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Frameworks for Distributional Analyses

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Presentation by Kevin Perese, Principal Analyst in CBO’s Tax Analysis Division, at the annual meeting of the Allied Social Science Associations.

CBO’s analyses of the distribution of household income and federal taxes rely on a broad measure of before-tax income to rank households and to serve as the denominator for the calculation of average tax rates across the income distribution. In this presentation, CBO examines the strengths and shortcomings of that distributional framework and of several alternative frameworks for analyzing the distributional effects of government transfers and federal taxes. Those alternative frameworks use market income (which excludes all government transfers and federal taxes), after-tax income (which includes government transfers and federal taxes), and gross income (which is a pretax income measure that excludes means-tested government transfers but includes transfers from social insurance programs).

Frameworks for Distributional Analyses

  1. 1. 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
  2. 2. 1CONGRESSIONAL 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.
  3. 3. 2CONGRESSIONAL BUDGET OFFICE Distributional Analyses Have Historically Been Tax-Centric
  4. 4. 3CONGRESSIONAL BUDGET OFFICE • 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
  5. 5. 4CONGRESSIONAL BUDGET OFFICE • 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
  6. 6. 5CONGRESSIONAL BUDGET OFFICE 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.
  7. 7. 6CONGRESSIONAL BUDGET OFFICE CBO’s Current Distributional Framework (Based on Before-Tax Income)
  8. 8. 7CONGRESSIONAL BUDGET OFFICE 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
  9. 9. 8CONGRESSIONAL BUDGET OFFICE 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)
  10. 10. 9CONGRESSIONAL BUDGET OFFICE 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.
  11. 11. 10CONGRESSIONAL BUDGET OFFICE Market Income Distributional Framework
  12. 12. 11CONGRESSIONAL BUDGET OFFICE 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
  13. 13. 12CONGRESSIONAL BUDGET OFFICE 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.
  14. 14. 13CONGRESSIONAL BUDGET OFFICE After-Tax Income Distributional Framework
  15. 15. 14CONGRESSIONAL BUDGET OFFICE 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
  16. 16. 15CONGRESSIONAL BUDGET OFFICE 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.
  17. 17. 16CONGRESSIONAL BUDGET OFFICE Trying to Strike a Balance
  18. 18. 17CONGRESSIONAL BUDGET OFFICE Cross-Sectional Analysis Large Intergenerational Transfers Trying to Strike a Balance
  19. 19. 18CONGRESSIONAL BUDGET OFFICE Gross Income Distributional Framework
  20. 20. 19CONGRESSIONAL BUDGET OFFICE 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
  21. 21. 20CONGRESSIONAL BUDGET OFFICE 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.
  22. 22. 21CONGRESSIONAL BUDGET OFFICE Going From Before-Tax Income Quintiles to Gross Income Quintiles Shuffles the Households.
  23. 23. 22CONGRESSIONAL BUDGET OFFICE 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
  24. 24. 23CONGRESSIONAL BUDGET OFFICE Before-TaxIncome Lowest Quintile Second Quintile
  25. 25. 24CONGRESSIONAL BUDGET OFFICE Before-TaxIncomeGrossIncome Second QuintileLowest Quintile
  26. 26. 25CONGRESSIONAL BUDGET OFFICE Before-TaxIncomeGrossIncome From Middle, Fourth, and Highest Quintiles Second QuintileLowest Quintile
  27. 27. 26CONGRESSIONAL BUDGET OFFICE Before-TaxIncomeGrossIncome Second QuintileLowest Quintile
  28. 28. 27CONGRESSIONAL BUDGET OFFICE Before-TaxIncomeGrossIncome From Middle, Fourth, and Highest Quintiles Second QuintileLowest Quintile
  29. 29. 28CONGRESSIONAL BUDGET OFFICE 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
  30. 30. 29CONGRESSIONAL BUDGET OFFICE 0 500 1,000 1,500 2,000 2,500 3,000 3,500 0 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 ChangeGovernmentBenefitReceived
  31. 31. 30CONGRESSIONAL BUDGET OFFICE 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?
  32. 32. 31CONGRESSIONAL BUDGET OFFICE 0 500 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
  33. 33. 32CONGRESSIONAL BUDGET OFFICE 0 500 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
  34. 34. 33CONGRESSIONAL BUDGET OFFICE 0 500 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
  35. 35. 34CONGRESSIONAL BUDGET OFFICE 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.
  36. 36. 35CONGRESSIONAL BUDGET OFFICE 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.

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