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3 FAMILY ECONOMIC INCOME AND OTHER 

INCOME CONCEPTS USED IN ANALYZING 

TAX REFORM 

Susan C. Nelson 

I. INTRODUCTION 

In analyzing the distributional consequences of the Tax Reform Act of 1986 

(TRA86), the choice of the income measure by which taxpayers are classified 

into income groups is an important one. The effects of a particular set of 

tax changes can look very different under different definitions of income. 

Similarly. the choice of the population to be examined-taxpayers under current 

law or all potential taxpayers-and the way people are grouped-by tax units as 

defined by current law filing rules or by natural family units-also influence 

the apparent impact of tax reform. 

In order to analyze tax changes in a meaningful way, the income classifier 

should be as consistent as possible with the principles of equity that will be 

applied to the tax system. The members of each income class should be viewed 

as being about equally well off, and those in higher-income classes should be 

considered consistently better off than those in lower income groups. 

Since the release of Tax Reform for Fairness, Simplicity, and Economic 

Growth in November 1984. the Treasury Department has used a measure termed 

"family economic income" (FEI) in its distributional analyses of tax proposals. This paper explains what is meant by family economic income and how 

that measure attempts to implement the theoretical concept of income commonly 

endorsed by economists for use in tax analysis. The paper also discusses some 

of the limitations of using FEI for public policy analyses. The paper 

compares family economic income with other measures used in tax analysis for 

classifying taxpayers according to their relative well-being. specifically 

adjusted gross income (AGI) and the version of expanded income currently used 

by the Joint Committee on Taxation (JCT). which is referred to here as 

Til~ autlror is very grateful to Don Fulh'rto11. James" Nttnns. Ell.!;t'IIL' Steualc•. Eric Toder. 

porticipams of tht• OTA Work in Progress Seminar Series. and other past and present nu•mbcrs of 

the 01A staff for comments 011 this papa. JamL'S Cilkt• pro1•ided invaluable' programming 

assistance. and Carolyn Gn•e11e was extn•mely hrlpful in preparing rlw manuscript and tables. 

77 
78 Susan C. Nelson 

"modified expanded income" or MEl. Finally, the apparent distributional 

effects of TRA86 with each of the three income measures as the classifier are 

presented and examined. 

In brief, FEI differs from AGI and MEl in several ways: 

o Family. FEI uses the family unit rather than the tax return for 

analyzing the distributional effects of taxation. Families with nearly 

equal incomes are more likely to be viewed as being in "equal" circumstances. a requirement for equity analyses. than are tax units with 

equal incomes. Dependents who fiJe their own tax returns are, for 

analytical purposes only, combined with those who support them, and the 

family is put in the appropriate income class. 

o Nonfilers. Families and individuals who do not file tax returns under 

present law are included in analyses based on FEI and MEl, whereas they 

are usually excluded from analyses using AGI. 

o Income. FEI is a comprehensive measure of income, independent of the 

prevailing tax law. To the extent feasible, it approximates economists' notion of income as consumption plus change in real net worth. 

It includes many forms of income not reported on tax returns, it 

measures more accurately other forms of income that are subject to tax, 

it attempts to avoid double-counting of income, and it adjusts for 

inflation. 

ln examining the distributional consequences of the Tax Reform Act of 

1986-an act which substantially broadened the tax base and restructured the 

tax system-family economic income provides a useful standard because of its 

independence from a particular tax law, as well as its solid conceptual 

foundation in a comprehensive definition of income. 

II. BACKGROUND 

Quantifying family economic income in a microdata file suitable for 

analyzing alternative tax proposals as the Treasury Department has done may be 

a recent occurrence, but the concept of economic income has been a fundamental 

part of economic thought for decades. Under the Haig-Simons definition of 

income (named after its use by Haig (1921) and Simons (1938)), income is the 

amount that a family or individual consumes in a particular time period plus 

the net increase or decrease in the value of their assets. This definition is 

cited repeatedly in academic discussions of income.

1 

It reflects economic 

well-being, or command over resources, because it is the amount that could be 

consumed without reducing net worth. 

In spite of the wide acceptance within the economics profession of the 

concept, empirical tax analyses have seldom attempted to measure economic 

income because of a lack of data. Many of the components of economic income 

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Family Economic Income 79 

are reported neither on tax returns nor on other national surveys. The 

Treasury Department's first large-scale attempt at overcoming the data 

problems and approximating economic income came in 1976 in preparation for 

Blueprints for Basic Tax Reform. That report moved towards a comprehensive 

measure of economic income, although a narrower concept termed "comprehensive income" was often used to classify tax units for distributional analyses. 

In congressional testimony in 198l, the Treasury Department analyzed the 

effect of "flat tax" proposals on the distribution of the tax burden by 

"uniform income" class, an income definition similar to economic income. 

As part of the Treasury Department • s 1984 study of tax reform that led to 

Tax Reform for Fairness, Simplicity. and Economic Growth, substantial improvements were made in the data base used for analysing tax reform proposals. 3 The new data base permitted a closer approximation of the theoretical 

notion of economic income and enabled tax units to be grouped into families. 

01. WHAT IS FAMILY ECONOMIC INCOME? 

"Family economic income." as developed by the Office of Tax Analysis 

(OT A). is an income measure that applies to all members of the U.S. population 

according to the family in which they live, regardless of whether or not they 

file a tax return under current law. 

A. Families 

For many people. the tax unit and the family are the same. A family can. 

however, consist of several tax filing units if dependents have incomes of 

their own. If children who are dependents for tax purposes have jobs or have 

investment funds in their own names. they may have to file returns to pay 

taxes or to receive refunds of taxes that were withheld. Yet, the standard of 

living of these "dependent fLiers" derives less from their own income than 

from the income of their families. Similarly, the family may support other 

family members who do not qualify for the dependent's tax exemption. ln these 

instances, the family is more meaningful than the tax-filing unit for classifying people in similar circumstances and for assessing the distributional 

4 burden of the tax system. 

For example, in a family with income of $50,000 a year a teenager may have 

a part-time job and show the same income on his or her tax return as a welfare 

mother working occasionally for the minimum wage. The child and the economic 

unit headed by the mother are not, in a meaningful sense, in similar economic 

circumstances, however. 

In order to analyze the distributional consequences of tax proposals that 

include any form of consumption tax-such as excise taxes or a value-added tax 

(VA T)-using the family is particularly imponant. While most income and 

income taxes can be attributed to separate family members, it is unclear how 
80 Susan C. Nelson 

to allocate the family's consumption spending, and the accompanying consumption taxes, among individuals. Much family spending is jointly consumed-such 

as housing-and even individual consumptiorrsuch as food and clothing-is 

unlikely to be related to the income of the dependent family member. 

