estimating the effects of proposed tax
legislation on fiscal year budget receipts, typically referred to
as the revenue effects. Although this portion of the Joint
Committee staff's work utilizes significant amounts of staff
resources and is highly visible, it by no means constitutes the
sole work of the staff.

To provide a more complete understanding of the role of the
Joint Committee staff in the tax legislative process, this
testimony includes as Appendix I a discussion summarizing the
history of the Joint Committee, the work of the Joint Committee
staff, and the role of the Joint Committee staff in the tax
legislative process.

This testimony will focus on the issue that has attracted
significant attention to the work of the Joint Committee staff in
recent years -- the methodology employed by the staff when
estimating the effects on Federal budget receipts of tax
legislation considered by the Congress. First, the testimony
will discuss the estimating methodology currently utilized by the
Joint Committee staff. Second, it will discuss a few of the
revenue estimates prepared by the Joint Committee staff in recent
years that have generated both some controversy and confusion
concerning the current estimating methodology. Third, it will
discuss some of the issues that arise in considering whether to
modify the existing methodology to take into account
macroeconomic effects, if any, that might occur from tax


Congress of the Bnited Mtates

Jor Committee on Taxation
Washington, BE 20515-6453

MAR 1 1 1992

MEMORANDUM
TO: Lindy Paull
PROM: Barry Lb. Gutman

SUBJECT: Revenue Estimate Request

In response to your request dated March 4, 1992, we are
Providing information concerning the top 1 percent of the income
distribution of individual taxpayers.

At 1992 levels, the top 1 percent of the income distribution
is defined as those taxpayers with adjusted gross income in excess
of $185,000. These taxpayers are expected to incur tax liability
of $127 billion.

You also asked for a revenue estimate for a hypothetical
100-percent tax imposed on taxpayers in the top 1 percent of the
income distribution. We are unable to provide an estimate for this

rovision. Our estimating models and methodology incorporate

havioral effects based on available empirical evidence to produce
reliable estimates of the effects of tax rate changes in general.
As a proposed tax rate nears 100 percent, however, we lack .
historical experience on which to base an estimate of the
behavioral aspects. While we could provide a purely static
tabulation of the revenue collected by @ 100-percent tax, this
figure would not reflect the behavioral response of taxpayers that
likely would occur.

We would be happy to review any data or statistical evidence
of which you might be aware that would help us provide the estimate
you have requested.



Congress of the nites States

Joint COMMITTEE ON TAXATION

Washington, D.E. 20515

Honorable Bob Packwood
Page Two

Second, the effect of bracket creep and economic growth causes the
number of taxpayers with income above $100,000 to grow rapidly from year
to year. Using 1981 data, approximately 400,000 taxable returns have
taxable income in excess of $100,000 and approximately 800,000 taxable
returns have expanded income in excess of $100,000. These factors also
cause a higher and higher fraction of the income of these taxpayers to be
above the $100,000 threshold. As a result, the revenue gain from these
proposals grows rapidly from year to year. We have not yet received
CBO’s economic assumptions for the upcoming year. Very likely, these
will include less inflation in the future, in which case we would scale

down these revenue estimates.

Needless to say, the numbers presented above do not represent
actual revenue estimates, since taxing 100 percent of anyone’s income
would force taxpayers to invest in tax avoidance devices or simply
encourage them not to earn income in the first place.

Sincerely,

David H. Brockway


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Over the last 12 years, the Joint Committee has received
ever increasing numbers of requests for revenue estimates and
other information from Members of Congress and Committee staff.
In the first year in which such records were kept (1983), the
Joint Committee received 150 requests for estimates. By
contrast, during 1993, the Joint Committee received 2,380
requests. In 1994, the Joint Committee staff received only 1,350
requests for revenue estimates. Although this number is
significantly smaller than the 1993 total number of requests,
most of the requests received during 1994 related to complex
proposals relating to health care reform. These proposals often
had significant interaction with other elements of any particular
health reform package and required, on average, more staff time
than the majority of requests received in 1993.

The Joint Committee staff expects the number of revenue
estimate requests received in 1995 to be much closer to the total
number of requests received in 1993 given the likelihood of
substantial tax legislation as the Congress considers the
Contract With America.

