June 19, 1997
Joint Tax Committee Distribution Table of the Roth Bill Produce Misleading Results
Tables Fail to
Reflect Nearly All of the Benefits
from the Tax Cuts that Principally Benefit High-Income Taxpayers
According to distribution tables the Joint Committee on Taxation has prepared, the tax cuts proposed by Senator William V. Roth, chairman of the Senate Finance Committee, would concentrate a large share of their benefits among middle-class Americans. This finding is sharply at odds with the content of the legislation; three of the plan's largest tax cuts the capital gains, Individual Retirement Account, and estate tax provisions provide the large majority of their benefits to households with high incomes. The Joint Tax Committee's distribution tables also are at odds with the distribution tables the Treasury Department has prepared on the Roth proposal.
The Joint Committee's handling of capital gains, IRA, and estate tax provisions results in a misleading picture of how the tax cut benefits would be distributed. The Joint Tax Committee's distribution tables reflect only a small portion of the tax cut benefits that taxpayers would receive from these three provisions.
The Joint Tax Committee distribution tables do not include the effects of the large reductions in estate and gift taxes in the Roth plan. The Joint Committee did not examine the distributional effects of these tax changes.
The Joint Tax Committee distribution tables do consider the effects of the changes in the capital gains tax and the IRA provisions. The distribution tables, however, go only through 2002. Because the capital gains tax cuts and the IRA provisions are heavily backloaded, they result in relatively modest reductions in revenue collections during the time period the Joint Tax Committee examined. From 1997 to 2002, the combined revenue loss from these two provisions totals only $4.3 billion over six years.
The revenue loss from the capital gains tax and IRA provisions rises dramatically in the period from 2003 to 2007. The combined revenue loss from these provisions is $40.1 billion from 2003 through 2007, or more than nine times the $4.3 billion loss from 1997 to 2002. But the Committee's distribution tables stop with 2002 and fail to examine the distributional effects of the Roth plan in subsequent years.
If the Joint Tax Committee had examined the capital gains and IRA tax provisions when they were fully in effect and if it also had distributed the effects of the reductions in the estate taxes the degree to which the tax benefits of the Roth plan accrue to high-income taxpayers would be shown to be vastly larger than the Joint Committee on Taxation tables indicate.
Combining the capital gains, IRA, and estate tax provision yields a revenue loss of $68.7 billion from 2003 to 2007. This is 16 times the revenue loss of $4.3 billion from 1997 to 2002 reflected in the Joint Tax Committee distribution tables.(1)
By 2007, the combined cost of the capital gains, IRA and estate tax provisions is $18.2 billion. This is 25 times the average annual cost of $720 million reflected in the Joint Tax Committee distribution tables for 1997 through 2002. Eventually, the Roth plan becomes a piece of legislation whose predominant effect is to provide upper-income tax relief and enlarge the after-tax incomes of those in the wealthiest strata of society.
Changes in Joint Tax Committee Methodology Skew the Distribution Tables
Why are the Joint Tax Committee tables constructed as they are? It should be noted that the methodology the Joint Tax Committee has used in preparing the distribution tables on the Roth plan differs in important ways from the methodology the Joint Committee employed until late 1994.
On numerous occasions in past years, tax bills were introduced that phase in the tax cuts they contained. Accordingly, the Joint Tax Committee had to address on many prior occasions the question of how to estimate the distributional effects of tax provisions whose full effects would not be felt for more than five years. Until the end of the 103rd Congress, the Joint Tax Committee traditionally addressed this issue by examining the distributional effects of the proposed tax changes when the changes were fully in effect. This also is the approach most tax analysts endorse. But the Joint Tax Committee did not use this approach in analyzing the distributional effects of the Roth tax package. It thereby significantly understated the effects of the backloaded tax cuts in the Roth plan, which primarily benefit high-income taxpayers.
The Joint Tax Committee also has changed its methodology in another critical respect. The capital gains provisions of the Roth tax package are shown to increase tax collections from 1997 to 1999. This increase in collections does not reflect an increase in tax rates or a change in tax law under which previously exempt income is made subject to taxation. Rather, the increased collections reflect voluntary changes in behavior by taxpayers who choose to make tax payments in these years that they largely would have made in later years.