Therefore, for analyzing income and consumption tax proposals, family 

economic income combines the incomes and the taxes of dependents with the 

incomes and taxes of those (usually parents) who support them. In 1983, there 

were 96 million tax returns filed, but the returns came from only 78 million 

different families. 

B. Nonr.Jers 

Since current law does not require all families and adult individuals to 

file tax returns, using the tax return unit as the basis for analyzing the 

distributional effects of tax reform omjts the effect on current-law nonfilers. Some nonfilers have too little income, or only nontaxable forms of 

income. Of 92 million families (including unrelated individuals who Jive 

alone or in groups) in 1983. over 13 million were nonfilers. AJmost half of 

the elderly and most families below the poverty line are nonfilers. 

In many cases the differences between filers and nonfilers are rather 

arbitrary. Many nonfilers have incomes from nontaxable sources-such as social 

security, welfare, and tax-exempt interest-as high as tax filers who receive 

income only from taxable sources. Other filers may have the same amount of 

income from the same source as nonfilers, but file simply to receive refunds 

of withheld taxes or of the Earned Income Tax Credit. Since assessments of 

tax equity should depend on how alternative tax systems treat individuals and 

families with similar amounts of income regardless of the sources. it is 

important to include both filers and nonfilers in any distributional analyses. 

Moreover, proposals to broaden the tax base might impose taxes on some who are 

nonfilers under current law and exempt some who presently file from paying 

tax. Tax analyses based solely on tax returns could not provide any 

information on nonfilers. 

C. Definition of Family Economic Income 

In attempting to quantify the Haig-Simons concept of income as consumption 

plus change in net worth. family economic income, as developed by OT A for the 

1984 Treasury report, adds together all the forms of income reported on 

individual tax returns (making adjustments where necessary for correct 

economic measurement) plus estimates of forms of income not reported on tax 

returns. Where possible. income is measured on an accrual basis: where that 

is not possible. realizations are used as a proxy. Family economic income 

attempts to allocate to individuals all the pre-tax income in the economy from 

resources owned by individuals. 

Family economic income can perhaps be most easily understood through 

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Family Economic Income 81 

comparisons with two commonly-used measures of income: "personal income" 

and "adjusted gross income." 

I . Comparison with Personal Income 

In the aggregate, the measure to which economic income is most similar is 

personal income (PI) as defined and measured in the National Income and 

Product Accounts (NIP A). Like personal income, "economic income" attempts 

to account for all the income of persons in the economy. 

There are a few notable differences between personal income and family 

economic income, however, as Table 3. 1 indicates. The largest difference is 

that FEI includes real retained pretax corporate earnings, which amounted to 

$155 billion in 1983. This reflects the view that corporations are not 

separate from their stockholders, but that the income of a corporation is 

Table 3. 1 COMPARISON OF PERSONAL INCOME AND 

FAMILY ECONOMIC INCOME, 1983 

Personal Income 

(Billions) 

$2,744.2 

Plus: Items in Family Economic Income Not in Personal Income 259.8 

Personal contributions for social insurance 

Real pretax corporate retained earnings 

Inflation adjustments on: 

Interest expenses, including mortgage 

Interest received 

Real net gain from sale of noncorporate assets 

119.6 

154.6 

51.9 

-88.0 

21.7 

Minus:ltems in Personal Income Not in Family Economic Income 101.5 

Federal hospital and supplementary medical insurance 

Miscellaneous government transfers 

Investment income received by nonprofit institutions 

or retained by fiduciaries 

Minus: Miscellaneous differences in measurement 

and definition-net 

Equals: "Family Economic Income" 

57.2 

19.3 

25.0 

20.4 

$2.882.1 

Source : Office of Tax Analysis. and Survev of Current Business. July 1984. April 1985. 

and July 1985. 
82 Susan C. Nelson 

income to the individuals who own it. either directly or indirectly through 

pensions and life insurance funds. On the other hand, the $25 billion of 

income of nonprofit institutions and fiduciaries, which is part of PI, is 

excluded from FEI. Although income of non profits does become income to 

someone-the student paying below-cost tuition, the poor receiving charitythere is no obvious way to allocate it to individuals. 

The next largest difference is that family economic income includes the 

$120 billion of "personal contributions for social insurance," whereas 

personal income does not. FEI is the family's pre-tax economic income. 

Inclusion is consistent with the view that the link between present contributions and future benefits is weak and uncertain, that the contributions are 

in effect taxes and that the social security benefits are transfer payments. 

Excluding the contributions from income suggests that the contributions and 

the benefits are viewed more like pension contributions and pension benefits. 

Some of the other differences between PI and FEI also relate to the 

characterization of transfer payments. Family economic income includes cash 

transfer payments but excludes in-kind payments (except for food stamps which 

function so much like cash), primarily because of the problems of valuation. 

Family economic income. therefore. excludes the $57 billion of "federal 

hospital and supplementary medical insurance,, and the $19 billion of , miscellaneous government transfer payments" that are induded in personal income. 

Other differences reflect the fact that personal income, like all NIPA 

concepts. ignores changes in asset and liability values. In the aggregate, 

the gains should offset the losses with no income generated for the economy as 

a whole. Ultimately. product produced must equal income generated. One of 

the fundamental objectives of family economic income, however, is to capture 

changes in the purchasing power of assets and liabilities. Family economic 

income, therefore, includes real capital gains and losses, adjusting the 

nominal values for inflation. while personal income includes neither capital 

gains nor inflation adjustments. Although most real gains net to zero in the 

aggregate since gains are generally matched by losses, for distributional 

analysis knowing who the winners and losers are is important. 

2. Comparison with Adjusted Gross Income 

Family economic income differs from AGI in concept and in magnitude. AGI 

is an artifact of the Tax Code in that it represents only income that lawmakers have decided in a particular year should potentially be subject to tax. 

Family economic income, on the other hand. is independent of changes in tax 

law and is useful for analyses of tax policy as well as of other subjects. 

