(FORTUNE Magazine) – Is the Senate Finance Committee's tax proposal really ''revenue neutral'' ? Finance Committee Chairman Bob Packwood would certainly like you to believe that revenue lost (mainly because of lower tax rates) would be offset by revenue gained (mainly through elimination of many business and personal deductions). His view has been endorsed by such fiscal eminences as Dan Rostenkowski, chairman of the House Ways and Means Committee, and James Baker, Secretary of the Treasury. But you have reasons to be dubious that the eminences really know what they are talking about. First, note a logical contradiction off in one corner of their presentation. They say the revenue neutrality pertains to a five-year cycle: there would be a tax increase of maybe $22 billion in the first year (because the rate reductions are not fully effective until the year's second half), offset by tax reductions during the next four years. But this implies that on a permanent basis the bill is really a tax cut -- a proposition that, in this age of huge deficits, none of the eminences is rushing to embrace. To be sure, the Finance Committee has been issuing reams of authoritative- looking data designed to support the idea of revenue neutrality. A press release issued on April 30 lengthily elaborated the good news for taxpayers in the bill, then asked, rhetorically, ''How is all this paid for?'' The committee's answer began with a $100-billion bonus for the Treasury from ''closing corporate loopholes'' (a reference principally to elimination of the investment tax credit and some generous depreciation schedules). Next, $50 billion would allegedly come from wiping out tax shelters (principally in real estate). Restricting deductions on IRA contributions would produce another $30 billion. A stiff minimum tax affecting both individuals and corporations would produce $40 billion. Finally, there was a guarded reference to the bill's wipeout of the ''capital gains exclusion'' -- the 60% of gains that is untaxed under present law -- said to be now costing the Treasury $220 billion a year. The wording leaves unclear how much of the $220 billion the Finance Committee expects to pick up. When Packwood was asked on This Week With David Brinkley why he thought the bill was revenue neutral, he pointed to expert opinions he'd received from the technicians at the Treasury and on the congressional Joint Committee on Taxation. It is true that these technicians have the only two econometric models in the U.S. designed to gauge the revenue effects of complex tax legislation. However, the models have their problems: for one thing, they frequently kick out different results. (They had a well-publicized row in 1979 over how much would be generated by the ''windfall'' tax on oil profits.) In 1981 and again in 1982, to cite the two most recent years for which complete data are available, both models underestimated revenues by around 5%. It is fairly clear that neither of them adequately simulates the responses of taxpayers to changes in the revenue code.

One reason it's clear is that the models do not attempt any such simulations: they assume that behavior does not change with marginal tax rates. Lawrence B. Lindsey, assistant professor of economics at Harvard and one of the numerous critics of the models, observed in a recent publication of the National Bureau of Economic Research that this assumption makes no economic sense. Economists are more or less unanimously agreed about the ability of tax rate changes to significantly affect a broad range of individuals' decisions: they affect willingness to enter the labor force, to contribute to charity, to incur entertainment expenses, to realize capital gains, and much more. The models' underlying assumptions seem especially peculiar with respect to capital gains. Why would anyone in his right mind realize a sizable gain in 1987? For many well-heeled investors, the effective marginal rate on capital gains will be rising by 60% or so (from 20% to around 32%) next year. It seems likely that many of them will rush to realize their gains this year. AT SOME POINT in the next few weeks, the arguments about the bill's revenue neutrality might revive some familiar old questions about supply-side economics. To much of the Washington establishment, supply-side economics has been badly discredited -- which is possibly why Packwood and his allies have been relatively restrained in arguing that the massive rate reductions now in prospect will give the economy a huge lift. But they just might. Harvard's Lindsey, who identifies himself as a ''moderate supply-sider,'' offers the following perspective. Most economists believe that the labor-supply elasticity for men of prime working age is around 0.1, meaning that their willingness to work rises about 10% as rapidly as income. After-tax salary under the Finance Committee bill would rise by as much as 46% (high-paid employees would keep 73% instead of as little as half of pretax earnings). That figure implies a 4.6% rise in the willingness of high-paid people to work, which in turn implies potentially huge increases in tax revenues. Based on a back-of-the-envelope calculation, Lindsey suggests that even with lower- than-expected capital gains receipts, annual revenues under the new bill could easily run $20 billion higher than expected. In short, it is possible to believe that Packwood's views on revenue neutrality are wrong while also believing that he has produced an extraordinarily good bill.