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Frameworks for Distributional Analyses

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Congressional Budget Office January 4, 2016 Frameworks for Distributional Analyses Annual Meeting of the Allied Social Science Associations San Francisco, California Kevin Perese Principal Analyst, Tax Analysis Division


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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. CONGRESSIONAL BUDGET OFFICE 1


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Distributional Analyses Have Historically Been Tax-Centric CONGRESSIONAL BUDGET OFFICE 2


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Distributional Analyses Have Historically Been Tax-Centric Why? • 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. CONGRESSIONAL BUDGET OFFICE 3


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Distributional Analyses Have Historically Been Tax-Centric Who Has Been Performing These Analyses? • • • • Joint Committee on Taxation Congressional Budget Office, Tax Analysis Division Treasury Department, Office of Tax Analysis Tax Policy Center (Urban Institute/Brookings Institution) CONGRESSIONAL BUDGET OFFICE 4


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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. CONGRESSIONAL BUDGET OFFICE 5


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CBO’s Current Distributional Framework (Based on Before-Tax Income) CONGRESSIONAL BUDGET OFFICE 6


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CBO’s Current Distributional Framework Used to rank households and as the denominator in average tax rate calculations Cash and In-Kind Govt. Transfers Market Income + = Before-Tax Income ‒ = After-Tax Income Direct and Indirect Federal Taxes CONGRESSIONAL BUDGET OFFICE 7


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Distribution of Household Income, Government Transfers, and Federal Taxes, 2006 (CBO’s Current Distributional Framework) Dollars Quintiles Lowest Market Income + Government Transfers = Before-Tax Income − Federal Taxes = After-Tax Income Average Federal Tax Rate (Percentage of Before-Tax Income) Second Middle Fourth Highest All Households 14,700 28,800 49,400 79,700 234,100 81,400 7,100 12,300 12,100 10,400 8,900 10,200 21,800 41,100 61,500 90,000 243,000 91,600 1,300 4,000 8,600 16,100 62,500 18,700 20,600 37,100 52,900 73,900 180,400 72,800 5.7 9.8 14.1 17.9 25.7 20.5 CONGRESSIONAL BUDGET OFFICE 8


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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. CONGRESSIONAL BUDGET OFFICE 9


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Market Income Distributional Framework CONGRESSIONAL BUDGET OFFICE 10


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Market Income Distributional Framework Cash and In-Kind Govt. Transfers Market Income + = Used to rank households and as the denominator in average tax rate calculations Before-Tax Income ‒ = After-Tax Income Direct and Indirect Federal Taxes CONGRESSIONAL BUDGET OFFICE 11


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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 crosssectional analyses. CONGRESSIONAL BUDGET OFFICE 12


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After-Tax Income Distributional Framework CONGRESSIONAL BUDGET OFFICE 13


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After-Tax Income Distributional Framework Cash and In-Kind Govt. Transfers Market Income + = Used to rank households and as the denominator in average tax rate calculations Before-Tax Income ‒ = After-Tax Income Direct and Indirect Federal Taxes CONGRESSIONAL BUDGET OFFICE 14


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After-Tax Income Distributional Framework Strengths Shortcomings • After-tax income is a proxy for overall economic wellbeing. • 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. CONGRESSIONAL BUDGET OFFICE 15


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Trying to Strike a Balance CONGRESSIONAL BUDGET OFFICE 16


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Trying to Strike a Balance Cross-Sectional Analysis Large Intergenerational Transfers CONGRESSIONAL BUDGET OFFICE 17


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Gross Income Distributional Framework CONGRESSIONAL BUDGET OFFICE 18


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Gross Income Distributional Framework Social Insurance Transfers Market Income Means-Tested Transfers + = + = Gross Income Before-Tax Income Used to rank households and as the denominator in average tax rate calculations CONGRESSIONAL BUDGET OFFICE ‒ = After-Tax Income Direct and Indirect Federal Taxes 19


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Gross Income Distributional Framework Strengths Shortcomings • The framework allows analysts to calculate meanstested 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. CONGRESSIONAL BUDGET OFFICE 20


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Going From Before-Tax Income Quintiles to Gross Income Quintiles Shuffles the Households. CONGRESSIONAL BUDGET OFFICE 21


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Overlap Between Gross Income Quintiles and Before-Tax Income Quintiles, 2006 Percentage Points Before-Tax Income Quintiles Lowest Middle Fourth Highest Total Lowest Gross Income Quintiles Second 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 CONGRESSIONAL BUDGET OFFICE 22


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Second Quintile Before-Tax Income Lowest Quintile CONGRESSIONAL BUDGET OFFICE 23


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Second Quintile Gross Income Before-Tax Income Lowest Quintile CONGRESSIONAL BUDGET OFFICE 24


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Second Quintile Gross Income Before-Tax Income Lowest Quintile From Middle, Fourth, and Highest Quintiles CONGRESSIONAL BUDGET OFFICE 25


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Second Quintile Gross Income Before-Tax Income Lowest Quintile CONGRESSIONAL BUDGET OFFICE 26


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Second Quintile Gross Income Before-Tax Income Lowest Quintile From Middle, Fourth, and Highest Quintiles CONGRESSIONAL BUDGET OFFICE 27


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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 CONGRESSIONAL BUDGET OFFICE 28


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A Hypothetical Policy Change $3,500 3,500 Government Benefit Received 3,000 2,500 2,000 1,500 1,000 500 0 0 50 100 150 200 250 300 350 400 Recipient’s Income as a Percentage of the Federal Poverty Guidelines CONGRESSIONAL BUDGET OFFICE 450 500 29


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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? CONGRESSIONAL BUDGET OFFICE 30


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Change in After-Tax Income Resulting From the Hypothetical Policy Change, Before-Tax Income Distributional Framework $ 3,000 2,500 Refundable Tax Credit 2,000 1,500 1,000 500 0 Lowest Quintile Second Quintile Middle Quintile Fourth Quintile CONGRESSIONAL BUDGET OFFICE Highest Quintile All Households 31


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Change in After-Tax Income Resulting From the Hypothetical Policy Change, Before-Tax Income Distributional Framework $ 3,000 2,500 Refundable Tax Credit 2,000 Means-Tested Transfer 1,500 1,000 500 0 Lowest Quintile Second Quintile Middle Quintile Fourth Quintile CONGRESSIONAL BUDGET OFFICE Highest Quintile All Households 32


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Change in After-Tax Income Resulting From the Hypothetical Policy Change, Gross Income Distributional Framework $ 3,000 2,500 Refundable Tax Credit 2,000 Means-Tested Transfer 1,500 1,000 500 0 Lowest Quintile Second Quintile Middle Quintile Fourth Quintile CONGRESSIONAL BUDGET OFFICE Highest Quintile All Households 33


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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. CONGRESSIONAL BUDGET OFFICE 34


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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. CONGRESSIONAL BUDGET OFFICE 35


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