Although it is the starting point for deriving family economic income. AGI 

of tax filers accounts for only about two-thirds of FEI. (See Table 3.2)5 

o FEI first adds to AGI estimates of the income in the economy that is 

not reported on tax returns. This consists of income of the nonfilers 

who do not need to submit returns because their income is so low 

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Table 3.2 DERIVATION OF FAMILY ECONOMIC INCOME 

FROM AGI, 1983 

(Millions) 

AGI of filers at 1983 incomes defmed by pre-TRA 1986 law $1,939,430 

+ Unreported/underreported income of filers 

+ Unreported income of: 

Legitimate nonfilers 

Delinquent nonfilers 

+ Adjustments: IRA & Keogh contributions, dividend 

exclusion, second-earner deduction, other 

+ Transfers: 

Nontaxable social security and railroad retirement 

Nontaxable unemployment compensation 

Nontaxable workmen's compensation 

Veterans' benefits 

Food stamps 

Welfare benefits (SSI, AFDC. etc.) 

+ Untaxed employer contributions to: 

Pensions and profit sharing 

Health and medical insurance 

Ufe insurance 

Military benefits and "fringe benefits" 

Other 

Taxable pensions 

+ Earnings on pension funds 

+ Earnings on life insurance, IRA, and Keogh funds 

+ Tax-exempt interest 

+ Real net rent on owner-occupied homes 

+ Real pre-tax corporate economic income 

- Dividends before exclusion - Dividend earnings of pension and Jife insurance funds 

- Capital gains in AGI 

+ Real net capital gains (except on corporate stock and 

other securities) 

+ Inflation adjustment for net interest of: 

Rentals, SBC's, partnerships. and Schedule A 

Schedules C & F 

+ Inflation adjustment for interest received 

+ Excess depreciation (tax depreciation minus economic 

depreciation) of: 

Rentals and SBC's 

Partnerships (gainers and losers) 

Schedules C & F 

+ Adjustment for percentage depletion and IDC's 

+ Netting of other losses and miscellaneous adjustments 

Equals: Family Economic Income. 1983 

122,414 

25,492 

103,952 

59.452 

162,377 

15,909 

11,868 

J2, 731 

12,266 

22,333 

97.120 

76,960 

6,937 

21,908 

2,427 

-77,496 

89,430 

22,823 

11.005 

55,357 

223,617 

-49,587 

-19,410 

-44.594 

21.665 

9,995 

5,977 

-88,012 

3,171 

3.049 

5.162 

2,297 

14,060 

$2.882.085 

Note: Some figures differ from those in Chapter 4 of this volume. Here the derivation of 

Family Economic Income starts with AGI under I 9861aw. whereas in Chapter 4 it starts with AGI 

under 1983 law. 
84 Susan C. Nelson 

(legitimate nonfilers). as well as income that should be reported, but 

is not, by filers and by delinquent nonfilers. 

o FEI also adds back to AGI certain "adjustments to income" reported on 

the tax return, principally IRA and Keogh contributions and the secondearner deduction. 

o Since FEI aims to measure income in the current year, it adds back net 

operating losses carried over from previous years. 

o FEI includes cash and certain near-cash transfers that are not subject 

to tax, principally social security benefits, welfare payments, unemployment and workers' compensation, veterans' compensation, and food 

stamps. Conceptually. "economic income" could include the cash value 

of in-kind transfers such as housing subsidies, and medicare and 

medicaid. These were omitted because of the difficulty of valuing 

them. Studies of the value of such in-kind transfers have found a 

substantial difference between the cost of the subsidies and the value 

the recipients attach to the transfer. 6 

o FEI adds in the untaxed portion of compensation such as employer 

contributions for pensions, health and life insurance, and other fringe 

benefits. So that pension income will not be double

-counted, it 

excludes pension income as received but includes the accrual of 

earnings on pension and life insurance plans. and on IRA and Keogh 

accounts. 

o A homeowner's investment in a house implicitly yields net rental income 

equal to the excess of the gross rental value of the house over costs, 

with costs including mortgage interest, depreciation, property taxes, 

and maintenance. This net rental income, adjusted for inflation, is 

included in FEI. (Personal income also includes net rent. but with no 

inflation adjustment.) 0 As mentioned earlier. FEI allocates pre

-tax corporate profits both to 

individuals who own stock directly and to those who own stock indirectly. for example, through shares of pension or life insurance funds. 

Implicit in this attribution of pre

-tax profits to shareholders is an 

assumption that the corporate income tax-part of pre-tax profits-is 

borne by shareholders. rather than. for example, by owners of capital 

in general, consumers, or labor. This assumption reflects the short

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run more than the long-run incidence. (An adjustment in the incidence 

of a tax could theoretically require adjustment of the pre-tax earn-

ings.) To avoid double counting the portion of earnings that is distributed as dividends. FEI subtracts dividends received, both directly 

and indirectly. Similarly. since retained earnings tend to be reflected in the price of corporate shares. capital gains in AGI that come 

from corporate stock are also removed to 

avoid double counting. 

7 

o Family economic income attempts to measure capital income correctly by 

removing the inflation component of nominal income and additional 

amounts of tax preference. It indexes interest receipts and expenses. 

and capital gains and losses. ll replaces tax depreciation with real 

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Family Economic Income 85 

economic depreciation, and attempts to adjust for the indexed taxpreference component of intangible ·drilling costs and percentage 

depletion allowances. 

D. Issues in Defining Family Economic Income 

Translating the Haig-Simons concept ofincome as consumption plus change in 

net worth into a quantifiable measure for tax analysis presents a number of 

instances where either the correct theoretical treatment is not clear, where 

imperfections in the data require compromises to be made, or where the correct 

conceptual treatment of income produces a mismatch in the timing of income and 

taxes reported. In the areas discussed below, the approach reflected in FEI 

may not be the onJy correct one. but a better one is not obvious. 

1. Pensions 

Pension benefits appear in FEI on an accrual basis; that is, a worker is 

credited with receiving income as the employer contributes to the pension fund 

and as that fund earns income. In this way, pensions are treated just like 

other income that is received currently, but saved. Conversely I pensions are 

not counted as income as they are received I since the pension benefits 

represent withdrawals of past earnings. rather than current income. Taxes are 

attributed to taxpayers at the time they are paid. This failure to attribute 

taxes to holders of tax-deferred pension plans until the time of withdrawal. 

even though no income is recognized then. can produce the anomalous result 

that tax is collected from those who have little or no current "income. " 

especially the elderly. It understates the taxes of workers receiving the 

employer contributions or earnings on their pension funds by failing to 

recognize their future tax liability. 

The treatment of pensions in FEI also makes no distinction between vested 

and nonvested workers, nor between contributions to defined benefit or defined 

contribution plans. Ignoring vesting would overstate the income of younger 

workers, who are less likely to be vested. However, since studies indicate 

that most workers with employer pension contributions ultimately vest. this 

approach is reasonable for most workers and avoids attributing all the past 

contributions whenever vesting occurs. Treating employer contributions and 

earnings on defined benefit plans in the same manner as additions to defined 

contribution plans mismeasures the income associated with defined benefit 

plans in many cases. On average . the value of additions to defined benefit 

plans probably equals the amount of the additions. but the value may differ 

substantially from the amount of the addition. depending on the circumstances 

of the particular plan and worker. 

