The Senate Tax Cuts and Jobs Act, as Passed by Senate (12/2/17): Static Distributional Analysis

Summary

This brief presents the static distributional impact of the Senate Tax Cuts and Jobs Act (TCJA), as passed on December 2, 2017, under two measures: the traditional measure and as tax shares. While the traditional measure receives the bulk of the media attention, it faces large shortcomings. Tax shares more closely relate to the income distribution measure that economists generally agree upon. The Senate TCJA has only a modest impact on tax shares.

Key Points

  • Under standard assumptions, the traditional measure indicates that in 2019, 33 percent of the reduction in taxes in the Senate plan accrues to households in the top one percent of the income distribution. By 2027, this group receives almost 43 percent of the tax change and, by 2040, 48 percent.

  • In contrast, the share of taxes paid by households in the top one percent of the income distribution is only moderately lower under the Senate TCJA. Under current policy, the top one percent will pay 28 percent of federal income taxes by 2027, rising to 30 percent by 2040 due to increasing progressivity over time under current policy. Under TCJA, their tax share falls to 26 percent by 2027 and returns to 28 percent by 2040.

  • By 2040, the top one percent will pay a slightly larger share of the nation’s tax base under TCJA relative to what they pay today under current policy, although both figures round to 28 percent.


The Senate Tax Cuts and Jobs Act, as Passed by Senate (12/2/17): Static Distributional Analysis

Introduction

Penn Wharton Budget Model (PWBM) recently analyzed both the static and dynamic analysis revenue and macroeconomic effects of the Senate Tax Cuts and Jobs Act (TCJA), as passed by the Senate on December 2, 2017. This brief describes the distributional effect of the Senate TCJA under the traditional measure and as tax shares. We previously reported distributional analysis of the House tax plan.

Distribution of the Federal Taxes Under Current Policy

The current U.S. tax system is highly progressive, with higher income households paying a greater share of total taxes than lower income households. While the first year of tax changes in the Senate bill is 2018, we focus on 2019, the year the corporate income tax changes to 20 percent, to show the first year that all policy changes in the bill are in effect. The year 2027 is another key date, as many changes to individual income taxes in the Senate TCJA will have sunsetted. The year 2040 provides a longer-term view.

Table 1 shows that, under current policy1, households in the top one percent of the income distribution will pay 28 percent of the nation’s total tax bill in 2019, while households in the bottom 40 percent pay a little more than one percent. The U.S. federal tax system becomes more progressive by 2040 under current policy.

Table 1: Share of Federal Taxes Paid Under Current Policy by Adjusted Gross Income (AGI)

Year
Adjusted Gross Income
(percentile)
2018
(percent)
2019
(percent)
2027
(percent)
2040
(percent)
0-20 0.3 0.3 0.3 0.1
20-40 1.1 1.2 1.3 0.7
40-60 6.1 6.2 6.6 4.4
60-80 16.9 16.9 16.8 15.6
80-90 16.0 16.0 16.0 16.1
90-95 12.8 12.8 12.6 13.2
95-99 19.2 19.1 18.9 19.9
99-99.9 15.1 15.1 15.1 16.2
99.9-100 12.5 12.5 12.5 14.0

Notes: Federal taxes include individual income tax (net of the outlays for refundable credits), payroll taxes, corporate income taxes and estate and gift taxes. Other transfers, such as ACA subsidies, are not included. Corporate income taxes are allocated under the assumption that owners of capital bear 75 percent of the tax burden.

Following the Joint Committee on Taxation, which is staffed by leading tax experts, the values shown in Table 1 assume that 75 percent of corporate tax rates are allocated to owners of capital. The other 25 percent is borne by labor in the form of lower wages. We return to this assumption below.

A Brief Primer on Distributional Analysis

Before we report distributional analysis for the Senate TCJA, a brief primer on distributional analysis is helpful. Much of the media’s existing focus on the distributional impact of the TCJA is missing valuable information that is likely more informative of the true distributional impact of the TCJA.

