Congressional Budget Office September 13, 2017 Methodological Improvements for CBO’s Analysis of the Distribution of Household Income Distributional Tax Analysis Conference Washington, DC Kevin Perese and Bilal Habib Tax Analysis Division As developmental work for analysis for the Congress, the information in this presentation is preliminary and is being circulated to stimulate discussion and critical comment.
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Two major methodology changes in the forthcoming report on the distribution of household income: • New income measure for ranking households and calculating average federal tax rates • Correction for underreporting of means-tested transfers in household survey data 2 CONGRESSIONAL BUDGET OFFICE
Distributional Analyses Have Historically Been Tax-Centric Why? 3 CONGRESSIONAL BUDGET OFFICE
Distributional Analyses Have Historically Been Tax-Centric • Everyone pays taxes (either directly or indirectly). • The tax system has explicit progressive/redistributive properties. • There are high-quality tax data. • There is a lot of theoretical work on tax incidence in the economics literature. 4 CONGRESSIONAL BUDGET OFFICE
But there’s more to government than just taxes . 5 CONGRESSIONAL BUDGET OFFICE
Increasingly, the distinction between tax and spending policies is more about the legislative process and less about the impact on households . 6 CONGRESSIONAL BUDGET OFFICE
CBO will use a new framework to analyze how means-tested transfers and federal taxes jointly affect the distribution of household income. 7 CONGRESSIONAL BUDGET OFFICE
CBO’s Previous Distributional Framework 8 CONGRESSIONAL BUDGET OFFICE
CBO’s Previous Distributional Framework Market Income Labor Income : Wages and salaries Business Income : Income from businesses and farms Capital Income : Capital gains, interest, and dividends Other Income : Mainly retirement income 9 CONGRESSIONAL BUDGET OFFICE
CBO’s Previous Distributional Framework Social Security Cash and In-Kind Medicare Government Transfers Medicaid Supplemental Nutrition Assistance Program + Unemployment Insurance Housing Assistance Market Income 10 CONGRESSIONAL BUDGET OFFICE
CBO’s Previous Distributional Framework Cash and In-Kind Government Transfers + = Market Before-Tax Income Income 11 CONGRESSIONAL BUDGET OFFICE
CBO’s Previous Distributional Framework Cash and In-Kind Government Transfers + = Market Before-Tax Income Income ‒ Federal Taxes Individual Income Taxes Payroll Taxes Corporate Income Taxes Excise Taxes 12 CONGRESSIONAL BUDGET OFFICE
CBO’s Previous Distributional Framework Cash and In-Kind Government Transfers + = Market Before-Tax After-Tax Income Income Income ‒ = Federal Taxes 13 CONGRESSIONAL BUDGET OFFICE
CBO’s Previous Distributional Framework Used as the basis for ranking Cash and In-Kind households and as the denominator Government Transfers in average tax rate calculations. + = Market Before-Tax After-Tax Income Income Income ‒ = Federal Taxes 14 CONGRESSIONAL BUDGET OFFICE
CBO’s Previous Distributional Framework Strengths Shortcomings • Before-tax income, a broad • The framework is tax-centric, income measure, is a proxy so it is less suitable for for both overall economic distributional analysis of well-being and ability to pay government transfers. tax liabilities. • Therefore, the redistributive Before-tax income is • properties of transfers and therefore an appropriate taxes are not treated equally. denominator for calculating average federal tax rates. 15 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework 16 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Market Income Labor Income : Wages and salaries Business Income : From businesses and farms Capital Income : Capital gains, interest, and dividends Other Income : Mainly retirement Income 17 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Social Security Social Insurance Medicare Benefits Unemployment Insurance + Market Income 18 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Social Insurance Benefits + = Mkt Income Market Plus Social Income Insurance 19 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Medicaid Social Insurance Means-Tested Supplemental Nutrition Benefits Transfers Assistance Program Housing Assistance, etc. + = + Mkt Income Market Plus Social Income Insurance 20 