The Joint Committee on Taxation has responded to
approximately 80 percent of the requests received in the last 4
years. In 10-20 percent of the requests answered, additional
information or followup responses were also provided. The
remaining requests were not answered for a variety of reasons,
including (1) insufficient staff manpower and resources to
respond to all the requests, (2) inadequate specification of the
proposal by the Member or Committee staff, and (3) insufficient
data available to respond to the request.



-12-

1. Proposals to Reduce the Rate of Tax on Capital Gains

Of the revenue estimates prepared by the Joint Committee
staff in recent years, none has attracted more attention than the
estimates of proposals to reduce the rate of tax on capital
gains. During the 1990 Budget Summit, significant attention was
devoted to the differences in estimates of capital gains
proposals prepared by the Joint Committee staff and the Treasury
OTA staff.

A general overview of the methodology the Joint Committee
staff utilizes to estimate capital gains proposals is presented
below. In particular, there is a discussion of the two most
significant issues to be considered when estimating capital gains

proposals: (1) the extent to which enactment of a reduction in
the rate of tax on capital gains will induce taxpayers to realize
capital gains (the “unlocking effect"); and (2) the fact that

current estimating methodologies fail to account for any possible
macroeconomic effects of a proposed capital gains tax rate
reduction.

The first step in estimating the revenue effects of a
proposal to reduce the rate of tax on capital gains is to
calculate the decrease in tax liability that would result from
lowering the tax rate for baseline gains (i.e., those capital
gains that would be realized even in the absence of a change in
rates), measured without taking taxpayer behavior into account.
This amount is calculated directly from the individual income tax
model described above. In doing this calculation, the Joint
Committee staff relies upon the forecast of capital gains
realizations incorporated in the CBO baseline.

The second step takes into account induced realizations
expected from the proposed rate change. Induced realizations
represent the additional gains taxpayers are expected to realize
as a result of a proposed lower tax rate on capital gains. These
"induced realizations" are calculated by combining two factors:
(a) the Joint Committee estimate of taxpayers’ behavioral
response to the proposed rate reduction (i.e., the assumed
elasticity); and (b) the gain realizations reflected in the CBO
revenue baseline. For many capital gains proposals, in the first
few years after a capital gains tax rate reduction takes effect,
the Joint Committee staff estimates that induced realizations
will be more than sufficient to offset the revenue loss resulting
from the lower rates, so that net Federal tax revenues are
increased. However, the Joint Committee staff’s estimates assume
that this initial surge in realizations is a temporary
phenomenon. Thus, the Joint Committee staff generally estimates
that, after an adjustment period, in most cases taxpayers will
settle into a more permanent level of realizations that will be
lower than the initial surge, but higher than would be expected


-15-

tax in 1990, little information was available from academic
literature or from the affected industries on the elasticity of
demand for cars, boats, jewelry and furs, and personal-use
aircraft with values in excess of the proposed excise tax
thresholds. Based on the available information, the Joint
Committee assumed that demand for these items was highly elastic.
Thus, the Joint Committee staff revenue estimate assumed a
significant change in consumption patterns stemming from the
implementation of the tax, i.e., it assumed a significant decline
in purchases of the taxed items. Furthermore, the Joint
Committee staff estimate assumed that some purchases of luxury
goods which were otherwise planned to occur after the
implementation of the tax were accelerated to avoid the tax. The
Joint Committee estimate also assumed an initial period of lower
than usual tax collections based upon an anticipated low level of
compliance with the tax in its initial years.

A comparison of estimates shown in the table below
demonstrates that the luxury excise tax in fact produced more
revenue than was expected in its first two years. This was due
to the unexpectedly large receipts from the tax on automobiles.
In addition, the tax on boats and jewelry produced more than the
anticipated revenues in the first two years of the tax. The tax
on furs generated the expected revenues for the 1991-1992 tax
period, while the tax on personal-use aircraft generated less
revenue than was anticipated. The table below compares the
original Joint Committee gross revenue estimates from 1990 for
the luxury excise tax with the actual tax receipts collected by
the IRS.