Menu
Tax Notes logo

CRS Distributional Estimates Find Wealthy Would Win Under Tax Bill

JUL. 2, 1997

97-669 E

DATED JUL. 2, 1997
DOCUMENT ATTRIBUTES
  • Authors
    Gravelle, Jane G.
  • Institutional Authors
    Congressional Research Service
  • Cross-Reference
    For prior coverage, see Doc 97-19647 (5 pages), 97 TNT 129-2, or H&D,

    July 7, 1997, page 297.
  • Subject Area/Tax Topics
  • Index Terms
    legislation, tax
    incidence
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 97-19776 (6 original pages)
  • Tax Analysts Electronic Citation
    97 TNT 130-24
Citations: 97-669 E

                            July 2, 1997

 

 

           DISTRIBUTIONAL EFFECTS OF THE PROPOSED TAX CUT

 

 

                          Jane G. Gravelle

 

                Senior Specialist in Economic Policy

 

                         Economics Division

 

 

SUMMARY

[1] The distributional effects of the congressional tax cut proposals have been the subject of some uncertainty. Estimates by the Treasury's Office of Tax Analysis (OTA) suggest that these tax cuts will favor high income individuals, while certain estimates taken from the analysis of the Joint Committee on Taxation (JCT) indicate the cuts will favor the middle class. These different perceptions of distributional effects of the tax proposals are the result of a number of different factors: income measures, taxes included, timing effects, measuring the distribution of liabilities versus benefits, and the choice of distributional measure. Conventional economic analysis suggests that the permanent benefits of the tax cuts will favor higher income individuals.

INTRODUCTION

[2] Tax cuts have been passed by both the House and Senate (H.R. 2014). Both the JCT and the OTA have provided distributional analyses of the effects of these proposals, with substantial differences between their reports. 1 The JCT provides a cash-flow, post-behavioral-effects distribution of taxes paid for each year from 1998-2002; the OTA provides a more comprehensive measure more consistent with how economists would measure the bill's benefits to individuals in different income classes. A study of the House proposals has also been prepared jointly by the Center on Budget Priorities and Citizens for Tax Justice (CBPP-CTJ). 2

[3] There are also differences in how income is classified and how results are presented. In particular, some results of the JCT analyses seem to suggest that the benefits are more concentrated toward middle income taxpayers, while the OTA analysis suggests the benefits accrue more heavily to high income taxpayers.

[4] For example, the OTA analysis of the House bill indicated that 31% of the benefits went to individuals with $200,000 or more of income and 64% of the benefits went to those with $100,000 or more of income. The shares in the Senate bill were 23% for incomes over $200,000 and 60% for incomes over $100,000. The claim has also been made, however, that three-quarters of the benefits in the House bill go to those with incomes under $75,000, based on the JCT numbers. This number is apparently the result of aggregating all changes in 1997-2002 using the JCT estimates.

[5] This report provides a brief discussion of the crucial differences between the two distributional methodologies; a more detailed discussion of these issues can be found in a previous CRS report. 3 There are five issues that affect the perceptions of distributional effect that differ between JCT and OTA: the income concept, the inclusiveness of taxes, the time period, the measurement of benefits versus liabilities, and the method of presenting results.

THE INCOME CONCEPT

[6] Different measures of income are used by the OTA and the JCT. Income reported on tax returns excludes many types of income and both groups use an expanded income measure that accounts for missing income items. The OTA has a broader measure that more closely approximates economic income; items that it includes, and that the JCT does not, are unreported income, accruals in pension and retirement plans, accrued rather than realized capital gains, the net imputed rent on owner-occupied housing, and more transfer payments. OTA income is also corrected for inflation. OTA constructed its comprehensive income measure for the Reagan tax reform proposal in 1984 and has used it since. The OTA measure is more consistent with economic income but its use requires extensive additional data collection and imputation: at least one of the JCT's reasons for its use of a narrower measure is data constraints. 4

