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Snapshot for May 31, 2006.

How to spot a progressive tax cut

The new head of President Bush’s Council of Economic Advisers, Edward Lazear of Stanford University, recently wrote in the Wall Street Journal that the president’s tax cuts have made the tax code more progressive.  This statement caps a long-standing campaign by conservative ideologues to muddle the concept of “progressive taxation.”  Economists disagree about many things, but there is a long-standing consensus that a “progressive” tax is one in which the average rate—i.e., tax liability divided by income—rises as income increases.  The tax code may be dubbed “more progressive” under a spurious White House definition of progressivity, but not according to any valid, commonly accepted one.

Taxes are a “burden” because, obviously enough, they reduce the income available for personal use.  (Taxes also finance public programs that provide benefits to households that are not necessarily counted as income, but that side of the government’s accounting ledger is not considered here.)  Advocates justify a progressive tax burden, defined in terms of a rising average effective rate of tax (ERT) because it reduces the inequality of after-tax income, compared to a flat, proportional tax or one with a falling ERT.  Most sales or consumption taxes have a falling ERT because saving tends to rise with income.

So, can we say that the president’s tax cuts have reduced the inequality of after-tax income?  The two major tax cuts since 2000 are the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, and the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003.  Their impact, estimated by William Gale and Peter Orszag of the Brookings Institution, is shown in the chart below.

The impact of the cuts is clearly uneven across the income scale.  In fact, the results are also uneven within the top quintile (see the chart’s three right-hand bars).  As shown, the gains of the top one percent are well above even the rest of the top 20% of the population, let alone the other 80%.

When the Bush Administration claims that it has improved the progressivity of taxes, it points to the percentage changes in shares of income taxes paid as evidence.  But as the chart shows, reaping large percentage cuts in taxes for those who pay little to begin with does little to boost the after-tax income of those at the bottom of the scale.  In other words, what matters most is not the change in what you pay in taxes, but the change in what you have left afterward.  In reality, the distribution of the after-tax gains was stacked heavily in favor of the highest-income taxpayers.

Source:  William G. Gale and Peter R. Orszag, “Bush Administration Tax Policy: Distributional Effects,” Tax Notes, September 27, 2004, pp. 1559-1566.

This week’s Snapshot was written by EPI economist Max B. Sawicky.