Specifically, the Joint Tax Committee estimates that the Roth capital gains provisions would produce a net increase in revenues of $8.6 billion from 1997 to 1999. These provisions would raise revenues initially because some investors would decide to take advantage of the new, lower capital gains tax rate to sell more assets than they otherwise would have sold in those years. The increased tax collections that result from the sale of an increased volume of assets in these years do not represent a tax increase the government has required investors to pay. To the contrary, the increase in tax collections would occur because some investors would elect to sell in the next two years some assets they otherwise would have sold at a later date. The investors would sell these assets because they concluded it was in their financial interest to do so.
The Roth IRA proposals also have this characteristic. These proposals, which primarily benefit taxpayers in the upper parts of the income distribution, are engineered so taxpayers can opt to pay taxes during 1999 through 2002 that they otherwise would pay in future years in return for very generous tax breaks for years to come. Here, also, affluent taxpayers would choose to accelerate a substantial amount of tax payments into the next several years because it would be in their interest to do so. And here again, the Joint Tax Committee treats these accelerated tax payments which taxpayers would elect to make to qualify for larger tax cuts in later years as tax increases being imposed on these taxpayers in the next several years.
Under the traditional methodology the Joint Tax Committee used in the past, the accelerated capital gains tax payments and IRA tax payments that individuals would elect to make in the next few years would not have been treated as tax increases imposed upon these individuals. It is only under the methodology the Joint Committee adopted in late 1994 that these additional revenue collections are treated as tax increases.
As a result of this change in methodology, the Joint Tax Committee's distribution tables reflect the incongruous assumption that the net effect of the Roth capital gains tax cut on wealthy investors is to saddle them with a tax increase from 1997 to 1999. This assumption is a clear demonstration of why the Joint Tax Committee's distribution tables are seriously flawed and distort the effects of current tax proposals on households at different income levels.
Leading Analysts Reject New Joint Tax Methodology on the Distribution of Capital Gains Tax Benefits
Many of the leading analysts in the field reject the new Joint Tax Committee method as producing severe distortions in the distribution of the benefits that a capital gains tax cut produces. Among those rejecting the new Joint Tax Committee approach are: Robert Reischauer, former director of the Congressional Budget Office; Henry Aaron, senior fellow at the Brookings Institution; and Jane Gravelle, the Congressional Research Service's leading tax expert and analyst. In addition, several years ago Gravelle co-authored an article on this matter with Lawrence Lindsey, a noted conservative economist who served until recently on the Federal Reserve Board and who supports a capital gains tax cut. In their article, Lindsey and Gravelle explicitly rejected the methodology the Joint Tax Committee has now adopted.
As Aaron has observed, investors who respond to a capital gains tax cut by selling more assets are people who face one set of opportunities under the current capital gains tax rates and find it financially advantageous not to make additional asset sales but face a more generous set of opportunities when capital gains tax rates are reduced and choose to follow a different course. "Since they have the option of doing what they did before (i.e., not selling additional assets), but the new, more favorable tax rates induce them to do something else, they must be better off," Aaron explains. "It is logically absurd to count them as worse off in any way whatsoever."
Aaron's view is supported by an article Gravelle and Lindsey co-authored in 1988 before Lindsey joined the Fed. In the article they stated:
"... suppose a reduction in the capital gains tax rate led to substantially more capital gains realizations [i.e., more sales of assets] and actually increased the tax revenue paid by upper-income groups....it would be totally inappropriate to say that their tax burden had increased. After all, with a lower tax rate, these upper-income taxpayers are less burdened than they were before, even though they pay more taxes."(2)
In addition, in a more recent analysis examining the new Joint Tax Committee methodology, Gravelle notes that the standard methodology, if anything, understates the benefits that investors would secure from a capital gains tax cut because it does not reflect the tax benefits they would receive when they voluntarily sell more assets to take advantage of a lower capital gains tax rate. She also observes that economists generally would reject the new methodology.
1. The $4.3 billion figure reflects the costs of the capital gains and IRA provisions from 1997 to 2002. As noted, the Joint Tax Committee's distributional tables ignore the changes in estate taxes.
2. This quote is from Jane G. Gravelle and Lawrence B. Lindsey, "Capital Gains," Tax Notes, January 25, 1988, p. 399. Gravelle included this quote in Jane G. Gravelle, "Distributional Effects of Tax Provisions in the Contract with America as reported by the Ways and Means Committee," CRS Report for Congress, April 3, 1995.