These problems with the treatment of pensions-the mismatch in the timing 

of pension income and taxes, and the lack of a distinction between vested and 

nonvested workers or between defined benefit and defined contribution plansarise because family economic income is an annual measure rather than a life-
86 Susan C. Nelson 

time measure. On a lifetime basis, pension income and taxes would be matched 

appropriately. Employer contributions for workers who did not vest in a plan 

would not be counted as income. And the total additions to a defined benefit 

plan would equal the benefits received. 

In an annual measure of income, pension income could be treated in several 

alternative ways, but none of them seem satisfatory either. The simplest 

approach would be to include pension income as it was received in retirement, 

on a realized basis instead of on an accrual basis. This would eliminate the 

three problems noted above, but it would seriously understate Haig-Simons 

income to the extent employer contributions for pensions and earnings on 

pension funds represented increases in net worth. A second alternative would 

be to include pension income both as it accrued and when it was received. 

This would alleviate the mismatch between income and taxes for retirees, but 

would overstate the aggregate amount of pension "income" in the economy and 

not solve the income measurement problems for current workers. A third 

approach would count both income and taxes on an accrual basis, associating 

deferred taxes with deferred income and removing from tax liability the taxes 

actually paid on pension benefits received. This would solve the mismatch of 

taxes and income, but calculating deferred taxes would involve uncertainty 

about the future tax system and the tax rate the individual worker would face. 

2. Corporate Income 

Allocating corporate income to individuals is one of the more controversial 

parts of FEI. Many people, particularly noneconomists, implicitly subscribe 

to the notion of a "corporate veil" and view the corporation as distinct from 

its stockholders. To them, corporate earnings do not belong to individuals 

until they are distributed. Others who see through the corporate veil may 

still disagree with the way FEI allocates corporate income among individuals. 

Rather than distributing the income on the basis of the direct and indirect 

ownership of stock (as FEI does), other assumptions of the incidence of the 

corporate tax would imply distributing the income on the basis of ownership of 

capital in general, or consumption, or labor income. For the long run, a 

corporate tax borne by all capital is a particularly popular view. 8 

Whether the incidence of corporate income and the corporate tax falls on 

stockholders or on owners of all capital, a problem arises with the share 

allocated to defined benefit pension plans. Should the corporate stock owned 

by defined benefit plans be attributed to the workers with rights to the 

pension benefits, or to the owners of the firms sponsoring the pension plans? 

If corporate income or taxes change. the finn 's contribution to the plan 

changes but not the pension benefits. This suggests that the corporate income 

and taxes allocated to defined benefit pension plans should be ascribed to the 

finn and not to the workers with rights to the plan. However, if the firm 

holds the worker's total compensation fixed. it would increase or decrease 

nonpension income in response to changes in net corporate income of the 

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Family Economic Income 87 

pension fund, and the incidence of corporate income and taxes would appropriately faiJ on the worker. Further analysis of defined benefit plans is 

necessary before this issue can be resolved. 

The inclusion of corporate income in FEI also leads to a possible mismatch 

between income and taxes in two respects. The first mismatch arises because 

capital gains on corporate stock are removed from a taxpayer's AGI when 

corporate income is attributed to the return (in order to avoid double 

counting of retained earnings in the aggregate), but the taxes on those gains 

remain. The taxes appear as realized, but the corporate income is included in 

FEI as it accrues. The result is that some taxpayers may have large tax 

liabilities from capital gains that accrued over many years but a relatively 

small amount of corporate income accruing in the tax year. 

A second mismatch may occur because corporate taxes have generally not 

been included in distributional analyses even though the income classifier 

includes corporate income. 

9 Whether or not this treatment is viewed as 

inconsistent depends in part on the question being addressed and on the role 

assigned to the income classifier. If the question is the distribution of 

Federal income taxes (or the effects of the Tax Reform Act of 1986), then the 

answer should include both corporate and individual income tax burdens. 

However, this is not the only approach useful in tax policy analysis. 

Examining individual income taxes alone provides an extremely important part 

of the distributional picture, and one that is more clearly defined and less 

controversial than the combined effect of individual and corporate taxes. 

Furthermore, an income classifier is intended to discriminate among people on 

the basis of their levels of economic well-being, to put people into the 

nright boxesn for analyzing the impact of any taxes: individual, consumption. 

even social security taxes. Including corporate income in the classifier but 

not in the taxes being examined adds no inconsistency to that analysis. 

Corporate taxes can of course be distributed along with individual taxes, 

given an incidenc-e assumption. Table 3.3 presents the distribution of family 

economic income, corporate income (the portion not attributable to foreigners, 

government or nonprofit institutions) as included in FEI, and the distributions of pre-TRA income tax liabilities with and without corporate taxes. 

assuming that corporate taxes are borne in proportion to the ownership of 

corporate income. The table shows that although corporate income is more 

concentrated in higher income classes than family economic income, combining 

corporate taxes with individual income taxes has relatively little effect on 

the distribution of the tax burden. From columns (I) and (2), the top two 

income classes receive 26 percent of all corporate income but only 12 percent 

of FEI; families with incomes of $20.000 or less receive only 7.5 percent of 

corporate income but 15 percent of FEI. In spite of this disparity between 

the two distributions of income. columns (3) and (4) show that the distributions of individual income taxes and individual plus corporate income taxes 

are quite similar. This results from the fact that corporate income happens 

to be distributed much like individual income tax liabilities, and from the 
88 Susan C. Nelson 

Table 3.3 DISTRIBUTIONAL COMPARISONS OF CORPORATE 

AND FAMILY ECONOMIC INCOME, AND INDMDUAL 

AND CORPORATE INCOME TAX LIABILITIES 

(1983 income levels, 1988 Jaw) 

Family 

Economic 

Income 

($l,OOO's) 

Corporate 

FEI Income 

(J) (2) 

Distribution of 1988 

Pre-TRA Law Tax Liabilities: 

Individual Individual & Corporate• 

(3) (4) 

(Percentage) 

< 0 -.24 0.23 0.10 0.12 

0- 10 3.23 1.24 0.47 0.58 

10- 15 5.28 2.29 1.67 1.77 

15- 20 6.85 3.76 3.22 3.30 

20- 30 16.08 10.65 10.51 10.53 

30- 50 29.88 23.26 26.29 25.83 

50- 100 26.85 31.89 30.98 31.12 

100- 200 6.15 12.70 10.63 10.94 

200+ 5.89 13.99 16.13 15.81 

Total 100.0 100.0 100.0 100.0 

• Assumes corporate income tcues are distributed in proportion to corporate income: in family 

economic income. 

fact that corporate income taxes only amount to about 20 to 25 percent of 

individual income taxes. The inclusion of corporate taxes is likely to have a 

bit more effect on the conclusions about the distributional consequences of 

the Tax Reform Act of 1986, however, because individual taxes were lowered 

while corporate taxes were raised. 

