Tax Cuts and Revenue Gains

A tax rate cut was enacted in the United States in 2003, yet tax revenues from capital gains were better than predicted. Many supply siders and Laffer curve enthusiasts are loving it. For example, Don Luskin wrote in the National Review:

[I]nstead of costing the government $27 billion in revenues, the tax cuts actually earned the government $26 billion extra.

CBO's estimate of the "cost" of the tax cut was virtually 180 degrees wrong. The Laffer curve lives!

Unfortunately, while the numbers Don refers to are correct, his analysis has some serious problems.

Don't get me wrong, I'd love it if Don's analysis was correct. I'm all for low tax rates because in the long run, due to the increased economic growth that coincides with lower taxes, everybody will be better off, rich and poor alike. Even the government will have more to spend in absolute terms.

There are several things in Don's analysis that have problems, but in this post I will focus on the biggest, yet simplest, problem: you can't compare predicted revenues with later actual revenues unless you have a high degree of confidence that the predictions are accurate. That simply isn't true for CBO predictions of revenues from taxes on capital gains.

First of all, the CBO knows that it has a terrible record predicting such revenues. On page 56 of "THE BUDGET AND ECONOMIC OUTLOOK: FISCAL YEARS 2001-2010" the CBO states:

Capital gains realizations, which are often considered relevant to the accuracy of forecasts, are notoriously difficult to predict. They constitute a relatively small percentage of individual tax receipts, however, and errors in forecasting them are unlikely to play a large role in errors in revenue forecasts.

In other words, they know that they're very bad at predicting capital gains revenues and they're not going to try to improve. And true to form, the CBO's predictions have been truly terrible. As and example, the following table shows the CBO's prediction of capital gains liabilities for 2001 through 2005 and the actual revenues:

Year   Predicted   Actual
-------------------------
2001:      129       61
2002:       95       47
2003:       54       47
2004:       46       71
2005:       58       81

The estimate for the predicted revenues was reported at the beginning of the year. The actual revenues were reported two years after that to allow the dust to settle, except for 2005 which was reported at the beginning of 2006. As you can see, being off by a factor of two is par for the course.

Therefore, you can assign very little meaning to the fact that revenues after the tax rate cuts were higher than predicted by the CBO.

The Invisible Heart

I just finished reading The Invisible Heart: An Economic Romance by Russ Roberts, an economist at GMU and blogger at Cafe Hayek. I'm now reading it to my 9 year old daughter who has definitely enjoyed the first three chapters and I have to heartily recommend the book for the purpose of introducing children to libertarian economics. It's an easy read, with lots of examples of economic issues. It's remarkably humerous given the subject matter, so it keeps the attention of those who generally fall asleep at the mere mention of economics. The plot has an interesting and surprising twist. The romance part is a little lame, but at least it's not steamy, so I can read it to my daughter without any worries.

All in all, I consider this obscure little book a real gem, especially for those who want to introduce younger folk to economics.

Being There: Part II

Being There was a movie starring Peter Sellers:

"Adapted by Jerzy Kozinsky from his own novel, the movie's about a simple-minded, middle-aged gardener who, after a lifetime of seclusion and safety in a Washington, D.C. townhouse, gets his first exposure to reality beyond the walls of his sheltered existence. His only reference to the world is through his childlike addiction to television, and when a chance encounter brings him into the inner fold of a dying billionaire (Melvyn Douglas), he suddenly finds himself the toast of Washington's political elite. His simple phrases about gardening are misinterpreted as anything from economic predictions to sage political advice..."

I'm watching a version of "Being There" play out right before my very eyes. I have a friend, Francine Busby, who is running for Congress as a Democrat in a heavily Republican district. She also ran during the 2004 elections and got less than 40% of the vote. Indeed, for the last election, it was so certain that the incumbent, Randy "Duke" Cunningham, would win the election, that pretty much anybody could get the democratic nomination, so it was Francine's for the asking. Francine has limited political experience (her only experience is that she sits on a school board), but it didn't matter since she (or any other Democrat) was going to lose anyway.

Duke Cunningham is now in jail for soliciting and accepting $2.4 million in bribes from Defense Contractors. There is a special election Tuesday to fill his empty seat in the house of representatives. Since Francine was the Democratic candidate in 2004, the Democratic party has decided to stick with her. Indeed, they've sent the best campaign managers and strategists, she's been able to raise more than $1 million for this election, and volunteers from all over the country are working around the clock for her campaign. She's running against 16 Republican candidates. The top vote getter from each party will progress to a second election in June. However, if someone gets more than 50% of the vote on Tuesday, they will immediately be installed as the representative for California's 50th district, and the June election will be cancelled.

