The IRET study focuses on the assumption of government revenue estimators that tax changes have no effect on major economic variables such as total employment, output, and productivity. The study finds that the estimators' assumption is mistaken. An alternative methodology taking account of the saving, investing, and work responses to the incentive effects of tax changes would provide much better guidance to policymakers than current estimates. IRET offers this study with the hope that it will help to clarify the issues that policymakers must resolve if tax policy is to be guided by a realistic assessment of how taxes affect economic and budget outcomes. Executive summary Tax changes alter aftertax prices and costs, thereby modifying the relative attractiveness of various products and activities.
People respond to incentive changes by adjusting how they use resources.
The resulting tax induced resource adjustments, in addition to affecting the mix of inputs used in production, the kinds of goods and services businesses produce, and the types of jobs available, often change the total amount of labor and capital services, hence, total production and total income. These changes in total employment and total income affect the bases of virtually every tax in the federal revenue system and the revenues the taxes produce. In opposition to this reality, the government s official revenue estimators proceed on the assumption that tax changes never effects overall economic activity. It is assumed, for example, that total employment and output will be the same whether personal income tax rates are raised or lowered, whether the capital gains tax rate is increased or decreased, whether the payroll tax rate is boosted or reduced, whether businesses are allowed to deduct their capital expenditures more promptly or more slowly. Further, although the estimators generally account for the adjustments that occur in response to excise tax changes and some other tax changes, such adjustments are limited to the markets directly affected by the tax changes, and the tax changes are explicitly deemed to have no effect whatever outside those markets.