The Tax Policy Center has changed the way it calculates income. The new definition, which TPC calls “expanded cash income” or ECI, will raise measured income for most taxpayers. ECI includes sources of income TPC previously excluded such as employer contributions to retirement plans and health insurance, income earned by retirement accounts, and food stamp (SNAP) benefits.     At first glance, this extra income will make it look as if households are getting a tax rate cut compared to TPC’s old model: They are paying the same amount of tax but on more measured income than before. Thus, their effective tax rate is lower. The change doesn’t mean Americans are getting richer or paying lower taxes. But it does mean TPC is more accurately figuring how much we do make. Why is TPC changing its model?  Two reasons. First, ECI is a more accurate measure of income. After all, employer-sponsored health insurance and returns from tax-preferred retirement accounts improve our well-being as much as wages or income from taxable investments.   Second, the new income measure will improve TPC’s ability to evaluate broad-based tax reform. It is likely that some proposals would tax sources of income we have not, until now, included. For instance, if Congress debates whether to tax employer-sponsored health insurance it would be odd to include those levies when we calculate tax rates without also adding the benefits to measured income. Similarly, an across-the-board limit on tax preferences could tax some insurance and retirement income. We need to expand our definition of income to understand how those changes will affect different households. Measuring income is really hard. There are lots of ways to do it, and none is perfect. Adjusted Gross Income (AGI) is most the familiar and that was what TPC used in its first model. It uses the tax code’s definition of income, but excludes many sources. So, in 2004,TPC created a broader measure we called cash income. Cash income includes AGI plus employee contributions to retirement accounts, tax-exempt municipal bond interest, non-taxable Social Security and pension income, cash transfers from the government,  the employer’s share of payroll taxes, and corporate tax liability (which is ultimately paid by individuals as investors or workers). But it still excluded some big sources of income.   ECI is all cash income plus employer-paid health insurance and other nontaxable fringe benefits, employer contributions to tax-preferred retirement savings plans, accruals within defined benefit pension plans, inside buildup in defined contribution retirement accounts such as 401(k)s, and SNAP. TPC still excludes Medicare and Medicaid benefits. The Congressional Budget Office, the congressional Joint Committee on Taxation, and the Treasury all use their own definitions of income. They are similar, but not identical, to one another and to TPC. Measuring income really is hard.   How does ECI change the way we measure income? Take someone with an annual salary of $50,000 who contributes 5 percent ($2,500) to her 401(k) and receives a 5 percent employer match, and whose employer pays $10,000 for her health insurance. Assuming she is single, has no dependents and takes the standard deduction, she’ll pay $5,304 in federal income tax in 2013. Her AGI is $47,500 ($50,000-$2,500) and her effective tax rate 11.2 percent  ($5,304/$47,500). Her cash income is greater--$53,825 ($50,000+$3,825 ($50,000 x .0765) in employer-paid employment taxes). By this measure, her effective tax rate drops to 9.9 percent. Her ECI is bigger yet--$66,325 ($53,825+$2,500 from her employer’s 401(k) match plus $10,000 in health insurance premiums). Based on her ECI, her effective tax rate falls to 8.0 percent. More broadly, the shift to ECI also changes the way income classes look. Combined with updated economic assumptions and other technical changes, income is higher and effective tax rates lower for each group.  For example, take those households in the middle 20 percent of income. Using the cash income measure TPC estimated that in 2013 this group will make between $39,800 and $64,500 and pay an average effective tax rate of 15.4 percent. But with ECI and other adjustments, middle quintile households will make between $45,500 and $76,100 and pay an effective tax rate of just 12.4 percent. Similarly, we had estimated that the top 1 percent of the income distribution began with households making $506,000. The average effective tax rate for the Top 1 percent was 35.7 percent.  With the updated model, entry into the top 1 percent requires more income—at least $551,000. And that group’s average effective rate falls to 31.4 percent Keep in mind that the shift from cash income to ECI adds more income for some households than others. For example, a household that gets employer-sponsored health insurance may move up the income distribution compared to a household that does not.     This change will take some getting used to. But, in the end, it will result in a more accurate measure of income and a better way to analyze major proposed changes to the Revenue Code.