The Institute for Research on the Economics of Taxation (IRET) is at it again. If you've ever wondered where the Wall Street Journal's editorial board gets its most half-baked ideas about taxes and economics, the IRET is your answer. Last year, they released a remarkable report concluding that repealing the estate tax would actually increase federal revenue. (See CTJ's response.)
Now the IRET claims that the Medicare tax reform included in the health care compromise before Congress would decrease GDP by 1.3 percent and actually reduce federal revenue by $5 billion a year.
The problem, according to IRET, is that taxes on investment income reduce incentives to invest, which results in less economic activity, fewer jobs and lower incomes. They believe that business profits and wages would fall so much that the resulting loss of tax revenue would more than offset the gain resulting from the increase in the Medicare tax. This is the flip side of the coin for "supply-side" theorists who believe that tax cuts (particularly tax cuts for investment income) will result in increased revenue.
Proponents of this analysis call it "dynamic" revenue scoring. Sadly for IRET, no one believes it. Even George W. Bush's Treasury concluded that the gross increase in revenue resulting from the economic impact of tax cuts is tiny and comes nowhere near the level needed to actually offset the cost of tax cuts (much less result in a net revenue gain). Economic advisers to conservative Republican presidents agree. For example, Martin Feldstein, Chairmen of Council of Economic Advisers under President Reagan, and Glenn Hubbard and Greg Mankiw, both CEA chairmen during the George W. Bush administration, all have been quoted as saying that tax cuts do not raise revenue. One would assume that they believe the reverse, that tax increases do not reduce revenue.
Some more moderate supply-siders (if such a thing is possible) concede that many tax increases do raise revenue and many tax cuts do reduce revenue, but they argue that taxes on investment income are something different. Certain types of investment income like capital gains and dividends, are more responsive to tax rates, they argue.
But there is no evidence to back this up. Proponents of this argument often point to the upticks in revenue from income taxes on capital gains income and claim that they are caused by the latest increase in the tax preference for capital gains. As we've pointed out before, capital gains tax revenue was higher at the end of the Clinton years, when the top rate for capital gains was higher, than any time since. The truth is that investment income simply bobs up and down in response to whatever is happening in the broader economy, without much discernable impact from tax policy.
There are other problems with the IRET's claims. In some places they are just factually wrong. One claim IRET makes is that the new Medicare tax on investment income "would be triggered by earning even a single dollar above the thresholds, after which all of the taxpayers’ passive income would be immediately subject to the tax. This creates a huge tax rate spike or 'cliff' at the thresholds."
Wrong. The memo and revenue estimates that the Joint Committee on Taxation (JCT) distributed by lawmakers on February 24 made clear that the President's version of the Medicare tax on investment income would be phased in over a range of income exceeding $200,000/$250,000, while the text of the revised version says it would apply only to unearned income to the extent that AGI exceeds the $200,000/$250,000 threshold. In other words, if a single person has AGI of $201,000 and $51,000 of this income is investment income, the 3.8 percent Medicare tax would only apply to $1,000 of investment income (not the entire $51,000).
In other words, IRET either talks about a tax policy that no one has proposed (such as a "cliff" for people with one dollar of income over the $200,000/$250,000 threshold) or retreats into a theoretical and fantastical world (where increasing taxes causes revenue to plummet and cutting taxes causes revenue to rise).
Of course, if we could raise revenue to pay for health care reform by actually cutting taxes, surely Democrats in Congress would have passed health care reform long ago.