Inspired by the Nobel-prize winning contribution of James Mirrlees, economists typically focus on the distribution of post-fisc income, which considers income net of taxes and transfers. As Mirrlees showed, optimal tax policy weighs (a) the general society benefit from redistributing income from high to low earners against (b) the economic distortions caused by reducing the incentive of high income earners to do the work that is needed to produce their high levels of income and the tax base. If there were no economic distortions, the optimal system would levy a confiscatory tax (100% tax rate) on all income and then distribute the proceeds equally to everyone, thereby collapsing the post-fisc income distribution and fully eliminating income inequality. Of course, an abundant amount of evidence shows that taxes do distort economic activity, and so the tradeoff is important. Put differently, the optimal distribution of post-fisc income is not empty.

Under the Mirrlees approach, distribution analysis reports the post-fisc income distribution before and after a policy change, and not just the change in post-fisc income by income class. Calculating the post-fisc income distribution, therefore, requires a very detailed modeling of both taxes and transfers. While some existing distributional analysis includes transfer income, it generally does not include potential interactions with tax reform. For example, a tax reform could change the take-up rate of SNAP and other programs. While PWBM has built out an integrated individual, payroll and business tax simulation module that includes transfer payments under current policy, we are currently still in process of modeling the interaction between tax and transfer programs. As such, we are not ready to report a full post-fisc income distribution.

Instead, PWBM reports two “reduced form” distributional measures: the traditional measure and tax shares. Neither measure is a perfect substitute for the post-fisc income distribution, but the traditional measure is likely more problematic of the two for the type of tax cuts considered under the Senate TCJA.

The traditional distributional measure indicates the share of the total value of the tax cut that accrues to various income groups. The most commonly cited measure in the media, in particular, reports the share of the total value of the tax cut that is projected to be received by the top one percent of income earners.

However, the traditional measure faces two significant shortcomings. First, the traditional measure ignores the fact that, under current policy, Table 1 shows that the top one percent of income earners already pay 28 percent of the nation’s federal tax bill, including individual taxes, payroll taxes, corporate income taxes as well as estate and gift taxes. As a result, even a proportional tax cut that, for example, reduced everyone’s tax bill by 10% would appear to accrue more to top income earners. Second, the traditional measure ignores the fact that the tax share paid by top income earners is increasing under current policy due to “real bracket creep” and other tax law features. Accordingly, even a tax cut that rewards the top one percent of income earners by more than 28 percent might, at least over time, simply reset their tax shares to its current level.2 Moreover, that reset might be optimal under the Mirrlees redistribution-distortion trade-off discussed above, especially if the current tax shares are deemed close to optimal.

In contrast, tax shares report the total fraction of taxes paid by income group, addressing these two problems. Tax share analysis, however, is potentially not a reliable sufficient statistic for the Mirrlees tax problem for dramatic and differential reductions in the tax base by income. However, for more modest tax reforms, like the Senate TCJA, changes in tax shares likely provide a more accurate reflection of changes in the post-fisc income distribution.

Importantly, both measures, only capture the intra-generational distributional impact of tax changes. As such, both measures don’t include the impact of the deficit financing in the Senate TCJA. To capture this effect, inter-generational distribution calculations, similar to Generational Accounting or, its close cousin, Generational Imbalances are required. PWBM is currently building out these measures as well.

Traditional Measure of Senate TCJA

Under the traditional distribution measure, many of the Senate’s TCJA tax changes appear to work to both increase and decrease progressivity. For instance, TCJA increases the standard deduction, which lowers the tax burden of lower-income households. However, the bill also eliminates personal exemptions, which increases their tax burden. In addition to 2018, the first year policies of the Senate bill are implemented, we also show 2019, when the new corporate rates are introduced.

Table 2 shows that the largest reduction from TCJA accrues to households in the top one percent of the income distribution, who, in 2019, receive 33 percent of the drop in taxes. In 2019, the middle quintile gets 6.4 percent of the reduction and the bottom quintile gets 0.3 percent of the reduction. By 2027, the top one percent of the income distribution receives 43 percent of the reduction in taxes, and by 2040, 48 percent of the total reduction in taxes. Households in the bottom three income quintiles receive less than 5 percent of the tax cut in 2040.

