Spring 2006 / No. 67
Dynamic analysis vs. irrational
behavior
The
government has great difficulty predicting tax revenue changes.
Repeatedly, the government’s forecasts of tax revenue changes
resulting from tax law amendments have been wrong. Usually they
have been dramatically wrong. Yet, the government patiently explains
that decreasing the capital gains tax rate will decrease tax
revenues, calculated carefully to the penny. And regardless
of your economic or political view, it remains a stunning failure
how poorly those estimates turn out.
Lately,
we have begun hearing the call to move from static to dynamic
forecasting. The traditional static approach assumes that no
one behaves differently when the tax law changes. But of course
they do. People evaluate the change, evaluate their circumstances,
and then make a rational determination of their best course
of action. To continue behaving the same way, regardless of
tax law changes, would be irrational. And so, what the government
is forecasting is how the revenue would look if everyone acted
irrationally. It may be interesting, but it certainly is not
useful.
Nor is it
instructive, we think. We have sat and listened to a home office
executive’s presentation on how his company’s voluntary
business would improve when they fully changed over to web
enrollment. And he was able to determine the exact amount of
improvement by assuming that sales stayed exactly the same
while he reduced enrollment costs based on the cost differential.
Our point?
The government has no corner on the market for irrationality. |
