- 18 -

Classifying taxpayers by income

The income concept used to place tax returns into income
classes is adjusted gross income (AGI) plus: (1) tax-exempt
interest; (2) employer contributions for health plans and
life insurance; (3) inside build-up on life insurance; (4)
workers’ compensation; (5) nontaxable Social Security
benefits; (6) deductible contributions to individual
retirement arrangements (IRAs); (7) the minimum tax
preferences; and (8) net losses, in excess of minimum tax
preferences, from passive business activities.

This definition of income represents an attempt to
include items that clearly increase the ability to pay taxes,
but that are not included in the present-law definition of
AGI. The adjustment for losses from certain passive
investment activities reflects the fact that investments in
such activities may result in losses for tax purposes that do
not represent real economic losses.

This income definition is subject to various
limitations. Because data that can accurately be matched
with tax returns are not available, the definition of income
omits certain items which clearly affect a taxpayer’s ability
to consume goods and services. Such items include accrual of
pension benefits, the value of certain fringe benefits (such
as military benefits, veterans benefits, and parsonage
allowances), means-tested transfer payments (such as Aid to
Families with Dependent Children, Supplemental Security
Income, food stamps, housing subsidies, and general
assistance), and imputed rent to owner-occupied homes. Thus,
a decision may be made to change the taxation of one of these
omitted items, such as changing the taxation of pension
benefits, but the impact of that change cannot be shown in
the distributional tables even though the change obviously
has a distributional effect.

One of the major problems in preparing income
distributions is selecting the appropriate unit of
classification. In all distributional analyses, the JCT
staff uses the tax-filing unit as the unit of classification.
The Treasury Department in recent years has begun using a
family concept for this purpose. Under this approach, a
family unit may consist of several tax-filing units.

However, because information is not available to match
members of the tax-filing units (parents, children, grandpar-
ents, etc.) on a family basis, the JCT staff believes the
greater accuracy of using the tax-filing unit as the unit of
classification outweighs the advantages of the family unit
classifier.


- 12 -

Ratios showing the fraction of a change in calendar year
liability that will show up as a change in collections for
the same fiscal year and for the following fiscal year are
based on patterns of withholding, estimated payments,
refunds, and final payments. For example, a proposal to
change individual income tax rates effective in calendar year
1993 would result in approximately 60 percent of the 1993
calendar year change allocated to Federal receipts in fiscal
year 1993 and 40 percent going to fiscal year 1994. On the
other hand, a proposal affecting the business income of
individuals for calendar year 1993 would result in only about
35 percent of the change in receipts allocated to the 1993
fiscal year and 65 percent going to the 1994 fiscal year.

In the first example, a large portion of the effect of
the tax rate change would be collected through wage and
salary withholding. Thus, the "fiscal split" more closely
resembles the 75-percent/25-percent division one would expect
since three quarters of calendar year 1993 falls in fiscal
year 1993 (January-September). In the second example, the
income involved often will not be subject to withholding.
That is, a much larger portion of the change will be observed
in quarterly estimated payments and final payments in the
following fiscal year (i.e., after October 1). Because most
proposals have specific start-up effects and transition
rules, it is not possible to generalize too extensively.
Thus, even the preceding analysis will not apply to some
proposals.

Certain situations arise when revenue estimates reflect
only a "speed-up" in receipts. Changing the rules for
estimated tax payments or the rules governing the withholding
on various types of income may have a significant fiscal year
revenue effect while not creating additional total tax
liabilities.

Interaction and stacking order

When two or more items within the Internal Revenue Code
are to be modified simultaneously, the result of the
combination of changes often produces a greater or lesser
revenue effect than the sum of the amounts shown for each
item separately. If this interaction is ignored, the
analysis is incomplete; if the interaction is assigned to any
one element of a proposal, that proposal inappropriately may
be accepted or rejected on that basis alone.

The proper interpretation of the revenues attributed to
specific provisions 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.



- 22 -

Moreover, JCT experience suggests that it is difficult
to anticipate in which details a Member will be interested.
Each estimate typically is based on a number of assumptions.
While most of these assumptions are probably not of direct
interest to a Member requesting an estimate, it may also be
that the estimate depends critically on assumptions about
which the Member might not inquire, or that some questions
cannot be addressed in a meaningful way without a lengthy
discussion of the estimation approach.

If a Member wishes to obtain additional information
regarding the methodology used to produce an estimate, the
Member may contact the Chief of Staff (as discussed in
question 4, above). As an alternative, the JCT staff finds
it more helpful to meet with Members and their staffs to
review the relevant assumptions. The staff also, where it is
warranted, produces documents or letters describing a
particular estimating methodology in detail.


-3-

calculations are required. First, one must determine the
revenue yield of present law. This is known as the revenue
baseline. Second, one must estimate the revenue yield that
will result from the tax law after it is modified. The
difference between the revenue forecast of the baseline and
the revenue forecast of the modified law is the revenue
estimate. The following discussion summarizes the analysis
used to derive a revenue estimate.

1. The Baseline

Budget period and the budget baseline

As mandated by the Congressional Budget Act, revenue
estimates published by the JCT staff provide a fiscal year
budget impact for the period ending five years following the
current fiscal year (total of six fiscal years). This
estimating convention is consistent with the forecasting
period utilized by the Congressional Budget Office (CBO) and
the Office of Management and Budget (OMB) when forecasting
economic aggregates and providing the budget baseline for
receipts and expenditures.

The reference point for a revenue estimate prepared by
the JCT staff is CBO’s five-year projection of Federal
receipts and outlays, 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 received over
the next five years in the absence of statutory changes. The
size of the revenue baseline is determined by CBO forecasts
of macroeconomic variables such as the annual rate of growth
of nominal gross national product (GNP), 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 State and local taxes paid
is statistically matched to various types of taxpayers.