Table 2: Share of the Total Value of TCJA Tax Cut Received by AGI

Year
Adjusted Gross Income
(percentile)
2018
(percent)
2019
(percent)
2027
(percent)
2040
(percent)
0-20 0.2 0.3 0.2 0.3
20-40 0.9 1.2 1.1 0.7
40-60 6.5 6.4 6.3 3.6
60-80 21.3 18.4 15.3 13.3
80-90 16.0 14.2 11.2 11.1
90-95 9.2 8.6 5.6 6.9
95-99 18.3 18.2 16.8 15.8
99-99.9 19.3 20.1 25.5 26.4
99.9-100 8.3 12.5 17.9 21.8

Notes: Federal taxes include individual income tax (net of the outlays for refundable credits), payroll taxes, corporate income taxes and estate and gift taxes. Other transfers, such as ACA subsidies, are not included. Corporate income taxes are allocated under the assumption that owners of capital bear 75 percent of the tax burden.

Tax Share Analysis of Senate TCJA

Using the tax share measure, Table 3 shows the share of taxes paid by income group under current policy and under TCJA. Overall, the shares of tax paid remains fairly stable after the adoption of TCJA.

In 2019, the share paid by the top one percent of the income distribution is 28 percent under both current policy and TCJA. By 2027, the tax burden falls from 28 under current policy percent to 26 percent under the TCJA. By 2040, the burden falls from 30 percent to 28 percent. Due to increasing progressivity over time under current policy, the top one percent pay a slightly larger share of the nation’s tax base by 2040 under TCJA relative to what they pay today under current policy, although both figures round to 28 percent.

Moreover, the share of taxes paid by the top 10 percent of the income distribution remains even more stable, at 60 percent under both current policy and TCJA in 2019 and 59 percent in 2027. By 2040, the share falls from 63 to 62 percent, but higher than current policy today.

Table 3: Share of Federal Taxes Paid with 75 Percent of Corporate Income Taxes Allocated to Owners of Capital

Current Policy Tax Cuts and Jobs Act
Adjusted Gross Income
(percentile)
2018
(percent)
2019
(percent)
2027
(percent)
2040
(percent)
2018
(percent)
2019
(percent)
2027
(percent)
2040
(percent)
0-20 0.3 0.3 0.3 0.1 0.3 0.3 0.3 0.1
20-40 1.1 1.2 1.3 0.7 1.1 1.2 1.3 0.7
40-60 6.1 6.2 6.6 4.4 6.1 6.5 6.6 4.4
60-80 16.9 16.9 16.8 15.6 16.6 16.6 16.9 15.8
80-90 16.0 16.0 16.0 16.1 16.0 15.6 16.4 16.6
90-95 12.8 12.8 12.6 13.2 13.1 12.8 13.2 13.8
95-99 19.2 19.1 18.9 19.9 19.2 19.2 19.1 20.3
99-99.9 15.1 15.1 15.1 16.2 14.9 15.0 14.2 15.1
99.9-100 12.5 12.5 12.5 14.0 12.8 12.8 12.1 13.2

Notes: Federal taxes include individual income tax (net of the outlays for refundable credits), payroll taxes, corporate income taxes and estate and gift taxes. Other transfers, such as ACA subsidies, are not included.

Sensitivity Analysis: Alternative Allocations of the Corporate Tax Incidence

As noted earlier, the above analysis assumes 75 percent of corporate taxes are distributed to owners of capital, with the remaining 25 percent distributed to workers in the form of lower wages. This distribution choice impacts both the traditional distributional analysis as well as tax shares, since owners of capital are more concentrated in higher income households.

Table 4 shows the tax shares under current policy and TCJA under the assumption that capital owners now gain 100 percent of the benefit from a cut in corporate taxes under TCJA. In sharp contrast, Table 5 shows the tax shares when capital owners receive only 25 percent of the benefit. Quite naturally, the Senate TCJA causes the tax shares paid by the top one percent of the income distribution to fall slightly more in Table 4 than in Table 5. However, even in Table 4, the change in tax shares is not substantial. In fact, the top one percent of income earners will still pay a larger share of the nation’s tax bill in 2040 under TCJA than they will under current policy in 2018.