The Republican party assumed that there was no way Francine would have a chance at 50%. As a result, until last week, they were happy to let the 16 Republican candidates "Duke" it out (so to speak), and have put no money or organizational support into this election. And it's too late now.

So last week, a poll came out showing Francine getting over 50% of the vote. The Republican party freaked and starting putting out attack ads. But the ads, put out by the national organization which doesn't understand our local politics, have generally helped Francine. For example, one ad claimed that Francine had taken money from "Defense Contractors" just like Duke Cunningham. They even listed some names of those people who worked for "Defense Contractors" that had donated to Francine's campaign.

One of those people is Irwin Jacobs. Irwin Jacobs is a highly respected and well liked person in San Diego. The companies that he's founded, including Qualcomm, have provided tens of thousands of excellent high-tech jobs here in San Diego. He has donated tens of millions of dollars to many charitable causes such as the San Diego Symphony. You couldn't get a better endorsement that having Irwin Jacobs support you. So one of the stupidest things the Republican could have done is to point out that Irwin Jacobs supports Francine. And that's exactly what they did. Most of their other attack ads weren't thought out all that well either.

If Francine wins on Tuesday, her luck will have been phenomenal every step of the way, from Duke being thrown in jail to incredibly incompetent attack ads by the Republicans. It's remarkably like the gardiner's luck in "Being There."

Wretchard Goes Gloomy

I rarely write about our involvement in Iraq. It's not that I don't think that it's important, it's just that I readily acknowledge that I have nowhere near enough data and understanding to do any sort of analysis or recommendations. I thought it was a bad idea to invade Iraq before we started, but here we are, and, like most other people, I'm mostly along for the ride.

I've noticed a tremendous range in assessments of the various events in Iraq. One one hand, you have the military gung-ho types like Austin Bay, Ralph Peters of the New York Post, and Victor Davis Hanson of the Hoover Institution. On the other hand, there's the more negative reporting and analysis by the New York Times and several other mainstream newspapers and magazines. There's also even more extreme opinion on both sides, but I won't even go there.

We're either doing swimmingly well or civilization in Iraq and around the world is about to collapse, depending on who you read. When confronted with a situation like this one, where there is clearly huge uncertainty, I look at the predictions and analysis of the various media and then remember those predictions and see how well they hold up as more data becomes available.

Nobody has anywhere near a perfect score. But when I look across all of the media and pundits, one has really stood out in being more accurate than the rest in his predictions and analysis: a writer who goes by the pseudonym of "Wretchard the Cat" at the The Belmont Club. I think his track record has been quite impressive.

Wretchard has been generally more positive about our involvement in Iraq and the war on terror than most of the media sources but has recently "gone gloomy" and that has me worried. His commenters pointed this out and here is his response:

I'm somewhat bemused by reports that Wretchard has gone "gloomy". I think it's important not to understate what the Coalition has achieved so far. It's been historic and probably unprecedented. But it's also important never to underrate the difficulties and to describe them as accurately as possible. Analysis should be persuasive on the basis of facts and reasoning and not on emotions.

Some time back there was a shift from the "insurgency" theme to the "civil war" theme. All the old names -- remember Fallujah? Tal Afar? Mosul? -- have gone to page 2. My guess is that we have gone into a new kind of game or endgame. It's important to recognize this. For some people it's always 2004 and everything is an undifferentiated soup, without phases and without developments. It's important to look at the new situation closely precisely because Act I may have ended and Act II Scene I about to begin.

And also:

A realistic assessment should include what has already been gained and what is left to gain. Some people think the Belmont Club is guilty of unwonted optimism simply because it is willing to accept what Zarqawi has practically admitted: that the Sunni insurgency is militarily beaten -- and that the struggle for the political outcome is now underway. And some readers may believe that I've gone all "gloomy" because I think the political outcome still hangs in the balance. But that is nothing more than stating a fact.

A rather unfortunate fact if it can't be made to work. It's certainly been a lot of effort wasted if we can't succeed in the final step of creating a workable political system in Iraq. Nonetheless, I'm not anywhere near thinking we should bail. We simply owe continuing support to the Iraqis, without which, the odds of civil war escalate. We shouldn't leave until it's clear that most of them want us too. David Ignatius of the Washington Post summarized my sentiments when he wrote:

As Prince Turki al-Faisal, the Saudi ambassador to Washington, remarked this week: "America came to Iraq uninvited. You should not leave uninvited."