CBO characterizes the budget baseline as designed to
show the pattern Federal Government revenues and spending
would take during the next five years if current law were
continued without change. Because many changes in budget
policies are likely to occur, the budget baseline is not a
prediction of budget outcomes. Rather, it serves as a
benchmark for measuring the budgetary effects of proposed
changes in tax and spending laws.

An alternative set of economic forecasts generated by
the Administration’s Council of Economic Advisers provides
the baseline for estimates done by the Treasury OTA staff.
Differences in resulting revenue estimates between the JCT



Review of methodology

The JCT staff is currently undertaking a comprehensive
review of the methodology used to prepare distributional
analyses of revenue estimates. Changes made as a result of
this review should better aid the members of Congress in
their analysis of proposed legislation.


- 25 -

The JCT staff also considers microeconomic, or
individual market-level, responses to changes in the tax
code. These effects are incorporated into JCT estimates
based on commonly accepted precepts about supply and demand.
For example, the revenue estimate for an increase in the
gasoline excise tax assumes a reduction in the amount of
gasoline purchased that is commensurate with demand responses
reported in studies of previous gasoline price changes.

The JCT does not estimate the effects of changes in
macroeconomic aggregates, which some people call "feedback"
effects. For example, the JCT assumes that gross national
product, the price level, and the total, national level of
employment are not affected by most tax changes. There are
several reasons why macroeconomic "feedback" effects are not
incorporated:

(1) The JCT takes the Congressional Budget Office (CBO)
baseline as given so that there is a common foundation for
JCT revenue estimates and the CBO expenditure estimates.
Consistent use of the baseline is necessary for symmetric
treatment in the analysis of the budgetary effects of changes
in outlays and changes in receipts.

(2) The effect of a tax change on macroeconomic
aggregates is often unclear. The magnitude, and even the
direction (positive or negative), of these effects would
depend on the theoretical model of the economy that is used
and assumptions about resulting monetary and fiscal policy
responses. There is no consensus in the economics literature
as to which model is appropriate in which circumstances.

(3) None of the theoretical models of the economy
provides sufficiently precise predictions of the timing of
tax-induced changes in macroeconomic aggregates to predict
the effects of a proposal on a specific year’s budget
receipts.

5. What are offsets in revenue estimates and how are they
used?

Because the baseline holds macroeconomic aggregates
fixed, a tax change that would affect one component of gross
national product is assumed to have an offsetting effect on
other components. For example, an increase in payroll taxes
is assumed to reduce taxable income in the economy, most
directly in the taxable net profits of producers because such
taxes may be deductible as business expenses. Hence, the
increase in revenues from the payroll tax is partially offset
by a decrease in revenues from income taxes.



- 21 -

4. After receiving a revenue estimate, how can I obtain
more information about how it was produced?

Follow-up questions concerning revenue estimates should
be directed to Harry L. Gutman (Chief of Staff, 225-3621),
Alan J. Auerbach (Deputy Chief of Staff, 225-3780), or
Bernard A. Schmitt (Associate Chief of Staff-Revenue
Analysis, 226-7575). If the person you contact cannot answer
your question or satisfy your concerns, he will:

o Determine the answer and respond in writing or by
telephone;

o Direct the appropriate estimator to provide the
relevant information to the Member’s staff; or

o Arrange a meeting between the Member and/or Member’s
staff and relevant JCT staff to discuss the issue.

5. Under what circumstances are revenue estimates done at
the request of one Member provided to other members and
non-Members?

Requests for revenue estimates of legislative proposals
are treated as confidential correspondence. Generally,
revenue estimates are released only to the Member making the
request. Therefore, the estimate remains confidential unless
the Member decides to make the estimate public. This
confidential treatment of Member proposals extends to the
process of developing tax legislation, which may involve
substantial consultation between a member (and his or her
staff) and the JCT staff. Similarly, any information
provided to the JCT staff to help in the formulation of a
revenue estimate is treated confidentially and not released
outside the JCT staff.

It should be noted, however, that any Member of Congress
may request a revenue estimate of tax-related legislation
which has been introduced or that otherwise has entered the
public domain. Accordingly, several members may request the
same estimate for a legislative proposal. In addition, when
a revenue estimate has been included in a publicly available
document (e.g., a revenue table summarizing a markup proposal
or the results of a markup), the estimate is made available
to anyone upon request.

6. Why doesn’t JCT include with each revenue estimate the
methodology used to produce that estimate?

The workload facing JCT revenue estimation staff has
grown rapidly in recent years. Providing additional details
with each estimate would slow the revenue-estimating process
unnecessarily, since such details may be desired only ina
small number of cases.


- 16 -
D. Distributional Analysis

Measuring the change in the tax burden

To accompany revenue estimates, 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 analysis attempts to measure the changes in
taxpayers’ economic welfare that result from changes in the
tax law. The JCT staff calculates the benefit or burden
assuming no change in behavior (this is not necessarily the
behavioral assumption in the corresponding revenue estimate) .
Taxpayers will, in general, alter their behavior only if the
change makes them better off. Consequently, the JCT
calculation is an approximation which tends to understate
benefits and overstate burdens, depending upon the extent of
behavioral response.

The distributions reported are distributions of the tax
incidence rather than the distribution of taxes paid. The
following example highlights the confusion which can arise by
an attempt to compare an analysis of the distribution of
taxes paid with an analysis of the distribution of the
after-tax benefit of the tax reduction (referred to by
economists as the "incidence" of the tax). Assume that when
bread costs $.60 per loaf that the consumer will purchase two
loaves, but if a tax of $.40 per loaf is imposed driving
price to $1.00 per loaf, the consumer purchases only one
loaf. The consumer pays $.40 in tax but only consumes one
loaf of bread rather than two. To reflect this lost
consumption as a burden of the tax, the JCT would estimate
the burden of this tax to be $.80, the amount of tax that
would have been paid had the consumer continued to purchase
two loaves. More dramatically, if when the tax on bread
were increased to $.80 per loaf the consumer purchased no
bread, an analysis of the distribution of taxes paid would
show that the consumer paid no tax. A tax incidence analysis
would show that the tax imposed a burden on the consumer
because he or she no longer consumes bread.

