When excise taxes, customs duties, and other types of “indirect” taxes are imposed on goods and services, they tend to reduce income for workers or business owners in the taxed industry and for others throughout the economy. Consequently, revenue derived from existing "direct" tax sources—such as individual and corporate income taxes and payroll taxes—will also be reduced. To approximate that effect, the Congressional Budget Office (CBO), the Joint Committee on Taxation (JCT), and the Treasury Department’s Office of Tax Analysis (OTA) apply a 25 percent offset when estimating the net revenue that legislation imposing some form of indirect tax is expected to generate. In other words, the estimated proceeds from the indirect tax are reduced by 25 percent to account for the resulting reductions in income and payroll taxes. The offset is made in addition to accounting for behavioral responses to the new tax.
Although applying the 25 percent offset for budget estimates is a longstanding convention, proposals to address global climate change have created greater public awareness of that practice. Because tradable emission permits would have economic effects that are identical to those of a tax on emissions, which would be an indirect tax, CBO applies the offset when calculating the revenue that such policies might generate. For example, if the issuance of emission permits was estimated to generate $100 billion in revenues in a given year, the estimate would also reflect an offsetting reduction of $25 billion in income and payroll taxes, for a net revenue gain of $75 billion. This brief explains that estimating convention—its rationale, application, and implications for policy decisions.