CBO’s Use of the Income and Payroll Tax Offset in Its Budget Projections and Cost Estimates

The collection of some types of taxes can affect the revenues generated by other taxes. In particular, excise taxes and other types of "indirect" taxes reduce the revenues derived from individual and corporate income taxes and payroll taxes. When analyzing the effects of legislation, the Congressional Budget Office and the staff of the Joint Committee on Taxation (JCT) take those effects on revenues into account.

Indirect taxes are imposed on goods and services rather than directly on wages, profits, or other forms of income. In addition to excise taxes, they include customs duties and certain compulsory governmental fees. Indirect taxes, whether paid by firms or passed on to consumers, reduce the income of workers and firms. The reduction, in turn, decreases the government’s revenues from “direct” tax sources, such as individual and corporate income taxes and payroll taxes.

Therefore, when CBO and JCT estimate the budgetary effects of changes in indirect taxes, they generally reduce the estimated change in indirect tax revenues by applying an income and payroll tax offset. The offset represents the change in revenues from income and payroll taxes caused by the change in the indirect tax.

The value of the offset varies each year because of differences in tax law and economic factors but in recent years has generally ranged from 21 percent to 25 percent of estimated revenues from indirect taxes; therefore, the net revenues generated from an indirect tax are only about three-quarters of the gross amount of revenues collected from the tax.

CBO applies the offset to budgetary estimates after accounting for people’s behavioral responses to the change in indirect taxes. The offset is not applied to estimates of spending proposals or to proposals that affect money collected by the government through a businesslike or market-oriented transaction with the public (such as fees collected from leasing federally controlled land).

This report explains how indirect taxes affect net tax revenues, how the rate of the income and payroll tax offset is determined, the cases in which CBO does and does not apply the offset in its cost estimates, and how it reflects the offset in its baseline projections of revenues under current law.