3. Capital Gains 

·In theory, Haig-Simons income includes capital gains as they accrue on all 

assets in the economy, adjusted for changes in purchasing power. Unfortu-

·nately, the necessary data on accruals on many types of assets are not 

available at the individual level. Tax returns provide data on realizations 

of gains on various types of assets. with information necessary to adjust for 

inflation during the holding period. Realized gains. however. may not reflect 

accruals very well since tax laws clearly influence the timing of the realization of gains and losses. FEI therefore contains only a proxy for an ideal 

measure of real accrued gains. 

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Family Economic Income 89 

For owners of corporate stock, retained earnings adjusted for inflation 

should represent real accruing capitaJ gains. The only real gains or losses 

that would not be reflected in reaJ retained earnings would be "unexpected 

gains." Theoretically, there is no reason why in the aggregate these unanticipated gains and losses should be either positive or negative, so we assume 

that they net out to zero. FEI includes real gains or losses on corporate 

stock on an accrual basis in the allocation of corporate income. Unfortunately, this approach eliminates the difference between successful and unsuccessful investors. 

For noncorporate assets, gains were estimated on a realization basis, in 

spite of the influence that tax laws have on decisions to realize gains, for 

two main reasons. First, there is no evidence on ownership of noncorporate 

assets that is as reliable as the receipt of dividends from corporate stock. 

Second, there is no measure of accruing gains on noncorporate and personal 

assets comparable to retained earnings on corporate stock. Family economic 

income, therefore, includes estimates of realized capital gains, adjusted for 

inflation over the estimated holding periods. on noncorporate assets identified as securities other than corporate stock, real estate, livestock, and 

"other assets. " In an attempt to offset some of the distortion in the timing 

of realizations caused by the tax laws, FEI followed the Tax Code's exampl.e 

and limited total real losses to $3,000 per return. 

4. Implicit Income 

Ideally. economic income would be measured before any effects of distorting 

taxation. Since markets tend to equalize after-tax rates of return. tax 

preferences can depress the pre-tax rate of return on a preferred asset, and 

comparatively heavy taxation can raise the pre-tax rate of return. relative to 

the returns that would prevail under a system of neutral taxation. This 

implies that the observed earnings on assets bearing different rates of tax do 

not necessarily refle.ct true pre-tax earnings. and that in computing economic 

income, adjustments should be made to measured incomes (with implicit income 

added or subtracted) for the effects of the tax structure on before-tax 

returns. For example, the tax exemption on municipal bonds lowers the 

interest earned on those holdings. The owners of the bonds receive implicit 

income that ideally would be counted in economic income. (They pay implicit 

taxes as well.) Similarly. if corporate assets are heavily taxed, then 

corporate income would be lower in the absence of distorting taxation. The 

distribution of this change in income among individuals depends on the 

incidence of the corporate tax that is adopted. For consistency. the incidence assumptions used t0 adjust pre-tax earnings should coincide with the 

assumptions used to distribute taxes. 

In practice. this type of adjustment to pre-tax earnings was not made in 

computing family economic income because of the complexities in modeling the 

rates of return that would prevail in a world with neutral taxation. 
90 Susan C. Nelson 

IV. EXPANDED INCOME AND MODIFIED EXPANDED INCOME 

While the Treasury Department has used family economic income for analyzing recent tax proposals, the Joint Committee on Taxation (JCT) developed its 

own broad measure of income. Understanding the Joint Committee's income 

concept ("modified expanded income" or MEl) is particularly important since 

the official congressional estimates of the distributional impact of the Tax 

Reform Act of 1986, and the House and Senate proposals leading up to it. were 

based on MEl. 

A. Definitions 

Since tax analysts have long recognized the limitations of using AGI as an 

income classifier. the Treasury Department. the Joint Committee. and others 

used "expanded income" through much of the 1970's as a measure that improved 

upon AGI and that could be derived solely from information reported on tax 

returns. Expanded income adds back identifiable items of tax preference that 

are excluded from AGI but that are subject to the minimum tax, and then 

subtracts investment interest deductions up to the amount of investment 

income. The tax preferences are primarily the excluded portion of nominal 

capital gains. and preferences such as excess amounts of depreciation, 

intangible drilling costs. and percentage depletion, for taxpayers filing 

minimum tax returns. (The preferences are measured as the excess over tax 

amounts. not over economic amounts.) 

Modified expanded income is similar to expanded income in that it adds back 

tax preferences reported on minimum tax returns and the excluded portion of 

capital gains; however, MEl makes no adjustment for investment interest 

expenses. MEl makes further adjustments to AGI. as shown in Table 3.4. 

Modified expanded income adds in some of the income of nonfilers. It adds 

back to AGI the IRA and second-earner deductions. It includes estimates of 

tax-exempt interest. employer contributions for health and life insurance. 

nontaxable social security benefits and some other transfers. MEl excludes 

losses arising from rental and royalty properties, estates, small business 

corporations, and from partnership interests that appear to be "passive." 

These exclusions are based on the fact that investments in certain passive 

activities may result in losses for tax purposes that do not represent real 

economic losses. Rather than attempt to separate real from tax losses. MEl 

simply sets all these passive losses equal to zero and excludes them. 

Modified expanded income applies to the traditional unit of tax analysis 

-the tax return-with two exceptions: the analyses exclude taxpayers under age 

16, and they include nonfilers as well as filers. The reason for excluding 

young taxpayers is that: 

"(t]his reflects the view that income of children under 16. who tend to 

have relatively low incomes, should. if possible. be added to that of 

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Table 3.4 DERIVATION OF MODIFIED EXPANDED INCOME 

FROM AGI, 1983 

AGI. 1983 levels defined by pre-TRA 1986 law 

+ Partial income of nonfilers• 

+ Adjustments: IRA's, second-earner deduction. other 

+ Losses on: 

Rents 

Passive partnerships 

Royalties, estates, SBC's, misc. 

