At the core of the political debate over the Tax Cuts and Jobs Act is an intense and sometimes emotional argument over who benefits. Not only do analysts and policymakers disagree over whether the tax cuts would tilt to those with middle-incomes or the wealthy, they can’t even agree on how to measure who benefits from the changes.
The soundest approach is to examine how a change in tax policy affects a household’s after-tax income. This shows the proportionate change in each household’s standard of living, and it is the featured measure reported in Tax Policy Center analyses.
Others, however, use different measures, such as the percentage change in taxes paid or changes in the share of taxes paid by an income group. For example, these metrics were used by the Joint Committee on Taxation in its recent report on the House and Senate tax bills. They are also occasionally used by other analysts and organizations.
These alternative measures, however, can be misleading. To see how, consider a simple example. Start with our current tax system where the top 1 percent pays 25 percent of all federal taxes. Now, imagine that everyone’s taxes are cut to zero except the richest person, who has to pay $1. If you measure the share of taxes paid, you would conclude that the share paid by the highest income households would increase to 100 percent of the total. That would “look like” a tax increase on the rich. But, by any reasonable definition, those high-income taxpayers would be getting the largest tax cut.
Similar problems arise from looking at the percentage change in taxes paid. Suppose one household earns $30,000 and pays $1 in federal income tax. Another household earns $30 million and pays $10 million in taxes. A tax proposal that cut the first person’s tax by $1 and the second person’s tax by $5 million would “look like” a bigger tax cut for the poorer household (a 100 percent reduction in taxes compared to a 50 percent reduction). To bring this debate back to the real world, we would all, of course, rather earn $30 million than $30,000, but holding that constant, who would you rather be: Someone whose taxes are cut from $1 to zero -- a 100 percent reduction in taxes paid -- or someone whose taxes are cut from $10 million to $5 million, only a 50 percent tax cut?
Both of these alternative measures also run into difficulties when dealing with refundable tax credits. This is because a refundable credit can actually make someone’s net tax liability negative, which complicates the calculation for changes in the share of taxes paid or percentage reduction in taxes, but can be accurately reflected as an increase in after-tax income. (This sometimes causes the Joint Committee on Taxation distribution tables to include a special note for particular income categories.)
With all of this in mind, focusing on changes in after-tax income paints a much clearer picture and poses less risk of being misleading.
