Adam N. Michel
As Republicans work to extend and expand the 2017 Tax Cuts and Jobs Act (TCJA) before it expires, politicians will relitigate the deceptive distributional statistics that purport to show who benefits most from tax cuts. These distribution tables are inherently limited, often grossly misleading, result in distorted policy outcomes, and make fundamental tax reform all but impossible.
Two questions should interest policymakers. First, did the tax change make individuals at different incomes better off, and by how much? Second, how did the tax reforms change the distribution of who pays how much tax (looking at the share of taxes paid, did the tax code get more progressive)?
The most often cited statistics on the share of total tax change by income group tell policymakers nothing useful about either question. When pundits say, for example, that 65 percent of the 2017 tax cut went to the top 20 percent of income earners, they are telling us nothing about people’s well-being or how the reform changed the distribution of taxes.
If we pay attention to the distribution tables, policymakers should focus on changes in after-tax income and percent changes in taxes paid. Using these two metrics, preliminary estimates for making the TCJA permanent indicate the law increases after-tax incomes for all income groups and cuts taxes the most for the lowest-income taxpayers.
Different Distributions of the Tax Cuts and Jobs Act
When Republicans passed the TCJA in 2017, government scorekeepers and numerous independent organizations released estimates of the law’s effects. The two tables below show how distributional estimates of tax changes, presented in different ways, can tell conflicting stories.
The first two columns in Table 1 report the Tax Policy Center and the Tax Foundation’s estimates of the TCJA’s effect on after-tax income from the time of passage. This measure tells policymakers if particular groups are made better off after the changes. The two sets of results from the TJCA tell a broadly similar story: all income groups saw higher after-tax incomes in 2018 following the tax cuts. The first two measures are not identical because the underlying models use different definitions of annual income and different methodologies for distributing some tax changes, like the corporate income tax.
The third column shows the Tax Foundation’s estimates for the dynamic change in after-tax income in 2027 if the TCJA were made permanent. Tax cuts like the TCJA—if permanent—have measurable medium- and long-run economic effects that lead to higher wages and a larger economy. Distributing these projected gains by income group, as the Tax Foundation does, shows that the initial inequalities in the static measures of tax changes are swamped by the economy-wide effects, with significant benefits at every income level. Still missing from this dynamic analysis is a measure of economic mobility, showing individuals’ ability to move between income groups over time.
Change in after-tax income tends to be economists’ preferred measure of tax changes because it shows a holistic measure of change in material well-being, scaled to their economic circumstances. However, the after-tax measures obscure the existing distribution of taxes and tell policymakers nothing about how the reform changes the tax code’s progressivity. Economist Jason Fichtner explains that “focusing solely on changes in after-tax income can be misleading because it implies that the amount of taxes currently paid is irrelevant to judging the equity of a proposed tax cut.”
Table 2 shows three additional measures of the TCJA’s distributional effects from the Tax Policy Center.
The first column shows the average dollar value of the tax cut by income group. Dollar values are useful in communicating the size of tax cuts in understandable numbers; percentages can be abstract and hard to contextualize for many people. However, when presented by income group, the tax cut’s size in absolute dollars leaves out critical information like the amount of taxes paid before the reform and the taxpayer’s base income.
The second column shows each income group’s share of the total tax change. This measure distributes the annual net tax cut (about $136 billion in 2018) based on income group. The share of total tax change is the least informative and most misleading statistic in distributional tables.
The share of total tax change is primarily a function of the underlying distribution of taxes paid before the reform. For example, if the TCJA had cut all income groups’ tax rates by an equal one percentage point, the share of the tax change would be identical to the pre-tax cut distribution of the tax burden.
Because the US tax burden is highly skewed toward upper-income taxpayers, any broad-based tax cut will follow a similar distribution. The top quintile of income earners was projected to pay 67 percent of the total federal tax burden absent the 2017 reform. The same group was projected to receive 65 percent of the 2017 tax cut’s benefit. A smaller tax cut share in relation to the underlying tax burden means the tax cuts were actually biased toward the lower-income groups. This is shown clearly in the final column.
The “share of tax change” metric gives policymakers a false impression about the distributional impacts of the tax reform. In this case, the TCJA actually increased the total share of taxes paid by the top quintile. This was born out in IRS data after the tax cuts, showing that the share of taxes paid by the top one percent of income earners increased from 38.5 percent in 2017 to 40.1 percent in 2018.
The final column shows the most informative measure: the percent change in each group’s taxes paid. This is also the percent change in average tax rates, which shows the tax cut relative to each income group’s pre-reform tax liability.
This measure is a direct function of how much money the government already takes from the taxpayer. For example, a one-percentage-point tax cut for someone paying an effective tax rate of 4 percent is a 25 percent reduction in their tax bill. The same one-percentage-point cut for someone facing a 25 percent tax rate is a much smaller 4 percent tax cut.
The change in taxes paid is the best measure to understand how tax reforms change the distribution of the tax system. Here, it is easier to see how the tax burden was shifted up the income distribution. Under the TCJA, each income group received a tax cut, but the highest-income groups received the smallest cuts relative to their total tax burden.
The data in Table 2 use the full federal tax base, which includes payroll and other taxes. The federal income tax burden is so heavily skewed toward higher-income earners that the bottom two quintiles paid negative income tax rates. These tax filers benefit from refundable tax credits that provide direct cash payments through the tax code, such as the child tax credit, the earned income tax credit, and Obamacare exchange credits.
You can’t give a federal income tax cut to people who don’t pay any income tax. However, an overreliance on targeting distributional tables—so that even the lowest-income taxpayers are shown as receiving a tax cut—incentivizes policymakers to increase spending programs in the tax code, as lawmakers did in 2017 by expanding the child tax credit.
Presenting averages for large groups can also cause problems, as it hides large dispersions of individual tax liabilities that are determined by more than just income. Fichtner discusses this in-depth in a 2004 analysis.
TCJA Permanence, Largest Tax Cuts to Lowest-Incomes
Distributional tax analysis will again be a key consideration as Congress prepares to make the tax cuts permanent. While the exact contours of the tax package are still being debated, we know that making the 2017 provisions permanent will have similar distributional effects as the original law.
The Tax Policy Center has estimated the effects of making the major individual tax provisions permanent. Their estimates show that TCJA permanence will make the tax code more progressive than the original 2017 law, sifting the tax burden further up the income distribution. As Figure 1 shows, the lowest income quintiles would benefit from the largest tax cuts under TCJA permanence relative to current law (which assumes the tax cuts expire). All income groups also have positive increases in after-tax income, with an average increase of 1.9 percent. Recent Tax Foundation analysis shows similar effects.
Standing in the Way of Reform
The distribution table statistics are primarily driven by the existing underlying distribution of the tax burden. Because higher-income Americans pay the vast majority of the income taxes, it means broad-based tax cuts will mechanically result in a similar distribution of the total tax cut. It also means that any reduction in lower-income tax burdens will be a meaningful tax cut simply because their starting tax burden was already comparatively low.
Fundamental tax reform of any type will require policymakers and the media to stop focusing so singularly on distribution tables. Rigid adherence to distributional analysis was behind the Biden-era campaign promise to not increase taxes on anyone earning less than $400,000 a year—a promise many progressives rightly noted would hamstring necessary (in their view) tax reforms. Such rigid adherence also keeps radical tax simplification, flat taxes, and consumption taxes from being seriously considered.