NCPA - National Center for Policy Analysis

TAX REFORM: WHO WILL PAY?

January 20, 2005

Regardless of what proposal President Bush's tax reform commission comes up with, the principal debate will be how much more or less each income class will pay relative to current law, says Bruce Bartlett, a senior fellow with the National Center for Policy Analysis.

There are two different concepts of distributional equity, says Bartlett:

  • Horizontal equity means that individuals with roughly the same income should pay about the same taxes.
  • Vertical equity has to do with ensuring that those with a greater ability to pay (the rich) pay a higher share of their income in taxes than the poor.

However, distribution tables used to analyze these effects distort reality in several ways.They tend to make people look richer than they are; for example, by assuming that the same capital gains would be realized regardless of how they are taxed. But obviously, people will realize more gains if the rate is reduced, thereby paying more taxes.

According to a new Treasury Department study:

  • Between 1996 and 2000, capital gains revenues more than doubled even though the maximum tax rate fell from 29.19 percent to 21.19 percent.
  • Although the rich paid most of these higher taxes, distribution tables showed them getting a huge tax cut.
  • Distribution tables exclude the higher incomes that may result from growth-oriented tax changes and implicitly assume that people are in the same income class year after year.

A new study by the Congressional Budget Office shows the high degree of income mobility of Americans by looking at the same group of individuals over a long time.One finding is that when households are classified by income, those in the second quintile (20 percent) of households had an income 26 percent higher when viewed over a 14-year period than when measured on an annual basis.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, January 19, 2005.

 

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