The distributional analysis is consistent with the
five-year budget horizon used for revenue analysis.
Specifically, the benefit or burden of a tax change reported

3 As discussed above, because the consumer changes his or
her behavior in response to the tax on bread, the estimate of
a burden of $.80 is an overestimate. However to refine such
an estimate further would require knowledge of the behavioral
response of each taxpayer or groups of taxpayers. Such
information generally is not available. On the other hand,
the revenue effect can be estimated if only the behavioral
response of taxpayers in aggregate is known.


- 8-

Unfortunately, cases frequently arise in which reliable
data are not available. In these situations, the estimating
staff must rely on their cumulative experience, guided by
relevant economic theory, to assess possible behavioral
responses resulting from proposed legislative changes. For
example, proposed changes in the tax treatment of life
insurance products, especially changes that discourage
partial surrenders or loans from life insurance contracts,
require assumptions about behavioral response. For each
proposal, an assumption must be made as to (1) whether tax-
payers will continue to invest in life insurance policies,
and (2) whether those taxpayers who do invest in life
insurance will make a partial surrender or a loan.
Assumptions of behavioral response are needed to determine
the effects of relatively small changes in a proposal, such
as the difference between a 10- or 15-percent additional tax
on partial surrenders or loans.

Generally, 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 response.

Holding fixed the level of macroeconomic aggregates

Revenue estimates often mistakenly are referred to as
"static" because the estimates assume no overall effect on
economic aggregates such as gross national product. In other
words, total employment, investment, and other economic
aggregates are assumed to remain unaffected by most tax
proposals. However, the components of these variables change
among sectors or industries. For example, when the deduction
for business meals was reduced, employment displaced in the
restaurant industry was assumed to be absorbed in other
industries (e.g., food wholesaling and retailing).

The performance of the economy is influenced by the
Federal Government’s overall monetary and fiscal policy, as
well as by many factors largely outside the control of
Government. These factors are incorporated into baseline
receipts estimates. It would be @ifficult, if not
impossible, to isolate and quantify the macroeconomic effects
resulting from proposed changes in the tax law. There are
several reasons for this. First, most changes involve detail
at a level far more specific than that of any existing
macroeconomic forecasting model. Second, it is not
meaningful to discuss the macroeconomic impact of a single
tax change in isolation of other changes in fiscal and
Monetary policy. Any increase or reduction in taxes requires
a compensating change in taxes or spending, either at the
same time or in the future. If debt is issued to pay fora
tax cut today, that debt must still eventually be paid off.
The Federal Reserve’s decisions regarding monetary policy



- 28 -
Cc. Distributional Estimates

1. Why doesn’t JCT show the distributional effects of all
proposals?

The JCT staff does not provide estimates of
distributional effects for proposals when it cannot accurate-
ly determine the impact of the proposal on different income
groups. Since it is possible to measure the magnitude of the
change in total taxes paid without knowing how these tax
changes are allocated among income groups, distributional
estimates generally are much more difficult than revenue
estimates. Also, unlike revenue estimates, distributional
estimates are not required before a proposal can receive
legislative consideration.

In some instances, data on the income levels of the
affected taxpayers are not available. For example, data on
each income group’s consumption of ozone-depleting chemicals
{upon which there presently is an excise tax) do not exist.

In other cases, it is conceptually difficult to allocate
the burden of certain taxes (such as those paid by businesses
er nonprofit groups) among individuals. As part of its
ongoing review of its distributional methodology, the JCT
staff is analyzing some of these conceptual issues. This
review may result in an expansion of the set of proposals for
which the JCT staff can provide estimates of distributional
effects.

2. What do the burdens in the new JCT distributional
tables represent?

The distributional tables prepared by the JCT staff
estimate the effects of particular proposals on the economic
well-being of taxpayers in different income classes. The
estimate of the change in economic well-being represents the
change in taxpayers’ annual economic tax burden over the
five-year budget window.

The measure of economic burden may not represent changes
in taxes paid, because the extent to which an individual is
made better or worse off by a particular provision may not
depend on whether he or she pays the tax. For example,
although an increase in an excise tax may require retailers
to remit larger payments to the government, it is often as-
sumed that the consumer of the taxed good actually bears the
burden of the tax (by facing higher prices than would other-
wise be the case). Thus, the JCT’s measure of the distribu-
tional burden resulting from such a proposal would show
consumers (who might fall in different income classes than
retailers) bearing a larger tax burden. For other provi-
sions, such as an increase in individual income tax rates,
measures of burden may correspond to changes in taxes paid.


-5-

2. Modeling and Forecasting Proposed Changes in Tax Law

Econometric and statistical simulation tax models

SOQI-based models

For most income tax revenue estimates, the JCT staff
relies on large computerized models of the Federal income tax
system and the economy. These microsimulation models use as
their primary input the confidential tax returns filed by
individuals, corporations, and fiduciaries with the IRS.
These data are provided to the JCT staff by the Statistics of
Income (SOI) Division of the IRS.

Based on economic theory, these models combine the most
recently available taxpayer information with forecasts of the
aggregate level of national income provided by CBO as part of
the budget baseline. For example, the JCT individual income
tax model currently is based on data from the SOI. This is a
random sample of approximately 200,000 individual tax
returns. The sample was chosen to reflect accurately all
major features of the individual income tax. The data in
these returns are statistically adjusted to match current
baseline projections for income, age of population, and other
economic and demographic variables for the period 1992
through 1997.

To estimate the revenue effects of most proposed changes
in the individual income tax, the JCT staff first uses the
model to calculate the tax for each of the sample returns in
the model on the basis of present law. It 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 the taxpayer’s return. For example, a 10-percent increase
in the personal exemption from $2,000 to $2,200 does not
necessarily increase the revenue loss associated with the
personal exemption by ten 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
make the results reflect outcomes for the more than 100
million United States individual taxpayers, the computer run
calculates the difference in total revenues between the
present law and the proposal. This result obtained from the
model is often only the first step in estimating the revenue
change associated with a proposal. For example, as discussed
below, off-model adjustments may be made to reflect
interaction among a package of proposals or to reflect fiscal
year budget reporting.