+ Excluded capital gains 

+ Minimum tax preferences. adjusted 

+ Tax-exempt interest 

+ Transfers: 

Nontaxable social security benefits 

Nontaxable workman's compensation 

Nontaxable unemployment compensation 

+ Employer contributions for health & life insurance 

+ Earnings on life insurance funds 

+ Miscellaneous. including dividend and interest exclusion 

Equals: Modified Expanded Income. 1983 

(Millions) 

$1 ,939.430 

10,604 

53,156 

25,333 

25,988 

8,042 

73,084 

5,452 

11.005 

156,258 

I 1,868 

15,909 

83,905 

13,415 

5,360 

$2.439,877 

•This reflects the income of nonfilers that could be estimated from the Census Bureau's 

Current Population Survey. 

their parents in order to achieve a more accurate measure of the distributional impact of tax change. " (Joint Committee on Taxation (J 985).) 

B. Comparison Between Modified Expanded Income and 

Family Economic Income 

The major differences between MEl and FEJ stem from the fact that FEI 

attempts to quantify a broad definition of income that is theoretically sound 

but difficult to estimate. whereas MEl extends AGI in modest ways that can be 

estimated with greater ease and confidence. To begin. FEI is a more 

comprehensive-and larger-measure of income than MEl: $2.9 trillion vs. $2.4 

trillion. respectively. As Table 3.5 shows. FEJ includes more sources of 

income than does MEl. 

FEI attempts to separate the real economic values from the amounts of 

income or loss reported for tax purposes. It does so by adjusting all returns 

with business income for estimated amounts of the major tax preferences. such 
92 Susan C. Nelson 

Table 3.5 DERIVATION OF FAMILY ECONOMIC INCOME 

FROM MODIFIED EXPANDED INCOME 

Modified Expanded Income 

+ Transfers: 

Welfare & Food Stamps 

Railroad retirement 

Veterans' benefits 

+ Pensions: 

Employer contributions & profit sharing 

Earnings on pension, IRA. Keogh funds 

Taxable Pensions 

+ Unreported income of filers & nonfilers 

+ Real net rent on owner-occupied homes 

+ Real pre-tax corporate economic income - Dividends before exclusion - Dividend earnings of pension and life insurance funds 

+ Preference adjustments: 

Passive losses 

Excess depreciation (tax depreciation minus economic 

depreciation) 

+ Inflation adjustment for net interest of noncorporate business 

+ Net adjustment in other preferences 

+ Capital gains adjustments: 

Realized capital gains 

Real net capital gains (except on corporate stock 

and other securities) 

+ Inflation adjustment for interest received 

+ Netting of other (carryover) losses 

+ Miscellaneous (including other fringe benefits, 

military benefits. Keogh contributions) 

(Millions) 

$2,439,877 

34,599 

6,119 

12,731 

97,737 

98,838 

-77.496 

240,194 

55,357 

223,617 

-49,587 

-19.410 

-59,363 

11,426 

15,972 

-3, t55 

-117,678 

21,665 

-88,012 

12.391 

26,387 

Equals: Family Economic Income $2

,882.085 

as accelerated depreciation and intangible drilling costs. that create losses 

for tax purposes but that are not real economic losses. Although the FEI 

approach cannot claim to adjust every tax return appropriately. on average and 

overall it removes the amount of tax preferences independently estimated to be 

present. MEl. on the other hand. disallows all losses in categories where tax 

shelters are most heavily 

concentrated. This approach makes no attempt to 

separate 

"real " from "artificial,. losses individually or overall. and it 

removes none of the benefit 

of tax preferences from profitable businesses. 

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Family Economic Income 93 

Family economic income attempts to measure Haig-Simons income correctly. 

Consequently, it adjusts for inflation, raising the income of taxpayers with 

large interest expenses and lowering the income of many with long-term capital 

gains and interest income. In addition, FEI attributes corporate income to 

its shareholders. Modified economic income makes no such allocation. 

Family economic income in general relies heavily on estimates of income and 

adjustments to income ("imputations") from sources other than tax returns, 

whereas only a few components of MEl are based on imputations: social security 

and the other transfer benefits, employer contributions, tax-exempt interest. 

earnings on life insurance funds. and the determination of which partnership 

losses are passive. MEl reflects a concern with variation added through the 

imputation process, whereas FEI aims more for the correct expected value of a 

theoretically sound measure. Capital gains provides an example of the 

contrasting approaches reflected in FEI and MEl. FEI attempts to include the 

best feasible estimate of the expected value of real accruing capital gains. 

Replacing gains on corporate stock with real retained earnings is a theorybased proxy for accruing capital gains but one that omits much of the real 

variation among stockholders in accruing gains and losses. MEl, on the other 

hand, maintains the variance reported on tax returns among winning and losing 

stockholders. However, its inclusion of 100 percent of nominal capital gains 

will always with certainty overstate the real (after inflation) capital gain. 

Beyond the definition of income, FEI and MEl differ in the unit of analysis 

to which they apply: FEI applies to families, whereas MEl applies to tax units 

in which the taxpayer is at least 16 years of age. Again, the MEl approach is 

more certain. Age of the taxpayer is known. whereas the family to which an 

individual who files his or her own tax return belongs cannot readily be 

identified. Rather, for FEI a family similar to the one to which the individual is likely to belong must be picked by information from other sources. 

In spite of the imprecision of "imputing" families to members who file their 

own tax returns, the income of the related individuals is typically a poor 

indicator of their standard of Jiving or well-being, even for dependent 

taxpayers over age 16. Whereas 92 percent of dependent fLiers have AGI of no 

more than $10,000, over half live in families with economic income over 

$50,000. Removing dependent filers under age 16 removes only 6 percent of all 

dependent filers. as Table 3.6 shows. Most dependent filers are between 16 

and 25 years old. 

V. IMPLICATIONS OF THE DIFFERENCES BETWEEN FAMILY 

ECONOMIC INCOME AND MODIFIED EXPANDED INCOME 

For all the differences between the income classifiers discussed above. how 

do the measures differ quantitatively. and what are the implications for tax 

policy analysis? 