[7] Some have criticized the OTA measure as causing the tax cut to appear more concentrated at higher incomes because the incomes have been expanded beyond those that are familiar to people. It is true that the OTA measure places more individuals in the higher income classes and thus more of the tax benefit than the JCT's measure. For example, under the OTA measure about 4% of the population is in the $200,000 and over category and about 20% in the $100,000 and over category; under the JCT measure the $200,000 and over class accounts for a little over 1% and the $100,000 and over class accounts for a little over 6%. Only about 13% of taxpayers have incomes over $75,000. This difference in income measure accounts partly for the different claims made about the distribution of the tax benefit.

[8] The OTA measure of income is the more accurate measure of economic income because it is more comprehensive. In any case, the influence of the income classifier is only part of the difference in the claims made about distribution. It can be rendered largely academic since the OTA simultaneously provided a distribution by population shares, and the JCT has also recently provided similar information. This distribution by population shares is largely unaffected by choice of income concept, and will be used from now on in this report.

TAXES INCLUDED

[9] The distributions can also differ depending on the taxes included. The OTA tax cuts include corporate as well as individual income tax reductions. The JCT provides distributions for both individual income tax reductions and for combined individual and excise tax changes. The JCT does not distribute the corporate tax in any of its measures. The OTA distributes the corporate tax in proportion to ownership of capital income in general, consistent with the economic literature which indicates the corporate tax burden is spread to all capital income. Neither distribution includes the estate tax. The CBPP-CTJ study provides a distribution of all tax changes and of entitlement changes as well.

TIME PERIOD

[10] The time period is crucial in measuring the distribution because so many of the tax benefits are pushed into the future. 5 This is especially true for indexation of capital gains in the House bill, which is applied only to newly purchased assets, does not take effect until 2001, and then must involve a three-year holding period. Virtually none of the revenue cost of capital gains indexing appears in the budget horizon. Since capital gains are very concentrated among high income taxpayers, the time period can greatly affect the distribution of the tax benefit. The benefits of backloaded IRAs are also delayed into the future, because the amounts in IRA accounts grow over time given annual dollar limits. The time period issue also interacts with the liabilities versus benefits issue discussed below.

[11] The OTA distribution uses a fully phased-in law and behavior; thus it is a better representation of the permanent distribution. However, it does not represent the full steady-state long run behavior, because there is an adjustment for capital gains indexing in the House bill to reflect the prospective nature of the benefit (it only applies to newly acquired assets) and the delay in implementation. The effects would be larger in the long run.

CHANGE IN LIABILITIES VS. BENEFITS

[12] A complicated issue is the distribution of actual tax payments versus distribution of tax benefits. This issue arises with capital gains and IRAs because of timing, but would be an issue for capital gains without timing effects. Both the OTA and JCT assume capital gains realizations will increase with rate cuts. Taxes collected on those realizations offset the initial revenue cost.

[13] The OTA measures the benefit of the tax as the tax savings with no change in realizations; the JCT measures the liabilities or actual tax payments (this is a recent change from prior JCT practice).

[14] The JCT approach can lead to peculiar results. In the first year of a capital gains tax cut, the assumed realizations response is so large that capital gains revenue actually rises. Clearly, high income individuals who have capital gains have benefitted from the capital gains rate cut; yet, in the distributional analysis of the JCT, the tax cut is shown as a burden.

[15] Some people are disturbed that the tax cut for distributional purposes can be larger than the tax cut for revenue purposes. But, there is no necessary conflict: if a tax causes a distortion, its burden is larger than its yield because of the additional economic loss from the change in behavior. Similarly, reduction in a distorting tax can cause a benefit larger than the tax saving. In theory, not only should the benefit reflect tax savings with no behavioral response, but also an additional benefit to reflect the reduction in distortion. Such a theoretically correct measure would concentrate even more of the benefit on high income taxpayers.

