Although economic analysis can be used to estimate the distribution of the tax system, or a tax change (a positive or descriptive analysis), it cannot be used to provide a normative or prescriptive analysis. Is a Progressive Federal Tax Structure Justified? The income tax is progressive, and even provides subsidies (negative taxes) for lower-income working individuals, often through the earned income credit. The corporate income tax is imposed on corporate profits as a proportional tax, but its burden on individuals depends on behavioral responses, as discussed subsequently in the " Incidence Assumptions " subsection of this report. Yet the standard does not answer the question of how much more. How Should Income in the Economy be Distributed? It is also important to keep in mind that even if the federal tax is progressive, such progressivity may be needed to offset state and local taxes that tend to be regressive, in order to avoid an overall regressive U.S. tax system. When effective tax rates rise with income a tax system is progressive, it is proportional when effective tax rates are relatively constant, or regressive, if effective tax rates fall as income increases. The measure of income can also affect impressions of tax burden unless distributional tables are presented based on population shares rather than measures of income. For example, imposing an excise tax may lead to a price increase. At the same time, all sources depict a similar qualitative picture about the progressivity of the federal tax burden distribution. Payroll, or social insurance, taxes rise slightly and then fall. The estate tax is the most progressive of all, although it is small. The estimates in Table 11 reflect current federal law; the actual pattern of tax changes will depend on whether and to what extent the 2001 and 2003 tax cuts are made permanent and what changes might be made to the alternative minimum tax, which, if it is not addressed, will eventually apply to a very large fraction of taxpayers, especially those with large families. Nevertheless, examining tax burdens from a lifetime perspective is likely to reduce the progressivity of the tax system, as some of the progressivity observed in a single cross section reflects the tendency of individuals to have lower incomes in the early and later years of life. Some of the measures that have been presented include (1) the share of taxpayers benefitted that fall below an income level; (2) the percentage reduction in taxes paid; (3) the tax cut as a percentage of income (both pre-tax and disposable); (4) the distribution of the tax cut by income class; and (5) the average tax cut. As suggested in the previous section, the percentage change in federal tax liability shows the largest percentage changes at the lower income and the smaller ones at higher levels, except for the very top level. A very different picture is presented with the distributional effect measured as a change in after tax income based on analysis by the Brookings-Urban Tax Policy Center (TPC), using the measure they favor, percentage change in after tax income. Thus, while the Treasury table seems to suggest that this group benefitted more than average ("15%" as compared with an overall benefit of 11%), many people would not characterize the relative benefits in this way.
Distributional issues often lie at the center of tax policy debates. Distributional analysis may address several issues: How should the tax burden be distributed or, are progressive (increasing as a share of income as income rises) taxes justified? What is the estimated distribution of the current system? How does a particular proposal change that distribution?
Unlike many analyses that study optimal behavior related to allocative issues and economic efficiency, economic analysis cannot be used to answer the questions of how the tax burden should be distributed. Such an answer would depend on social preferences. Economic analysis can, however, identify trade-offs and frame the issue analytically. For example, a number of plausible answers to this question could justify progressive tax structures.
Methodological issues, such as the income classifier, the unit of analysis, and assumptions regarding incidence all affect the estimates of the distribution of the current tax burden. Yet all show a similar qualitative result: the federal tax system is progressive throughout its range, although it tends to get much flatter at the top. This pattern is primarily due to the individual income tax, which is quite progressive, and actually provides subsidies at lower-income levels. The other major tax is the payroll tax, which is a larger burden than the individual income tax for more than 80% of the population. This tax is first progressive and then regressive (effective tax rates fall with income). The corporate income and the estate taxes, while much smaller, are also progressive, whereas excise taxes are regressive. This overall progressive pattern has been in place historically, and is expected to continue in the future, although effective tax rates are currently low compared with other periods.
Unlike the federal tax system, state and local taxes tend to be regressive. Thus, a progressive federal tax system would be necessary to prevent overall U.S. taxes from being regressive. The combined taxes appear slightly progressive. Looking at taxes from a lifetime perspective would move the system more toward a proportional tax because average lifetime incomes reduces the variability of income. Studies have suggested that overall lifetime taxes are roughly proportional to income.
Many different measures have been used to characterize the effects of a particular tax change on the distribution of income. A very different impression of tax changes may be obtained depending on the measure used. One popular measure, the percentage change in tax, can be misleading, because as taxes become very small even a negligible absolute change in taxes leads to a very large percentage change. For measuring the relative distribution of income, percentage change in disposable income provides a better measure of how resources are distributed. By this measure, the recent tax cuts made incomes less equal.
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