Table 3. 7 presents a simple comparison of the three income measures. the 

alternative units of analysis, and the inclusion of nonfilers. It confirms. 
94 Susan C. Nelson 

Table 3.6 AGE DISTRIBUTION OF DEPENDENT FILERS, 1983 

Number Distribution 

Age (I ,OOOs) (percentage) 

Under 16 I, 101 8.2 

16 - 20 6,917 51.2 

21- 25 3,813 28.2 

25- 65 1,329 9.8 

65 and over 351 2.6 

All 13,509 100.0 

Table 3.7 DISTRIBUTION OF RETURNS AND FAMILIES, 

FILERS AND NONFILERS, UNDER 

ALTERNATIVE INCOME CLASSIFIERS 

( 1983 Levels of Income) 

Returns Age 16 & over 

Income All Returns b): AGI b): MEl Families b): FEI 

Class Filers Nonfilers Total Filers Nonfileu Total Filers Nonfilers Total 

($1 ,OOOs) (1) (2) (3) (4) (5) (6) (7) (8) (9) 

(Percentages) 

< 0 .9 . I .8 .5 . I .4 . I 1.0 .3 

0- 10 35.0 99.5 48.4 26.0 93.7 39.7 6.3 50.3 15.6 

10- 15 14.4 .3 11 .5 14.9 4.6 12.8 11.7 18.8 13.2 

15- 20 11.3 .1 9.0 12.6 l.l 10.2 12.6 10.8 12.2 

20- 30 16.9 .0 13.4 8.1 .4 6.5 22.8 10.8 20.2 

30- 50 16. 1 .0 12.8 19 .4 . 1 15.5 28.5 6.4 23.8 

50 - 100 4.6 .0 3.6 6.8 .0 5.5 15.7 1.7 12.8 

100- 200 .7 .0 .5 .9 .0 .7 1.8 . l 1.5 

200+ .I .0 .I .3 .0 .3 .5 .0 .4 

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 

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for example, that the broader the measure of income and the unit of analysis, 

the higher the distribution of income appears: families classified by economic 

income (column 9) tend to falJ into much higher income classes than do returns 

of people at least age 16 classified by MEl (column 6), which in tum are in 

higher income classes than returns from all age groups classified by AGI (column 3). Only 29 percent of all families have economic income under $15,000, 

while over half the tax units headed by people age 16 or older have MEl below 

$15,000, and 60 percent of total tax units have AGI below this level. By 

family economic income $15,000 is clearly a low-income class, whereas it is a 

middle-income class according to the two other approaches. At the other end 

of the income scale, 15 percent of the families have economic incomes above 

$50,000, but only 4 percent of the tax units have that much AGI and only 

6.5 percent of the units not headed by children have that much MEl. 

Nonfilers clearly lower the distribution of income under each of the three 

approaches, although Jess so for family economic income than for the other two 

measures. This occurs mainly because of the income sources included in FEI 

but excluded from AGI and MEl, such as means-tested transfer payments and 

unreported income from the underground economy. 

A question that Table 3. 7 does not answer is whether the differences in the 

three approaches stem mainly from the income classifiers or from the unit of 

analysis. Table 3.8 addresses this issue. Table 3.8 compares the distribution of adult tax units by MEl (column J) with the distribution of families by 

Table 3.8 DISTRIBUTION OF TAX UNITS 

Income 

Class 

($1,000s) 

< 0 

0- 10 

10- 15 

15- 20 

20- 30 

30- 50 

50- 100 

100- 200 

AGE 16+ BY MODIFIED EXPANDED INCOME, 

FAMILIES BY MODIFIED EXPANDED INCOME 

AND BY ECONOMIC INCOME 

(1983 Levels of Income) 

Age 16 & over Families Families by 

by MEl by MEl Economic Income 

(1) (2) (3) 

(Percentages) 

0.4 0.3 0.3 

39.7 24.1 15.6 

12.8 12.7 13.2 

10.2 11.8 12.2 

6.5 J 9.3 20.2 

15.5 21.1 23.6 

5.5 9. I 12.8 

0.7 1.2 1.5 

200+ .3 .4 .4 

Total 100.00 100.00 100.00 
96 Susan C. Nelson 

MEl and FEI (columns 2 and 3, respectively). The largest differences among 

the three columns appear in the $0-$10,000 class: 40 percent of the tax units 

fall in this MEl class, compared to 24 percent of the families, and only 16 

percent of the families if classified by FEI instead of MEl. (These figures 

include nonfilers, but the conclusion is the same for filers alone.) These 

figures suggest that both the unit of analysis-adult tax unit vs. family-and 

the income classifier affect the analysis, with the unit of analysis apparently having a slightly larger effect than the choice of income classifier. 

The crucial question for tax policy analysis is how do the different 

approaches to measuring income and classifying people alter the conclusions 

about tax changes. The answer for the Tax Reform Act of 1986 appears to be 

that the choice of approach matters a lot .

1 0 

Table 3. 9 compares individual income tax liabilities under 1988 law before 

and after TRA86 under the three classification approaches, estimated at 1983 

levels of income. Under both old and new law, the family economic income 

approach shows income classes below $50,000 bearing a smaller fraction of the 

Table 3.9 INDIVIDUAL TAX LIABILITIES UNDER 1988 LAW, 

BEFORE AND AFTER THE T~X REFORM ACT OF 1986, 

BY ECONOMIC INCOME OF FAMILIES, MODIFIED 

EXPANDED INCOME OF RETURNS AGE 16 AND OVER, 

AND AGI OF RETURNS 

(1983 Levels of Income) 

MEl of Returns Economic Income 

Income AGI of Returns Age 16 and over of Families 

Class Prior TRA Percent Prior TRA Percent Prior TRA Percent 

($l.000s) Law Law Change Law Law Change Law Law Change 

(Percentages) 

0 - 10 1.9 1.7 - 15.6 1.2 1.0 -17.7 .5 .4 -24.3 

10- 15 4.8 4.3 -14.6 3.6 2.8 -25.8 1.7 1.2 -34. I 

15 - 20 6.5 6.4 -6.5 5.3 4.9 -13.0 3.2 2.7 -18.9 

20- 30 16.5 16.4 -4.9 14. 1 13.8 -6.7 10.5 10.2 -7 . I 

30 - 50 29.5 29.8 -3.5 28.9 28.6 -5.9 26.3 26.3 -4.8 

50- 100 19.2 20.2 .2 22.5 23.7 .0 31.0 32.3 -.8 

100- 200 8.6 8.7 -3.7 8.9 9.3 -. 1 10.6 11.2 . 1 

200+ 12.9 11.9 - 12.3 15.4 15.9 -1.8 16. 1 15.5 -8.5 

Total 100.0 100.0 -4.7 100.0 100.0 4.7 100.0 100.0 -4.7 

Addendum: 

Negative Income . I .5 . I .0 .0 .0 . I .3 . I 

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tax burden and classes with at least $50,000 of income paying a larger share 

than either of the other two methods. This pattern is consistent with the 

conclusion of Table 3. 7 that the distribution of income appears higher with 

the broader measure of income. 

