[PPT] - Congressional Budget Office January 4, 2016 Frameworks for PowerPoint Presentation

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Congressional Budget Office

Annual Meeting of the Allied Social Science Associations San Francisco, California

January 4, 2016

Kevin Perese Principal Analyst, Tax Analysis Division

Frameworks for Distributional Analyses

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CONGRESSIONAL BUDGET OFFICE

Frameworks for Distributional Analyses

by Edward Harris Kevin Perese Joshua Shakin

The information in this presentation is preliminary and is being circulated to stimulate discussion and critical comment as developmental work for analysis for the Congress.

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Distributional Analyses Have Historically Been Tax-Centric

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Everyone pays taxes

(either directly or indirectly).

There are explicit

progressive/redistributive properties in the tax system.

There are high-quality tax data.
There is a lot of theoretical work on tax

incidence in the economics literature.

Why? Distributional Analyses Have Historically Been Tax-Centric

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Joint Committee on Taxation
Congressional Budget Office, Tax Analysis Division
Treasury Department, Office of Tax Analysis
Tax Policy Center (Urban Institute/Brookings Institution)

Who Has Been Performing These Analyses? Distributional Analyses Have Historically Been Tax-Centric

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But there’s more to government than just taxes. Our goal is to use a framework that allows for the analysis of the distributional effects of government transfers while dealing with the effects of large intergenerational transfer programs in cross-sectional analyses of household income.

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CBO’s Current Distributional Framework (Based on Before-Tax Income)

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Market Income Before-Tax Income After-Tax Income Cash and In-Kind

Govt. Transfers

Direct and Indirect Federal Taxes

‒ = + =

CBO’s Current Distributional Framework

Used to rank households and as the denominator in average tax rate calculations

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Quintiles Lowest Second Middle Fourth Highest All Households Market Income 14,700 28,800 49,400 79,700 234,100 81,400

+ Government

Transfers 7,100 12,300 12,100 10,400 8,900 10,200

= Before-Tax

Income 21,800 41,100 61,500 90,000 243,000 91,600

− Federal Taxes

1,300 4,000 8,600 16,100 62,500 18,700

= After-Tax

Income 20,600 37,100 52,900 73,900 180,400 72,800 Average Federal Tax Rate (Percentage of Before-Tax Income) 5.7 9.8 14.1 17.9 25.7 20.5 Dollars

Distribution of Household Income, Government Transfers, and Federal Taxes, 2006 (CBO’s Current Distributional Framework)

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CBO’s Current Distributional Framework

Strengths Shortcomings

Before-tax income, a broad

income measure, is a proxy for both overall economic well-being and ability to pay tax liabilities.

Before-tax income is

therefore an appropriate denominator for calculating average tax rates.

Because before-tax income

includes government transfers, retired households are relatively evenly spread among before-tax income groups.

The framework is tax-centric,

so it doesn’t allow for analysis of government transfers—that is, analysts cannot calculate meaningful transfer rates or net tax and transfer rates.

Therefore, the redistributive

properties of transfers and taxes are not treated equally.

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Market Income Distributional Framework

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Market Income Before-Tax Income After-Tax Income Cash and In-Kind

Govt. Transfers

Direct and Indirect Federal Taxes

‒ = + =

Market Income Distributional Framework

Used to rank households and as the denominator in average tax rate calculations

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Market Income Distributional Framework

Strengths Shortcomings

Market income is an intuitive

measure of pre-government income.

The framework lets analysts

calculate transfer rates, tax rates, and net tax and transfer rates.

“Market income” suggests no

government intervention, but the measure includes the effects of other, less direct governmental policies.

Market income is not a good

proxy for overall economic well-being and ability to pay tax liabilities.

Life-cycle patterns in market

income make retired people appear poor in cross- sectional analyses.

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After-Tax Income Distributional Framework

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Market Income Before-Tax Income After-Tax Income Cash and In-Kind

Govt. Transfers

Direct and Indirect Federal Taxes

‒ = + =

After-Tax Income Distributional Framework

Used to rank households and as the denominator in average tax rate calculations

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After-Tax Income Distributional Framework

Strengths Shortcomings

After-tax income is a proxy

for overall economic well- being.

It can be used as a

benchmark for how income inequality is changing over time regardless of source (market income, transfers, or taxes).

After-tax income is not an

appropriate denominator for calculating tax or transfer rates because taxes and transfers are included in it.

