Static vs. Dynamic Tax Analysis: What's Up?
As the chart above from today's WSJ shows, the 2003 cut in the capital gains tax produced a doubling of tax receipts to $97 billion in 2005 from $47 billion in 2002. That's twice what Congress predicted. For 2006, Congress predicted less than $60 billion in capital gains tax revenues, and the actual revenue collected was more like $105 billion, which is about a 81% forecast error, pretty large even by government standards one would think.
This result seems typical - tax revenues collected after tax cuts are usually much higher than predicted by Congress. What is going on? Here are several possibilities:
1. Congress only knows how to use static tax analysis, and doesn't know how to account for changes in behavior in response to changes in tax rates.
2. Congress knows how to use dynamic tax analysis to account for changes in behavior, but static analysis is easier.
3. Congress understands that changes in tax rates will change behavior, but modeling or capturing or quantifying the changes in behavior is too difficult.
Which one is correct? I am not sure.