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Social Insurance Means-Tested Benefits Transfers + = + Mkt Income Market Plus Social Income Insurance ‒ Federal Taxes Individual Income Taxes Payroll Taxes Corporate Income Taxes Excise Taxes 21 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Social Insurance Means-Tested Benefits Transfers + = + Mkt Income Market Plus Social Income Insurance ‒ Federal Taxes Taxes Before Refundable Credits Individual Income Taxes Payroll Taxes Refundable Tax Credits Corporate Income Taxes (significant portions Excise Taxes classified as budgetary outlays) 22 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Social Insurance Means-Tested Refundable Benefits Transfers Tax Credits + = + Mkt Income Market = After-Tax Plus Social Income Income Insurance ‒ Federal Taxes Before Refundable Credits 23 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Social Insurance Means-Tested Refundable Benefits Transfers Tax Credits + = + Mkt Income Market = After-Tax Plus Social Income Income Insurance ‒ Federal Taxes Used as the basis for ranking households Before Refundable and as the denominator in average Credits tax and transfer rate calculations. 24 CONGRESSIONAL BUDGET OFFICE
CBO’s New Distributional Framework Strengths Shortcomings • The framework allows • The measure of income— analysts to calculate means- market income plus social tested transfer rates, tax insurance benefits—does not rates, and net tax and fully represent one’s ability transfer rates. to pay tax liabilities. It recognizes that life-cycle • • Social insurance programs income patterns make social have some redistributive insurance benefits difficult to effects that the framework analyze in a cross-sectional does not capture. framework. 25 CONGRESSIONAL BUDGET OFFICE
Average Federal Tax Rates Market Income Before-Tax Plus Income Social Insurance Versus Framework Benefits Framework 26 CONGRESSIONAL BUDGET OFFICE
Average Federal Tax Rates by Income Group, 1979 to 2013 Percent 30 Highest Quintile 25 20 Fourth Quintile 15 Middle Quintile 10 Second Quintile Before-Tax Income as Denominator and Household Ranking Measure 5 Lowest Quintile 0 1980 1985 1990 1995 2000 2005 2010 -5 27 CONGRESSIONAL BUDGET OFFICE
Average Federal Tax Rates by Income Group, 1979 to 2013 Percent 30 Highest Quintile 25 20 Fourth Quintile 15 Middle Quintile 10 Second Quintile Before-Tax Income as Denominator and Household Ranking Measure 5 Lowest Quintile Market Income Plus Social Insurance Benefits as Denominator and Household Ranking Measure 0 1980 1985 1990 1995 2000 2005 2010 -5 28 CONGRESSIONAL BUDGET OFFICE
Differences between the frameworks are primarily at the bottom of the income distribution. Differences can be decomposed into two, partially offsetting, steps: 1. New denominator, and 2. New household rankings. 29 CONGRESSIONAL BUDGET OFFICE
Average Federal Tax Rates, by Select Income Groups, 1979 to 2013 Percent 20 15 Second Quintile 10 Before-Tax Income as Denominator and Household Ranking Measure 5 Lowest Quintile 0 1980 1985 1990 1995 2000 2005 2010 -5 30 CONGRESSIONAL BUDGET OFFICE
Average Federal Tax Rates, by Select Income Groups, 1979 to 2013 Percent 20 Market Income Plus Social Insurance Benefits as Denominator and Before-Tax Income as Household Ranking Measure 15 Second Quintile 10 Before-Tax Income as Denominator and Household Ranking Measure 5 Lowest Quintile 0 1980 1985 1990 1995 2000 2005 2010 -5 31 CONGRESSIONAL BUDGET OFFICE
Average Federal Tax Rates, by Select Income Groups, 1979 to 2013 Percent 20 Market Income Plus Social Insurance Benefits as Denominator and Before-Tax Income as Household Ranking Measure 15 Second Quintile 10 5 Lowest Quintile Market Income Plus Social Insurance Benefits as Denominator and Household Ranking Measure 0 1980 1985 1990 1995 2000 2005 2010 -5 32 CONGRESSIONAL BUDGET OFFICE
Average Federal Tax Rates, by Select Income Groups, 1979 to 2013 Percent 20 15 Second Quintile 10 Before-Tax Income as Denominator and Household Ranking Measure 5 Lowest Quintile Market Income Plus Social Insurance Benefits as Denominator and Household Ranking Measure 0 1980 1985 1990 1995 2000 2005 2010 -5 33 CONGRESSIONAL BUDGET OFFICE
Correcting for Underreporting of Government Transfers A Regression-Based Approach With Preliminary Results 34 CONGRESSIONAL BUDGET OFFICE
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