-4-

staff and the Treasury OTA staff often can be traced to
differences between these sets of economic forecasts.

Interpretation of present law

Under certain circumstances, the baseline may be
unclear. Issues may arise as to the appropriate
interpretation of present law. In cases in which present law
is unclear or the Internal Revenue Service (IRS) has taken a
litigating position that has been challenged by taxpayers,
the analysis of the revenue effect of a proposed statutory
change first requires an assumption of the most defensible
interpretation of present law. The JCT staff makes such a
determination by giving considerable weight to the
interpretation of the IRS and Treasury Department and by
taking into account all other relevant information, including
the extent to which the IRS interpretation has prevailed in
court.

An example of an area in which present law is unclear is
the tax treatment of insurance for long-term care expenses.
There has been no guidance published by the IRS. In order to
estimate the revenue effects of proposals to clarify the tax
treatment of long-term care insurance, the JCT staff will be
required to make assumptions about the status of long-term
care insurance under present law. As part of its analysis of
present law, the JCT staff has met extensively with
representatives of the long-term care industry to learn the
industry’s view of present law.



-17-

by income class is the annual change (held constant except
for growth in the economy) whose present value over the
five-year budget horizon equals the present value of the
impact of the actual provision. That annual change is
reported as a dollar amount in the first year of the budget
horizon. .

The following examples illustrate the method by which
the JCT calculates the annual change in benefit or burden.
In all three of the examples below, the economy is assumed to
grow at a rate of 5 percent per year. Any reduction in tax
burden from a permanent reduction in marginal tax rates is
assumed to grow at the same rate of 5 percent per year. The
interest rate used for present value calculations is 10
percent.

Example 1.--Consider a permanent cut in marginal tax
rates that reduces an individual's tax burden by $100 in
1993. Because of the assumed growth rate, that individual’s
tax burden would be reduced by $105 in 1994, $110 in 1995,
$116 in 1996, and $122 in 1997.

The distribution methodology finds the reduction in the
1993 tax burden (with subsequent reductions increasing at the
economy’s growth rate) which has a present value over the
five-year budget horizon equal to the present value of the
actual tax reductions that will occur from 1993 through 1997
($415.31). In this case, the answer is $100 (implying
subsequent reductions of $105, $110, $116 and $122,
respectively) --the tax reduction actually received in 1993.
Because the tax change is immediate and permanent, the answer
is the same as if only 1993 were considered.

Example 2.--Suppose, instead, that the cut in marginal
rates is effective only for 1993. In this case, the same
taxpayer’s gain would be $100 in 1993, but $0 in each of the
four subsequent years in the budget period. With an interest
rate of 10 percent, this one-year tax burden reduction has
the same present value to the taxpayer ($90.91) as a
permanent tax reduction that reduces the burden by roughly
$22 in 1993, with 5-percent growth in each subsequent year.
In gu3° case, the change in the taxpayer’s burden is reported
as $22.

Example 3.--Finally, assume that the tax reduction is of
the same magnitude as in Example 1, but is delayed, taking
effect only in 1997. The taxpayer’s benefit is $122 in 1997,
but $0 in each of the first four years of the budget period.
An immediate, permanent reduction in taxes of about $18 in
1993 (growing by 5 percent thereafter) would provide the same
present value benefit ($75.75) to the taxpayer. In this
case, the change in burden is reported as $18.


Data sources

As discussed above, to the extent possible, revenue
estimates prepared by the JCT staff are based on tax return
data supplied by the IRS. When non-tax data are required,
estimates are done with the best and most reliable data
sources otherwise available. Frequently, data may be
available from other government agencies, such as the
Department of Commerce, the Department of Transportation,
Department of Labor, 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 has provided much useful
information, including information relating to pension plan
participation by income class, that is not otherwise
available.

When other Federal or State government data sources are
not available, it is necessary to find other reliable
sources, such as research done by leading economists or
statistically-valid surveys done by the General Accounting
Office (GAO) or consulting or research organizations.
Infrequently, the only available data are those supplied by
taxpayers affected by proposed changes.

Behavioral responses

Revenue estimates prepared by the JCT are dynamic in
that they account for disaggregate behavioral responses.
When tax policy places limitations on the ability of
taxpayers to deduct passive losses, the JCT approach assumes
that individuals change investment patterns and corporations
claim a portion of the losses no longer available to
individuals.

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

In many cases, empirical research can provide estimates
of taxpayer responses to proposed changes in tax legislation.
If adequate data exist, responsiveness can be estimated
statistically. For example, sufficient data are available to
permit revenue estimates to take into account the expected
change in demand for cigarettes that would result from a
change in price due to a change in the cigarette excise tax.



- 23 -
B. Elements of Revenue Estimates

1. Why can’t estimates outside the budget window be
provided?

In preparing revenue estimates, the JCT staff is
required to use the budget baseline and related macroeconomic
forecasts provided by the Congressional Budget Office (CBO).
The CBO provides these forecasts for a five-year period (the
"budget window"). These forecasts form the fundamental basis
for all revenue estimates. Their use ensures that various
revenue estimates and distributional analyses will be
comparable.

While the JCT is constrained to provide estimates only
for the five-year budget period, the JCT staff will provide
general information concerning the likely pattern of revenue
changes beyond the five-year budget window whenever it is
deemed relevant to a complete analysis of proposed
legislation. However, the JCT staff generally will not
provide a specific revenue estimate for more than a five-year
period because its accuracy would be seriously diminished due
to unavailability of CBO forecasts beyond the five-year
period, the uncertainty of long-range economic forecasts, and
other assumptions relevant to its preparation.

