TPC produces distribution tables that provide information on how a tax proposal affects different households and thus the progressivity or regressivity of the tax system. For reasons discussed below, there is no perfect measure of how tax changes affect household welfare. We thus present a variety of measures of the effects of tax changes, but argue that the percentage change in after-tax income is the most reliable measure of the overall effects on the distribution of wellbeing.

Ideally, we would like our tables to measure the impact that a tax proposal has on the distribution of economic wellbeing across households (what economists refer to as "utility" or welfare), but that is an abstract concept that cannot be directly measured. In practice, there is no perfect measure of the distributional impact of a tax change. We assume that a household's economic wellbeing, or welfare, is closely linked to its after-tax income. Current after-tax income measures the annual new resources available to a household to devote to consumption or saving. Thus, the most informative distributional measure may be the percentage change in after-tax income. A tax cut that increases everyone's after-tax income by the same percentage leaves the relative distribution of after-tax income unchanged. A tax cut that increases after-tax income proportionately more for lower- than for higher-income taxpayers will make the tax system more progressive (or less regressive). One that increases after-tax income proportionately more for higher-income taxpayers than for lower-income taxpayers will make the tax system less progressive (or more regressive). Note that since the income tax is one of the most progressive taxes in the federal system, an across-the-board income tax cut that left the progressivity of the income tax unchanged would still make the overall tax system less progressive, because proportionally less revenue would be collected from the most progressive sources.

Some analysts believe that other measures, such as the share of the tax cut received, and the size of the tax cut in both absolute dollars and as a percentage of initial tax liability, are more accurate representations of the distribution of tax burdens. Each of these measures is useful for certain purposes, but can be misleading. The share of a tax cut received by each income group may be misleading because the income tax is highly progressive. For example, high-income taxpayers may garner a large share of an income tax cut, but the tax system could still become more progressive if high-income households’ share of the tax cut is smaller than their share of after-tax income.

The tax cut in dollars may be similarly misleading because high-income households have substantially more income than others and pay more tax. Thus, even a progressive tax cut (that is, one that gives a bigger percentage increase in after-tax income to lower-income households than to higher-income households) is often larger in dollar terms for higher-income households than for lower-income households.

A third measure, the percentage change in tax liability, may be extremely misleading if it is used to assess the impact of a tax proposal on the change in the relative wellbeing of households with different incomes. Because low-income taxpayers pay less tax than high-income taxpayers under any system where taxes depend on ability to pay, a small tax cut for a low-income household can yield an enormous percentage reduction in tax liability, even though it does not raise after-tax income significantly. For example, consider one household that earns $20,000 and pays $1 in taxes and another that earns $2 million and pays taxes of $500,000. Suppose that legislation is enacted that provides a $1 tax cut for the low-income household and a $100,000 tax cut for the high-income household. The percentage reduction in tax liability is 100 percent for the low-income household but only 20 percent for the high-income household. In terms of its effect on current household resources, such a tax cut increases the after-tax income of the poor household by only 0.005 percent while increasing after-tax income of the wealthy household by 5 percent. Relying on the percentage change in tax liability makes the tax cut appear to be tilted toward the low-income household even though the legislation provides the high-income household with a percentage increase in after-tax income that is 1,000 times larger than the low-income household’s negligible change in tax.

TPC's distribution tables also show the impact of a tax proposal on effective tax rates (ETR). In general, an ETR expresses tax liability as a share of pretax income. Thus, a household with income of $100,000 that pays $15,000 in federal taxes would have an effective tax rate of 15 percent. Clearly, ETRs are highly sensitive to the definition of income used in the denominator and to which taxes are included in the numerator. Including more taxes in the analysis would tend to drive the average ETR up, whereas using a broader definition of income would tend to drive it down.

Two other considerations in measuring the effect of tax changes on progressivity are: (1) which taxes to include, and (2) how to measure income. TPC includes the following federal taxes in its calculation of tax burdens: individual and corporate income taxes; payroll taxes for Social Security and Medicare; excise taxes; and the estate tax. The ideal measure of income would be as closely related to economic wellbeing as possible. TPC uses a broad measure of income called Expanded Cash Income (ECI). We define ECI as adjusted gross income (AGI) plus: above-the-line adjustments (e.g., IRA deductions, student loan interest, self-employed health insurance deduction, etc.), employer paid health insurance and other nontaxable fringe benefits, employee and employer contributions to tax deferred retirement savings plans, tax-exempt interest, nontaxable Social Security benefits, nontaxable pension and retirement income, accruals within defined benefit pension plans, inside buildup within defined contribution retirement accounts, cash and cash-like (e.g., SNAP) transfer income, employer’s share of payroll taxes, and imputed corporate income tax liability.

Finally, it is important to note that the ultimate effect of any proposal that lowers or raises overall tax burdens will depend on how the tax change is financed. For example, a regressive tax increase (such as imposition of a value-added tax) could end up being progressive if the revenues finance even more progressive social spending. A progressive tax cut, such as an increase in the earned income tax credit for people without qualifying children, could ultimately be regressive if other even more progressive programs were cut to pay for it.

Updated January 2024