Tax Policy Center (TPC) uses a broad measure of pre-tax income, which we call “expanded cash income” or ECI, to analyze the distribution of federal taxes. The purpose of an income classifier is to proxy for taxpayers’ economic well-being and their ability to pay taxes. The measurement of income also matters importantly for the calculation and interpretation of effective tax rates (ETRs), the amount of taxes paid measured as a percentage of income. An income measure that understates economic income overstates effective tax rates and the burden of tax policy changes, measured either as the change in ETR or the percentage change in after-tax income. If omitted sources of income vary across households, taxpayers may be incorrectly ranked and calculated tax burdens will not accurately reflect the true distribution, either within or across income groups.

In the initial versions of the tax model, TPC used adjusted gross income (AGI) as the income classifier because it was readily available on income tax returns. But AGI has serious deficiencies. It is far from comprehensive—causing many households to be mischaracterized—and its definition can change with changes in tax law. It excludes such items as untaxed Social Security and pension benefits, tax-exempt employee benefits, income earned within retirement accounts, and tax-exempt interest. Beginning in 2004, most TPC tables reported tax burdens relative to cash income, a broader measure of income equal to AGI plus 1) above-the-line adjustments, 2) employee contributions to tax-preferred retirement accounts, 3) tax-exempt interest, 4) nontaxable Social Security and pension income, 5) cash transfers, 6) the employer share of payroll taxes and 7) imputed corporate tax liability. A description of TPC’s previous income measures is available here.

In mid-2013, TPC began using ECI, an income measure that is broader than cash income. ECI equals cash income plus 1) tax-exempt employee and employer contributions to health insurance and other fringe benefits, 2) employer contributions to tax-preferred retirement accounts, 3) income earned within retirement accounts, and 4) food stamps. For a more complete description and analysis of ECI, see “Measuring Income for Distributional Analysis” (July, 2013).

The primary motivation for adopting this broader income measure was to characterize differences in the economic status of individual taxpayers more completely and accurately. By construction, income concepts that closely align with current tax rules—such as AGI—understate the relative economic well-being of taxpayers who benefit most from some major tax preferences. This is especially important in the context of evaluating more comprehensive tax reform proposals that contemplate taxing income sources that are not included in narrower measures (e.g., proposals to tax some or all employer contributions to health insurance or to reduce the amount of tax-free income earned within qualified retirement plans by placing tighter limits on contributions).