2. Why do estimates change during a legislative session?
How does JCT determine when to change estimates?

JCT staff attempts to be both timely and thorough in the
provision of estimates. Sometimes these goals conflict,
requiring the issuance of revised estimates. New information
about affected taxpayers or methodological improvements may
require changes. Other reasons an estimate may change
include revisions to the forecast of tax receipts and other
macroeconomic variables provided by the CBO, an alteration in
"stacking order" (whether and how an estimate accounts for
interactions with other proposals contained in pending
legislation), regulatory and judicial developments, and
changes in the period covered by the estimate (usually three,
five, or six years depending upon the rules of the House or
Senate pursuant to which the estimate is issued).

The JCT staff is aware of the difficulties caused by
changes in estimates when legislation is being actively
considered, and attempts to balance this concern with the
task of providing Members with accurate information. Changes
that would have major impacts on Federal budget receipts are
likely to be communicated as they become known. In addition,
original responses often include caveats indicating the
potential for subsequent change: for example, the response to
a request for an estimate of a proposal creating a variable
oil import fee may note that the estimate is dependent on
world oil prices.


DISCUSSION OF REVENUE ESTIMATION
METHODOLOGY AND PROCESS

Prepared by the Staff
of the

JOINT COMMITTEE ON TAXATION

August 4, 1992
JCX-31-92


- 10 -

business income will be taxed. However, the corporate income
tax model models only C-corporation behavior. Only an
off-model adjustment will reflect this shift of resources.

In this example, the staff would adjust the results of the
microsimulation model for estimates of future changes in
business form. This process may require extensive data
collection from a wide variety of government and/or private-
sector sources. Projects of this nature often must be based
in large part on the judgment of the economists aided by
other information gathered from various data sources,
economic theory, statistical probabilities, and other models.

Cash-flow scorekeeping

Assessing the revenue effects of certain proposals may
be unusually difficult because they not only change the
amount of tax collected, but also change the timing of tax
collections. Traditional budget scorekeeping accounts for
the revenue effects of proposed legislation on a cash-flow
basis; in other words, the effect of a provision on budget
receipts in the five-year budget period is estimated without
regard to whether the provision will also affect budget
receipts in any subsequent year.

As an example, this scorekeeping method scores
"deductible IRAs" as losing more revenue than "special IRAs".
The traditional deductible IRA can be viewed as a provision
which both delays payment of tax on the contribution until
withdrawal and effectively exempts from tax any earnings on
capital accumulation beyond the amount that represents
interest on the delayed tax. Thus, the timing of tax
payments results in a revenue loss to the Government in the
early years, but a revenue gain in later years when the funds
are withdrawn. So-called special IRAs would not permit
deduction of amounts contributed to IRAs, but would exempt
all earnings and qualifying withdrawals from taxation. In
this case, the timing of tax payments results in little
revenue loss in the early years, but more substantial revenue
loss in later years when the funds are withdrawn. However, a
present-value calculation demonstrates that so long as tax
rates do not change the long-term cost to the Federal
Government of deductible IRAs and special IRAs will be
approximately equal. This is because a present -value
approach recognizes that tax will eventually be collected on
funds in deductible IRAs when withdrawn.

Calculating revenue estimates on a present-value basis
requires making assumptions about the baseline for activity
that occurs beyond the five-year reporting period. Such
estimates are likely to be less accurate than shorter term
forecasts; that is, there is greater uncertainty of pre-
dicting the amount of receipts that are anticipated to be
received after the five-year reporting period. Moreover,
additional assumptions, such as an appropriate discount rate,



-9-

cannot be assumed independent of fiscal policy actions. Yet,
it is rarely clear what fiscal and monetary actions will
result from the tax change in question. Finally, despite
extensive theoretical and empirical research, there is still
a great deal of uncertainty and controversy about the effects
of taxation on economic growth, investment, savings,
productivity, and interest rates.

Furthermore, while specific tax policies may
significantly influence certain sectors of the economy, they
may not have significant influence on overall totals.
Moreover, as noted above, for consistency and comparability
in budget planning, Congressional estimates of tax as well as
spending legislation are constrained to be consistent with
CBO macroeconomic forecasts.

Ordinarily, the following economic variables, as
supplied by CBO, are assumed to be unchanged by proposed tax
law changes for revenue-estimating purposes:

-- Gross national product

-- Total employment

-- 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 is allowed to vary. Examples of elements of
economic forecasts that may be reallocated include the
following:

-- Shifts between corporate and noncorporate income

-- The mix of gross private investment (e.g.,
equipment versus structures)

-- Relative prices

Off-model adjustments

After a microsimulation model produces a preliminary
estimate of the revenue effect of a proposal, it is often
necessary to make what are called "off-model" adjustments.
These adjustments address questions that cannot be answered
by directly applying the simulation models. They are the
most time-consuming and often the most difficult aspects of
the estimating process.

A tax cut that encourages a particular activity may be
expected to attract resources from other activities, thus
reducing tax revenues from the abandoned activities. For
example, a change in corporate tax rates would be expected to
change future decisions concerning the choice of business
form (e.g., S-corporation versus C-corporation) by which



- 30 -

APPENDIX

Number of Revenue Requests Received
by the Joint Committee on Taxation Staff,

1985-1992
Number
Year of requests
19B5. Le eee eee ee eee acne eee e eens 348
1986........ eee cece cere ese neene oe 474
sh: iy Bre 420

pi) 7: 900

1989. .... 0.0.0.0 ee se ceeeeeeeeeccese 1,290
1990: Correspondence.............. 950
Tables (Budget Summit). . . 336

Total........... ars

- 1,286
TOOL... eee eee eee eee see eececeene ++. 1,460

1992 [as of 7/21/92]...... seeeeeeee 1,790



- 29 -

Sometimes, a proposal’s distributional effects may
appear to be inconsistent with its revenue estimate. A
simple, although extreme, example is the introduction of a
large tax on a particular good. If the tax is so high as to
completely eliminate consumption of the good, then the
revenue estimate will be zero, but the burden on different
income classes will be positive (since they are now spending
their income on presumably less-preferred goods) and possibly
quite large. A practical, less extreme example of the
distinction between revenue and distributional impacts can be
found in the JCT’s analysis of the five-cents-per-gallon
gasoline tax increase in the 1990 budget agreement. In that
case, distribution of burden was based on current levels of
consumption, while the revenue estimate accounted for reduced
demand resulting from higher prices. In general, a
proposal’s revenue impact cannot be directly inferred from
the accompanying distributional table.