Table 4: Share of Federal Taxes Paid with 100 percent of Corporate Income Taxes Allocated to Owners of Capital

Current Policy Tax Cuts and Jobs Act
Adjusted Gross Income
(percentile)
2018
(percent)
2019
(percent)
2027
(percent)
2040
(percent)
2018
(percent)
2019
(percent)
2027
(percent)
2040
(percent)
0-20 0.3 0.3 0.3 0.1 0.3 0.3 0.3 0.1
20-40 1.1 1.1 1.2 0.6 1.1 1.1 1.2 0.6
40-60 5.8 5.9 6.3 4.1 5.8 6.0 6.4 4.2
60-80 16.4 16.4 16.3 14.9 16.2 16.4 16.5 15.3
80-90 15.6 15.5 15.6 15.5 15.6 15.8 16.1 16.1
90-95 12.6 12.5 12.4 12.8 12.8 12.9 13.0 13.5
95-99 19.2 19.1 18.9 19.8 19.2 19.2 19.0 20.2
99-99.9 15.7 15.7 15.6 16.9 15.4 15.1 14.7 15.7
99.9-100 13.5 13.5 13.5 15.3 13.6 13.2 12.9 14.1

Notes: Federal taxes include individual income tax (net of the outlays for refundable credits), payroll taxes, corporate income taxes and estate and gift taxes. Other transfers, such as ACA subsidies, are not included.

Table 5: Share of Federal Taxes Paid with 25 percent of Corporate income Taxes Allocated to Owners of Capital

Current Policy Tax Cuts and Jobs Act
Adjusted Gross Income
(percentile)
2018
(percent)
2019
(percent)
2027
(percent)
2040
(percent)
2018
(percent)
2019
(percent)
2027
(percent)
2040
(percent)
0-20 0.3 0.3 0.2 0.0 0.3 0.2 0.3 0.0
20-40 1.3 1.3 1.4 0.8 1.3 1.3 1.4 0.7
40-60 6.6 6.7 7.1 4.9 6.5 6.6 7.0 4.8
60-80 17.9 17.9 17.8 16.9 17.5 17.5 17.7 16.8
80-90 16.8 16.8 16.9 17.3 16.7 16.7 17.1 17.5
90-95 13.4 13.3 13.1 14.0 13.5 13.5 13.6 14.4
95-99 19.2 19.2 18.9 20.1 19.3 19.2 19.1 20.4
99-99.9 14.0 14.0 13.9 14.7 13.9 13.9 13.3 14.0
99.9-100 10.5 10.5 10.6 11.3 11.1 11.0 10.5 11.2

Notes: Federal taxes include individual income tax (net of the outlays for refundable credits), payroll taxes, corporate income taxes and estate and gift taxes. Other transfers, such as ACA subsidies, are not included.

Conclusion

The Tax Cuts and Jobs Act proposes significant changes to both individual and corporate taxes. Under the traditional measure, TCJA appears to mainly benefit higher income earners. However, in terms of tax shares paid by income, TCJA has a modest impact. In fact, due to rising tax progressivity over time under current policy, higher income households will eventually pay the same or slightly larger fraction of the nation’s tax burden under TCJA than they do today under current policy, on a static basis.

However, if the government is unable to pay for TCJA’s tax cuts with reductions in spending, then a greater amount of debt will be shifted toward future taxpayers. This important inter-generational wealth transfer, which can have a deleterious impact on a dynamic economy, requires complementing standard intra-generational distributional measures with inter-generational distributional analysis.


  1. PWBM’s integrated model includes both revenue and spending policy. For our tax simulator, we model “current law” that allows tax provisions to expire as scheduled, consistent with JCT’s approach. For our spending side, we model “current policy” that does not, for example, allow changes to mandatory changes when, for example, the Social Security’s trust funds are exhausted. For debt calculations and dynamic analysis, this integration provides a more holistic analysis since some government benefit formulas, including the initial calculation of Social Security benefits upon retirement, are explicitly tied to the growth in average wages throughout a participant's lifetime.  ↩

  2. To be sure, between the tax reform date and some future date, the top one percent of income earners might pay a tax share that is lower than current policy values today. However, keeping the tax share constant over time requires time-indexation of tax policy variables, which is very complicated. Given that the Senate’s TCJA has little impact on tax shares, this consideration seems second order in importance.  ↩