July 9, 1997

Congressional Research Service Analysis Supports
Treasury Estimates of Effects of Tax Bills

Analysis Criticizes Aspects of Joint Tax Committee Methodology

by Robert Greenstein

An analysis issued July 2 by the Congressional Research Service finds that the methodology the Treasury Department had used to measure the effects of the tax bills on different income groups is "more consistent with conventional economic analysis" than the methodology the Joint Tax Committee uses. CRS concludes: "Using measures more consistent with conventional economic analysis and the permanent provisions of the bills, the Treasury OTA's estimates indicate that by any distributional measure, the tax cuts favor higher income individuals in the House and Senate bills, with the effects more pronounced in the House bill." The CRS analysis also notes that some aspects of the Joint Tax Committee's methodology "can lead to peculiar results."(1)


Definition of Income

The CRS analysis supports the definition of income the Treasury has used in its analysis of the bills, a definition that was developed in 1984 by the Reagan Treasury Department and has been used since then by the Reagan, Bush, and Clinton Treasury Departments. CRS notes that compared to other income definitions, the Treasury definition of income "is the more accurate measure of economic income because it is more comprehensive."

CRS also notes that while the Treasury income definition results in a larger number of families being shown to have incomes over given income levels, this definition has little effect on the proportion of tax benefits shown to go to the various income quintiles, the top five percent of households, etc. CRS states: "This distribution [of the tax benefits of the House and Senate bills] by population shares is largely unaffected by choice of income concept."


Measuring Tax Cuts Only Through 2002

CRS states that "the time period is crucial in measuring the distribution because so many of the tax benefits are pushed into the future....Virtually none of the revenue cost of capital gains indexing appears in the budget horizon. Since capital gains are very concentrated among high income taxpayers, the time period can greatly affect the distribution of the tax benefit. The benefits of backloaded IRAs are also delayed into the future..." The Joint Tax Committee, however, measures effects only through 2002.

CRS states that the Treasury estimates provide "a better representation of the permanent distribution" of the tax cut benefits. The CRS paper indicates that if the Joint Tax Committee had prepared estimates for years beyond 2002, the Joint Committee's estimates would move closer to those the Treasury had produced. CRS also notes that even the Treasury estimates do not capture the full effects of capital gains indexing and that the Treasury estimates also do not include the effects of the estate tax reductions, implying that the Treasury estimates understate the degree to which the tax cuts ultimately would benefit those with high incomes.


Corporate Tax Cuts

The Treasury estimates include the effects of the corporate tax cuts in the bills. The Joint Tax Committee estimates, as well as other distribution estimates some Republican Members of Congress have cited, exclude the effects of the corporate tax cuts. CRS notes that Treasury's method of estimating the effects of the corporate tax reductions on different income groups is "consistent with the economic literature."


The Effects of Capital Gains Tax Cuts

CRS is critical of the approach the Joint Tax Committee uses to assess the effects of capital gains tax reductions on different income groups. Because the House and Senate bills reduce the capital gains tax rate, investors would sell some assets sooner than would otherwise be the case to take advantage of the lower tax rate. As a result, investors would pay some capital gains taxes in the next few years they would largely pay in later years if the capital gains tax rates were to remain unchanged. In addition, under the capital gains indexing provisions of the House bill, investors could elect to pay capital gains taxes in 2002 they otherwise would pay in subsequent years in return for the ability to use in future years the additional capital gains tax cut that indexing provides.

Investors would choose to sell more assets in the next few years and to pay some capital gains taxes in 2002 they otherwise would pay later only if they concluded they would make more money, and secure larger tax cuts over time, by doing so. The Joint Tax Committee, however, treats the tax payments investors would elect to make in the next few years, rather than in future years, as tax increases that would be imposed on them. The Joint Committee subtracts these "tax increases" from the tax cuts wealthy individuals would receive, making the net tax cut these individuals would get appear very small.

CRS is critical of this feature of the Joint Tax Committee's methodology. "The JCT approach can lead to peculiar results," CRS writes. "In the first year of a capital gains tax cut, the assumed realizations response [i.e., the increase in the sale of assets] is so large that capital gains revenue actually rises. Clearly, high income individuals who have capital gains have benefitted from the capital gains rate cut; yet in the distributional analysis of the JCT, the tax cut is shown as a burden."

End Notes

1. Jane G. Gravelle, Distributional Effects of the Proposed Tax Cut," Congressional Research Service, July 2, 1997. Gravelle is widely recognized as a leading expert in tax policy.