-6-

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

Other models

In addition to the large microsimulation models based
upon large samples of tax returns, a variety of econometric
models are utilized to estimate the revenue impact of changes
in laws relating to business investment and depreciation,
natural resources and energy, employee benefits, and other
issues.

Frequently, the information needed to calculate the
revenue effects of a proposal is not available from the tax
return data or may be available only for a limited number of
affected taxpayers. In these instances, it is necessary to
look beyond the SOI data files and construct a model that
relies on alternative sources of data. For example,
proposals relating to excise taxes require information on the
consumption of various commodities. Furthermore, it is often
necessary to estimate statistical relationships from these
data to predict how certain groups of taxpayers might alter
their behavior when confronted by the proposed tax change.

In addition, if a distributional analysis of the change is
required, it may be necessary to account for those taxpayers
not presently filing returns. Each of these steps would
involve extensive use of auxiliary data not directly related
to tax returns.

Sometimes data are available on tax returns but are not
sufficiently disaggregated, or are reported in such a way as
to be of little help to the estimator. In these situations,
one can often obtain useful information by other means and
"blend" the various data sources to produce a better
estimate. A familiar example would involve calculating the
effects of a proposed change in depreciation lives or
methods. Typically, such a proposal would be narrowly
focused on a particular type of plant or equipment (metal
working machinery, for example). Since taxpayers are not
required to list the type of equipment purchased (only the
total amount within each category of depreciable asset), the
JCT staff relies on aggregate investment figures provided by
the Department of Commerce’s Bureau of Economic Analysis
(BEA) to allocate investment and depreciation deductions to
specific firms. There are numerous other instances when
non-SOI data are used in modeling tax law changes. They
include proposals that alter the tax treatment of pension
contributions, insurance company reserves, research and
development expenditures, certain employee benefits, and
tax-exempt bonds.



- 20 -
II. REVENUE ESTIMATION PROCESS

This part answers some of the commonly asked questions
regarding the JCT staff revenue estimation process and
procedures.

A. Administrative Procedures

1. Why do I need revenue estimates from the JCT? How do
I request an estimate?

The JCT staff is the official scorekeeper of Congress
for the budgetary implications of any proposed tax changes.
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. In order for a tax proposal to be considered by
Congress, it must be accompanied by a JCT revenue estimate.

A Member who wishes a revenue estimate should send a
written request to Harry L. Gutman, Chief of Staff, Joint
Committee on Taxation, 1015 Longworth House Office Building.
The request should describe in as much detail as possible the
provisions of the proposal to be estimated (including an
effective date), include any statutory language available,
and also include the name of a contact person in case there
are questions about the details of the proposal. The request
generally must be signed by a Member of Congress.

2. How can I get the general information needed to
formulate a proposal and request an estimate?

The professional staff of the JCT consists of lawyers,
accountants, and economists. UCT staff is available to
Members and their legislative staff to help formulate
proposals and to discuss the possible economic, legal,
administrative, and revenue implications of such proposals.
It is often helpful to meet with the JCT staff to discuss
proposals before a formal revenue estimate is requested.

3. How are staff priorities set in providing estimates?

All Members of Congress may request estimates from the
staff of the JCT. Work on estimates is begun on a first-in
first-out basis, with some exceptions made for previously
estimated proposals. However, difficulty in obtaining data
and developing the necessary model may result in some
responses taking longer than others. Requests from House
Ways and Means and Senate Finance Committee Members may
receive higher priority when legislation is pending in the
respective committee.


- 26 -

6. What are the basic data sources used by JCT in producing
estimates?

The starting point for many revenue estimates is tax
return data supplied to the JCT staff by the Internal Revenue
Service. These confidential data are usually samples of the
tax returns actually filed by taxpayers and are chosen so
that they are representative of all individual, corporate,
and other fiduciary filers. Frequently, however, revenue
estimates must be prepared for proposals for which tax
return data are not available. When this occurs, estimates
are done with the best and most reliable data sources
otherwise available.

Frequently, data are obtained from other governmental
agencies, such as the Department of Transportation,
Department of Commerce, Department of Labor, Department of
Health and Human Services, the Social Security Administra-
tion, and the Federal Reserve Board. For example, the
Current Population Survey conducted by the Bureau of the
Census has provided much useful data, including information
relating to pension and health insurance plan participation
by income class that is not otherwise available. Likewise,
the Department of Labor conducts a quarterly survey of
consumer expenditure patterns (CES) that is the only
comprehensive data source of its kind. Additionally, certain
types of publicly available data are purchased from private
firms as well as academic institutions that specialize in the
collection, transcription, and interpretation of this
information. Infrequently, the only available data are those
supplied by companies or taxpayers affected by proposed
changes.

7. What role do the revenue estimates and information
provided by outsiders (including lobbyists) play
in the formation of JCT estimates?

Revenue estimates prepared by outsiders do not play a
role in JCT estimates. However, revenue estimating is an
information-intensive process and outside information,
whether or not accompanied by an estimate, may be useful in
helping form the JCT estimates. Outside information may be
helpful, for example, when data relevant to the estimate are
proprietary and therefore not otherwise available to the JCT
estimator.

It should be noted, however, that when information is
provided by parties with a direct interest in the issue, the
information is closely reviewed for possible bias.



-2-

I. REVENUE ESTIMATION METHODOLOGY

A. Overview

Revenue estimates measure the anticipated changes in
Federal receipts that result from proposed legislative
changes to the Internal Revenue Code.