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Trying to Strike a Balance

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Cross-Sectional Analysis Large Intergenerational Transfers

Trying to Strike a Balance

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Gross Income Distributional Framework

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Market Income Before-Tax Income After-Tax Income Social Insurance Transfers Direct and Indirect Federal Taxes

‒ =

Gross Income Distributional Framework

Gross Income Means-Tested Transfers

= = + +

Used to rank households and as the denominator in average tax rate calculations

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Gross Income Distributional Framework

Strengths Shortcomings

The framework allows

analysts to calculate means- tested transfer rates, tax rates, and net tax and transfer rates.

It accounts for life-cycle

income patterns caused by the receipt of social insurance benefits.

Gross income does not fully

represent people’s ability to pay their tax liabilities.

There is some redistribution

in social insurance programs that the framework does not capture.

Social insurance benefits and

the taxes that finance them are not treated equally.

Not including public goods

results in an incomplete fiscal picture when calculating net tax and transfer rates.

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Going From Before-Tax Income Quintiles to Gross Income Quintiles Shuffles the Households.

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Overlap Between Gross Income Quintiles and Before-Tax Income Quintiles, 2006

Before-Tax Income Quintiles Lowest Second Middle Fourth Highest Total Gross Income Quintiles Lowest 81.2 14.5 3.9 0.5 0.0 100 Second 18.6 73.8 6.5 1.0 0.1 100 Middle 0.0 11.2 84.7 3.9 0.2 100 Fourth 0.0 0.0 5.5 92.8 1.7 100 Highest 0.0 0.0 0.0 2.0 98.0 100

Percentage Points

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Before-Tax Income Lowest Quintile Second Quintile

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Before-Tax Income Gross Income Second Quintile Lowest Quintile

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Before-Tax Income Gross Income

From Middle, Fourth, and Highest Quintiles

Second Quintile Lowest Quintile

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Before-Tax Income Gross Income Second Quintile Lowest Quintile

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Before-Tax Income Gross Income

From Middle, Fourth, and Highest Quintiles

Second Quintile Lowest Quintile

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A Hypothetical Policy Change

A targeted payment of $3,000 to households below 100 percent of the federal poverty guidelines that phases out linearly between 100 percent and 400 percent of the federal poverty guidelines

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500 1,000 1,500 2,000 2,500 3,000 3,500 50 100 150 200 250 300 350 400 450 500 Recipient’s Income as a Percentage of the Federal Poverty Guidelines $3,500

A Hypothetical Policy Change

Government Benefit Received

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What are the distributional effects of such a policy (implemented as a means-tested transfer program or as a refundable tax credit) using a before-tax income framework and a gross income framework?

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500 1,000 1,500 2,000 2,500 3,000 Lowest Quintile Second Quintile Middle Quintile Fourth Quintile Highest Quintile All Households

Refundable Tax Credit

$

Change in After-Tax Income Resulting From the Hypothetical Policy Change, Before-Tax Income Distributional Framework

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500 1,000 1,500 2,000 2,500 3,000 Lowest Quintile Second Quintile Middle Quintile Fourth Quintile Highest Quintile All Households

Refundable Tax Credit Means-Tested Transfer

$

Change in After-Tax Income Resulting From the Hypothetical Policy Change, Before-Tax Income Distributional Framework

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500 1,000 1,500 2,000 2,500 3,000 Lowest Quintile Second Quintile Middle Quintile Fourth Quintile Highest Quintile All Households

Refundable Tax Credit Means-Tested Transfer

$

Change in After-Tax Income Resulting From the Hypothetical Policy Change, Gross Income Distributional Framework

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Using a before-tax income framework produces different distributional results depending on whether the policy is implemented as a refundable tax credit or a means-tested transfer, even though they are economically identical policies. Using a gross income framework, however, produces identical distributional results.

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Notes

Market income consists of labor income, business income, capital gains (profits realized from the sale of assets), capital income excluding capital gains, income received in retirement for past services, and other sources of income. Government transfers are cash payments and in-kind benefits from social insurance and other government assistance programs. Those transfers include payments and benefits from federal, state, and local governments. Before-tax income is market income plus government transfers. Social insurance transfers are Social Security benefits for workers, spouses, survivors, and the disabled; Medicare payments; and unemployment insurance benefits. Gross income is market income plus social insurance transfers. Means-tested transfers include payments and benefits from Medicaid; the Supplemental Nutrition Assistance Program, or SNAP (formerly Food Stamps); housing assistance programs; and several smaller programs. Federal taxes include individual income taxes, payroll taxes, corporate income taxes, and excise taxes. After-tax income is before-tax income minus federal taxes. Income groups are created by ranking households by various income measures, adjusted for household size. Quintiles (fifths) contain equal numbers of people.