[16] The use of liability changes reflecting behavioral responses is also intertwined with the time period chosen. Two important behavioral responses included in the estimates transfer tax liabilities from the future into the present: the assumption that individuals will shift existing amounts in their IRAs to the new backloaded IRAs (paying a tax now but reducing taxes in the future) and the assumption that people will sell or mark-to-market capital gains assets and pay tax in order to qualify for indexing. The second effect occurs only in the House bill.

[17] In addition, the assumed increase in realizations in the JCT analysis causes the tax base and revenue cost of indexing in the House bill to be much larger, but this cost is outside the budget window and the JCT distributional tables.

[18] The confusion that use of liabilities and timing can create is shown in table 1. The JCT distribution varies considerably depending on the year. 1998 has a smaller share due to the capital gains realizations response and 2001 has a smaller share due to the realization of gain to qualify for indexing. (In 1997, not shown, overall taxes increased). The JCT distribution moves closer to the OTA permanent distribution during other years and would move even closer over time. The further distribution towards high incomes in the CBPP-CTJ study reflects full account of capital gains indexing and the estate tax.

   TABLE 1: DISTRIBUTION OF HOUSE TAX CUTS TO HIGH INCOME TAXPAYERS

 

 _________________________________________________________________

 

 Study                        Top Fifth  Top 10%  Top 5%  Top 1 %

 

 _________________________________________________________________

 

 OTA                              67        47      36       19

 

 JCT  1998                        34        11       0       *

 

 JCT  1999                        44        23      13        7

 

 JCT  2000                        46        26      16       11

 

 JCT  2001                        24        *       *        *

 

 JCT  2002                        48        30      21       14

 

 JCT  2002 (With Excises)         47        28      20       15

 

 CBPP-CTJ (All Taxes)             80        69      58       40

 

 _________________________________________________________________

 

      Source: Congressional Research Service. An * denotes a tax

 

 increase. Calendar 1997 is not shown since it has an aggregate tax

 

 increase.

 

 

[19] The Senate proposal is also concentrated towards high income individuals, but not as heavily as the House proposal. Using OTA numbers: the top fifth receives 65%, the top tenth 42%, the top 5% receives 28% and the top 1% receives 13%. The President's new proposal, which would focus capital gains tax cuts away from the very high income, would allocate 32% to the top fifth, 12% to the top tenth, 7% to the top 5% and 3% to the top 1%.

METHOD OF PRESENTATION

[20] The JCT tables present only one type of direct distributional measure: the percentage change in tax liabilities (the measure shown in table 1). The OTA presents four measures: the average tax reduction, the percentage distribution of the tax reduction, and the tax change as a percent of pre-tax income and taxes paid.

[21] In discussing these measures it may be appropriate to distinguish between absolute measures and relative measures. For example, average tax reductions per unit provide information on the absolute size of a tax benefit across the income classes, which is a straightforward measure. Another way of examining this same effect is to compare the distribution of the tax benefit with the distribution of the population. If each proportion of the population is getting the same share of the benefit, then the benefits are equal. Both of these measures can inform us about how a tax cut is changing income without being misleading, although it is important to remember that existing income and tax payments are more concentrated among high income individuals. Unless a tax provision is refundable, it will have little benefit for the bottom fifth of the population.

[22] A different type of measure is a relative one that tries to examine how the tax benefit is changing the overall distribution of income in the country -- that is, is it making incomes more equal or less equal? In general, the best method for measuring this is to examine the percentage change in disposable (after-tax) income. If the percentage change is equal, then the tax change is not making incomes more equal or less equal. If the percentages are higher among higher income individuals the change is making incomes less equal. This measure is not used in the tables, although it has been used in the past by OTA.