This discussion outlines the major elements involved in
revenue estimating methodology performed by the JCT staff.
The demand for analyses of revenue effects has increased
significantly in recent years. The number of revenue
estimate requests doubled from 420 in 1987 to 900 in 1988,
and increased further to 1,290 in 1989, and to 1,460 in 1991
(see Appendix A). With the increased demand for revenue
analysis, the JCT staff has received numerous inquiries about
the methodology and process of revenue estimation. Part II
of this pamphlet provides information about the revenue
estimating process in a question and answer format.

JCT revenue estimating staff

The estimating staff currently consists of 14 economists
and four computer specialists. All the economists in this
group have advanced degrees. These individuals are
responsible for the data collection and modeling necessary to
estimate the revenue effects of proposed changes in the
Internal Revenue Code. They draw on the professional
expertise of other JCT staff, other tax professionals, as
well as the academic literature on the economics of taxation
to assist them in their analysis.

Interaction with Treasury Staff

The UCT staff works closely with the staff of the Office
of Tax Analysis of the Treasury Department ("Treasury OTA
staff"). This interaction provides continuous consistency
checks in model development and maintenance. Although
specific Congressional Member requests remain strictly
confidential, the sharing of research and certain resources
improves the overall estimating process.

B. Elements of Revenue Estimates

Requests for revenue estimates range from those
affecting broad groups of taxpayers (e.g., proposals to
exempt all interest and dividends from gross income or to
adopt a value-added tax) to those affecting narrowly defined
taxpayers (e.g., a proposal to provide targeted relief toa
few taxpayers). Each proposal is estimated using essentially
the same methodology. In simple terms, two basic



- 13 -

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
provisions are to be changed. 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 JCT staff utilized this second method to
analyze the Tax Reform Act of 1986. This method showed the
revenue impact of adding or deleting specific provisions 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) .

Measuring revenue effects against a baseline which holds
fixed macroeconomic aggregates requires accounting for an
additional type of interaction. Under the assumption of a
fixed macroeconomic baseline, a tax change that would affect
one component of gross national product is assumed to have an
offsetting effect on other components of gross national
product. For example, an increase in payroll taxes is
assumed to reduce taxable income in the economy. This
reduction in taxable income may result directly from
declining taxable net profits of producers, as payroll taxes
are deductible business expenses, or it may result from a
decrease in consumer demand for all goods and services as
after-tax income falls.

Compliance and enforcement

Implicit in all revenue estimates are assumptions
concerning compliance and enforcement. The revenue yield of
any provision results from compliance by taxpayers, that is,
voluntary behavior and enforcement (including penalties
assessed by the IRS). Enforcement actions by the IRS also
affect the level of voluntary compliance. In general, levels
of compliance and enforcement are held constant within the
baseline forecast. For example, a change in tax rates does
not change the number of delinquent non-filers nor does it
increase the IRS audit rate.

Certain changes in law are specifically designed to
improve compliance and also have the potential to affect
enforcement. An example is the extension of information re-
porting to previously uncovered income sources. Information
reporting generates compliance revenue by changing taxpayer
perceptions of the risks involved with noncompliance. In
addition, the information reporting document could be of use



- 15 -

Cc. Tax Expenditure Estimates and Revenue Estimates@

Under the Congressional Budget Act, the JCT is mandated
to transmit annually to the House and Senate Budget
Committees its estimates of tax expenditures during the
five-year budget period. After transmitting its report to
the Budget Committees, the JCT staff has traditionally
published its list of tax expenditure estimates.

Tax expenditure estimates measure the decreases in
individual and corporate income tax liabilities that result
from provisions in income tax laws that have been enacted to
provide economic incentives or tax relief to the private or
public sectors. The estimates measure the extent of relief
to particular kinds of taxpayers relative to a comprehensive
income tax structure in which no economic incentives are
provided.

As defined in the Congressional Budget Act, tax
expenditures relate only to the corporation and individual
income taxes. Other parts of the Internal Revenue
Code--excise taxes, employment taxes, estate and gift
taxes--also have exceptions, exclusions, refunds, and
credits, but they are not currently considered tax
expenditures because they are not parts of the income tax.

The JCT staff traditionally lists as a tax expenditure
any item for which there is a reasonable basis for such
classification and a revenue loss above a de minimis amount.
The list is intended to be informative and cannot be viewed
as revenue estimates of legislative proposals.

Tax expenditure estimates do not represent an attempt to
measure the revenue effects of repeal of a provision.
Rather, they are a measure of the economic incentives
provided by provisions within the current law. They do not
include (1) behavioral responses, (2) transitional effects,
or (3) possible interaction with other incentives.

2 For a more detailed discussion of the concept of tax
expenditures see, Joint Committee on Taxation, Estimates of
Federal Tax Expenditures for Fiscal Years 1993-1997

(JCS -8- -92), April 24, 1992.



INTRODUCTION

This document, + prepared by the staff of the Joint
Committee on Taxation ("JCT staff"), provides a discussion of
the JCT staff revenue estimation methodology and process.
This document is prepared to help answer questions that have
been asked concerning these functions.

Part I of the document discusses revenue estimation
methodology. Part II answers certain commonly asked
questions concerning the revenue estimation process. The
Appendix includes data on the number of revenue estimate
requests received by the JCT staff in recent years.

This document may be cited as follows: Joint Committee on
Taxation, Discussion of Revenue Estimation Methodology and
Process (JCX-31-92), August 4, 1992.


- 24 -

3. What explains the different revenue patterns observed
for particular estimates over the budget window?

Revenue estimates generally measure the flow of tax
payments resulting from a legislated change in the tax law.
These estimates are presented as changes in fiscal year
budget receipts to be consistent with the Federal
Government's cash flow accounting system. Normally,
estimates will follow a pattern consistent with the
forecasted growth of macroeconomic aggregates.

