Distribution tables—estimates of who wins and who loses from changes in tax law—are central to any debate about tax reform. Such analyses frequently show the plans put forward by Republican politicians to be severely regressive, delivering large income gains for high-income families and little for the overwhelming majority of families. The blueprint for tax reform released by House Republicans in 2016, for example, would increase after-tax incomes for the top 1 percent of families by 13 percent in the first year after enactment but would increase incomes for the bottom 95 percent of families by less than half of 1 percent.
In response, proponents of regressive tax plans often assert—either implicitly or explicitly—that distribution analysis is flawed and fails to account for the benefits of the additional economic growth that the plans would purportedly generate. This view is mistaken. A traditional distribution analysis provides an approximation of the change in economic well-being resulting from a change in tax law. Distribution analysis is thus useful precisely to determine whether tax reform delivers gains for people across the income distribution or only for those at the top.
In the special case of revenue-neutral reform—an ostensible target for current reform efforts in Congress—distribution tables capture the primary gains from increases in economic efficiency in their estimates of changes in after-tax income. In the case of revenue-losing reform, distribution tables overstate the gains from reform, as apparent increases in after-tax incomes will ultimately need to be clawed back through offsetting tax increases or spending cuts. Only in the case of revenue-raising reform will distribution tables understate the gains. Thus, in the most likely cases for tax legislation this fall, distribution tables will either reflect or overstate the gains from any increases in economic efficiency, to the extent they exist at all.
Simply stated, invocations of growth cannot be used to wave away regressive distribution results. Reforms such as the 2016 House Republican blueprint would boost incomes for high-income families at the expense of working- and middle-class families. As Republicans in Congress and the Trump administration continue to develop a proposal for tax reform, it is worth revisiting in this column—and an accompanying issue brief—why traditional distribution tables are precisely the analytical tool they will need to determine if their tax reform plan does, in fact, deliver equitable growth.
Distribution analysis estimates the change in tax burden resulting from a change in tax law assuming no change in behavior. These estimates of the change in the tax burden can then be used to compute a range of summary statistics, including the average tax change, the percentage change in income, or the percent of families getting a tax cut or tax increase for various subgroups of the population.
Critics of distribution analysis often point to the assumption that behavior does not change when tax reform is enacted as a flaw in the analysis. Yet the assumption that behavior is unchanged provides a better approximation of the change in economic well-being resulting from a proposal than allowing behavior to change because the behavioral responses have little direct value to the people changing their behavior.
Why are the behavioral changes of little direct value to families? Because families generally do the best they can in the economic circumstances in which they find themselves; modest changes in behavior due to tax reform do not change their own well-being much at all. If the behavioral changes were to matter a great deal, then it would imply that families were knowingly making choices against their own interest—such as turning down good job offers—before tax reform.
While distribution analysis is appropriately conducted under an assumption of fixed behavior, that does not mean there are no potential economic benefits from behavioral changes that result from tax reform. Gains are possible, but they primarily manifest through their impact on the government budget. For instance, if people change their consumption patterns in response to a new limitation on an unjustified tax expenditure that finances a rate reduction, then those changes will generally improve the government’s fiscal position. This improvement in the government’s fiscal position will make it possible for legislators to provide what appears to be a net tax cut under the assumption of unchanged behavior at no cost to the government. In other words, if a revenue-neutral tax reform plan generates increases in economic efficiency, then the distribution analysis will show a net tax cut even if the cost of the tax reform to the government is zero.
It is precisely legislators’ choices about how to design a tax plan that will determine how that free-to-the-government tax cut is allocated across the income distribution. Indeed, it should not be surprising that the impact of changes in public policy are determined by legislators’ choices about how to change public policy. Recognizing that the potential gains in economic well-being for U.S. families derive from how legislators choose to distribute tax cuts made possible by improvements in the government’s fiscal position appropriately places the focus on the choices legislators make.
Focusing on growth in economic output rather than changes in well-being as measured by distribution analysis not only ignores the potential for tax reform to have different impacts across the income distribution, but also overstates the economic gains from reform by counting increased output as a benefit without accounting for the costs of generating that output. Indeed, the greater risk in the coming months is not that distribution analysis will understate the gains from tax reform, but rather that distribution analysis will overstate the gains and understate the regressivity due to its treatment of increased borrowing should policymakers turn from revenue-neutral tax reform to tax cuts.