[23] What about the role of the other percentage measures -- of pre-tax income and of taxable income? The former will tend to produce slightly different percentages (and smaller ones) when taxes are already present and is not as precise in indicating the overall effects on income equality, but provides a reasonably accurate measure of relative distribution. For both bills, this measure suggests that the tax cut in the House proposal will make after-tax incomes more unequal, increasing income by 1.2% for the top 1%, by 1.1% for the highest fifth, by 0.9% overall, and by only 0.2% to 0.3% in the bottom 40%. In the Senate version, the benefits are greater in the high, but not the very top income classes -- the top fifth receives a 1% increase, but the top 1%, a 0.8% increase.

[24] The percentage changes in tax liability are higher for lower income individuals in the JCT tables, while the reverse occurs in the OTA tables. The percentage of tax changes can, however, be misleading. If the percentages rise across the income levels (given an initially progressive system), the results indicate less equality. If they fall, however, the percentages can be very misleading. For example, suppose that a family pays only $10 dollars in income tax. A ten dollar tax cut will, therefore, be a 100% tax reduction and will appear very large. For this reason, tables of percentage changes in taxes paid may indicate little about the distributional benefits of a tax change.

CONCLUSION

[25] Distributional analysis of the tax proposal can yield different impressions depending on many factors. For example, the statement that 75% of the tax benefit is received by those with incomes under $75,000 is true only when years in which offsetting induced tax payments from behavioral change are used. (The JCT has not provided distributional tables for the second 5 years). In 2002, the number would be 63%, and it would decline over time, continuing beyond the ten year budget horizon. Moreover, an income of $75,000 is quite far up the income distribution using the JCT income measure: only about 13% of taxpayers earn incomes above $75,000. That is, by the fifth year, 13% of the taxpayers receive 37% of the benefit using measures of liability.

[26] Using measures more consistent with conventional economic analysis and the permanent provisions of the bills, the Treasury OTA's estimates indicate that, by any distributional measure, the tax cuts favor higher income individuals in the House and Senate bills, with the effects more pronounced in the House bill.

 

FOOTNOTES

 

 

1 The estimates are contained in a series of distributional tables with various dates in June 1997.

2 The Impact on Families in Different Income Categories of the Tax and Entitlement Changes Approved by House Committees, by Wendell Primus and Kathryn Larin, Center on Budget and Policy Priorities and Robert S. McIntyre and Michael P. Ettlinger, Citizens for Tax Justice, June 23, 1997.

3 These distributional issues are discussed in more detail in a previous CRS report which also discussed the differences in distributional methodologies. See Distributional Effects of Tax Provisions in the Contract with America as Reported by the House Ways and Means Committee, by Jane G. Gravelle, Report 95-455, April 3, 1995.

4 These income measures are discussed in several different studies. See Susan C. Nelson, Family Economic Income and Other Income Concepts Used in Analyzing Tax Reform, in Compendium of Tax Research 1987, Office of Tax Analysis, U.S. Department of Treasury; U.S. Congress Joint Committee on Taxation, Methodology and Issues in Measuring Changes in the Distribution of Tax Burdens, Joint Committee Print, June 14, 1993; various chapters in Distributional Analysis of Tax Policy, edited by David F. Bradford, Washington, D.C., The AEI Press, 1995.

5 Timing issues are discussed in more detail in two recent CRS reports: The Revenue Cost of Capital Gains Tax Cuts, Report 97-559 E, June 16, 1997 and Individual Retirement Accounts (IRAs) and Related Proposals, Report 97-629 E, June 20, 1997, both by Jane G. Gravelle.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Gravelle, Jane G.
  • Institutional Authors
    Congressional Research Service
  • Cross-Reference
    For prior coverage, see Doc 97-19647 (5 pages), 97 TNT 129-2, or H&D,

    July 7, 1997, page 297.
  • Subject Area/Tax Topics
  • Index Terms
    legislation, tax
    incidence
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 97-19776 (6 original pages)
  • Tax Analysts Electronic Citation
    97 TNT 130-24
Copy RID