It is often noted that the first-year revenue effect in
any five-year estimate is "small" relative to succeeding
years. The basic cause of this apparent anomaly is that most
taxpayers accrue and pay their taxes on a calendar year basis
while the Federal fiscal year ends on September 30.
Typically, only 75 percent of tax liability accrued on a
calendar-year basis falls in the corresponding fiscal year.
For example, if individual income tax rates were changed
effective January 1, and even if withholding were immediately
adjusted, the first-year receipts would reflect only 75 per-
cent of the first-year accrual whereas the second and
succeeding years’ receipts would reflect 75 percent of the
present-year accruals plus 25 percent of the prior years’
accruals. Often, changes in tax payments resulting from
changes in the individual income tax do not occur until the
following April. Corporate income taxes and excise taxes
similarly are affected by the difference between calendar
and fiscal years, and by the schedules under which the
various taxes are paid.

Another type of revenue estimate involves only changes
in the timing of payments without a change in underlying
liability. In the case of a speed-up of payments, the pat-
tern is typically an increase in Year 1 receipts, followed by
little or no change in succeeding years. Since only the
timing of payments is affected, the movement of payments to
Year 1 results in a equal decrease in payments in Year 2. In
turn, the payments moved up from Year 3 to Year 2 offset the
loss of payments in Year 2 and so forth.

4. What role do assumptions about behavioral responses to
tax changes play in revenue estimates?

All JCT staff estimates incorporate several types of
behavioral effects. The simplest are those that change a
taxpayer's filing strategy or status. For example, if an
increase in the standard deduction would make it advantageous
for a taxpayer to switch from itemizing deductions to
claiming the standard deductions, the estimate assumes
taxpayers do so.



CONTENTS

INTRODUCTION... 2... eee e cece ccc cee cece e cece eee e ce eeee

I. REVENUE ESTIMATION METHODOLOGY..............-22008
A. OVEFVIEW. 26. eee cece cee ee eee
B. Elements of Revenue Estimates..............

c.

D.

1. The baseline......................0208-

2. Modeling and forecasting proposed
changes in tax law.....................

Tax Expenditure Estimates and Revenue
EStimates........ cee cece cece eee eee

Distributional Analysis................0005

Il. REVENUE ESTIMATION PROCESS.............2.2c2eeceee

APPENDIX:

A.
B.

Cc.

Administrative Procedures...............005

Elements of Revenue Estimates..............

Distributional Estimates...................
Number of Revenue Requests Received by

the Joint Committee on Taxation Staff,
1985-1992... cc ce cece tee

15
16
20
21
23

28

30


- 27 -
8. Are estimates ever checked for their accuracy?

Every revenue estimate is subject to a comprehensive
internal review prior to being transmitted to the requesting
Member. In certain instances, particularly when the
economics literature gives little guidance, the estimate and
a detailed description of the underlying assumptions and
methodology are conveyed to experts outside the JCT staff to
solicit additional views, comments or suggestions. In
situations where data are readily available, calculations are
straightforward or when offsetting interactions are
unambiguous, the accuracy of revenue estimates is generally
monitored in the ordinary course of updating and calibrating
the various models used for revenue estimation. This is
usually the case, for example, when a proposal is enacted
into law either in isolation or as part of a small,
narrowly-focused piece of legislation.

In other cases, there are a number of practical reasons
why an ex post analysis would be problematic. First,
economic forecasts that were relied upon in arriving at the
estimate may prove to have been incorrect and the estimate
certainly would have been different if a different forecast
had been uséd. Second, much like the case of changed
economic forecasts, subsequent tax legislation may change the
context in which the initial estimate was made. For example,
a deduction is more valuable to taxpayers when marginal tax
rates are high than when marginal tax rates are low. Third,
in many instances, estimates assume that there is a behav-
ioral response on the part of taxpayers to several provisions
enacted simultaneously and it is often very difficult to
measure accurately the differential impact of each provision
with the data available.


- 11 -

are required, and the reliability of these assumptions could
be challenged. For example, the present-value revenue cost
of IRAs will be sensitive to the assumptions made about when
taxpayers make withdrawals from their IRAs; this assumption
has a much smaller effect on revenue estimates of IRA
proposals done on a cash-flow basis (assuming most
withdrawals are outside the five-year budget period).

The use of a five-year reporting period for revenue
estimates can understate revenue effects for other reasons as
well. If the effective date of a proposal is delayed or if
the proposal is phased in during the reporting period, the
long run revenue effects of the proposal will not be
reflected by revenue estimates provided for the reporting
period only.

Although constrained to provide revenue estimates only
for the five-year budget period, the JCT staff attempts to
provide additional information concerning the likely pattern
of revenue changes beyond the five-year window whenever it is
deemed relevant to a complete analysis of proposed
legislation. However, the accuracy of actual revenue
estimates provided for more than a five-year period would be
seriously diminished due to the uncertainty of any long-range
economic forecasts and other assumptions relevant to the
preparation of a revenue estimate.

Calendar year liabilities and Federal fiscal year receipts

To be useful tools in budget analyses, estimates must be
presented in a form consistent with the Federal Government’s
cash-flow accounting system. That is, 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 as fiscal year receipts
to the Treasury Department. However, because the majority of
taxpayers calculate and pay taxes on a calendar year basis
and most data sources are available in calendar year terms,
analyses are conducted on a calendar year liability basis.
For purposes of distributional analyses, calendar year data
are used exclusively. Because taxes are most often
calculated on a calendar year liability basis, the
translation of changes in calendar year tax liabilities into
changes in the fiscal year receipt of taxes is necessary.
This translation is referred to as a "fiscal split." While
the mapping of calendar year liabilities into Federal fiscal
year receipts can be complex, the general relationships for
certain categories of proposals have been determined from
historical tabulations.



- 14 -

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 law change in order 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 would be counted unless there were
adequate resource allocations to justify counting the
enforcement revenues.

The JCT staff does not estimate the administrative costs
incurred by either the IRS or taxpayers that may result from
proposed legislation.