In tenns of the percentage change in personal tax liabilities, the three 

approaches provide notably different conclusions at the bottom and the top of 

the income scale. First, while the lowest income classes receive the largest 

percentage tax cuts under all three methods, the size of the percentage 

reductions varies substantially. Classifying families by FEI shows the 

largest reductions, with the MEl approach next, and the standard method of AGI 

of returns showing the smallest cuts. This variation probably stems more from 

the different units of analysis than from the different income classifiers. 

The increases in the personal exemptions, the zero bracket amounts, and the 

Earned Income Tax Credit in TRA86 were particularly beneficial to lowerincome taxpayers filing joint or head of household returns, while little of 

the base broadening affected them. Removing the personal exemption on 

dependent filer returns, on the other hand, tended to increase taxes for 

dependent filers, who represent a large portion of taxpayers with low AGI, a 

smaller fraction of ta.xpayers with low MEl, but who are grouped with their 

families in the economic income columns. 

The second substantial difference in implication of the three approaches 

appears in the top income class. According to the FEI and AGI approaches, 

taxpayers with incomes of $200,000 or more receive above-average personal tax 

cuts, whereas they get below-average cuts under MEl. Differences among the 

classifiers probably account for more of this contrast than do differences 

among the units of analysis, since virtually any return in the top class would 

also belong to a family with very high income. 

In particular, the full taxation of capital gains and the passive loss 

provisions of TRA86, combined with the ways the various income classifiers 

treat these fonns of income, provide much of the explanation. These two 

provisions broadened the tax base of anyone with capital gains or passive 

losses and thereby tended to increase their taxes. By treating passive losses 

and capital gains almost as they are in the new tax law. MEl moves into 

higher-income classes taxpayers with these fonns of income. who also tend to 

have tax increases. Since pre-TRA AGI includes only 40 percent of nominal 

capital gains, classifying by AGI puts taxpayers with capital gains (and the 

associated tax increases) into above-average income classes. but not into as 

high a class as under MEl. AGI puts taxpayers with passive losses into much 

lower-income classes than does MEl. The FEI treatment of capital gains 

(adjusting for inflation and substituting a share of corporate income for 

realized gains on stock) and passive losses (adjusting all business income. 

gains as well as losses. for tax preferences) would put taxpayers in much 

lower classes than does MEl but probably not as low as AGI. Consequently. the 

general reduction in tax rates benefits the taxpayers in the top FEI and AGI 

classes much more than base broadening hurts them. whereas the opposite is 

true for taxpayers classified in the top MEl category. 
98 Susan C. Nelson 

VI. CONCLUSION 

This paper has explained the measure of family economic income. which 

recent Treasury analyses have used. and compared it to alternative income 

classifiers. Table 3.9 confirms that the distributional impact of individual 

income tax reform can vary significantly with. among other things. the income 

classifier and unit of analysis on which the comparisons are based. 

Several implications for policy analysis can be drawn from the disparate 

pictures of tax reform painted by Table 3.9. First. there is no single 

"right" way to give quantitative answers to questions about equity. Indeed, 

not only can the conclusions vary with different income classifiers and units 

of analysis, the conclusions depend on how the tax Jaws are modeled (whether 

behavioral adjustments are incorporated, whether all provisions are included). 

whether corporate taxes are included or just individual taxes. the year for 

which the analysis is performed (TRA86 has a number of phase-ins). as well as 

more technical issues such as the year to which the data base applies (OT A has 

used 1983 income levels because of the difficulties of extrapolating into the 

future). 

Second, although there is no single right way. it is important for analysts 

to resolve among themselves as many of the differences in approaches as 

possible. The alternative is that the choice among approaches would fall to 

policymakers who lack the background or expertise to judge technical alternatives. The choice of the unit of analysis-family vs. retu~may be one 

exception where the policymaker's sense of the appropriate basis for equity 

comparisons could be quite useful. 

FOOTNOTES 

1 Among standard references are Mus grave ( 1959) and Goode ( 1976). Musgrave states on 

p. 

165: "The concept of taxable income which has gained increasing acceptance among fiscal 

theorists is that of total accretion. Income is defined to equal consumption during a given 

period, plus increase in net worth. According to this concept, all accretions to wealth are 

included. in whatever form they are received or from whatever source they accrue." 

Recent users of this definition of income include David Bradford (1983), p. 23L; and 

Pechman (1985), p. 11. 

2 Testimony of John 

E. Chapoton. Assistant Secretary of the Treasury for Tax Policy, before 

the Senate Finance Committee. September 28, 1982. 3 For further discussion. see "The Treasury Individual Income Tax Simulation Model, " by 

Cilke and Wyscarver. Chapter 2 in this volume. 4 Many surveys. including those conducted by the Bureau of the Census. often use the housebold as the basis of observation. A household is based on living arrangements and can include 

unrelated individuals living together. The family as used by OTA requires that all members not 

only live together but also be related. or meet the dependency test in the tax code. or be 

married filing separate returns. This definition seems appropriate for analyzing ~ 

liabilities. 5 Since the concept of "family economic income" was developed for Tax Re.fonnfor Fairness. 

Simplicity. and Economic Grow1h in 1984. the adjusted gross income used as the starting point 

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refers to pre-TRA Jaw. FEI can be derived just as well from AGI under TRA, but some of the 

adjustments would differ. 

6 Sce U.S Census Bureau Technical Paper No. 50. Alternative Methods for Valuing Selected 

In-Kind Transfu Benefits and Measuring Their Effect on Poverty. March 1982. 

7 As is discussed in the following section. this adjustment is not precise since it removes 

reaJized gains and replaces them with accruing gains. 1 This view is generally traced to Harberger ( 1962). For more recent examples, see Pechman 

( 1985) and Feldstein ( 1987). 9 Treasury analyses using FEI have been criticized for not including the corporate taxes as 

part of the individual tax burden. See Ballentine (1986). 10This analysis considers changes only to individual income taxes. As indicated above 

(Section III.D .2 and Table 3.3). OTA can and does analyze distributional effects of tax changes 

with imputations for corporate taxes paid by each group. Such calculations are not provided 

here, however, for several reasons. The focus of this paper is the income classifier. not 

alternative ways to measure changes in tax burdens from tax reform (which could be the subject 

of a separate paper). Distributions of individual income taxes alone were the standard analyses 

examined during the tax reform debates. In addition, the incidence of the corporation income 

tax is still body debated by economists. The distribution of taxes is much more sensitive to 

the assumption chosen than is the distribution of an income measure that includes corporate 

income. 

REFERENCES 

Ballentine, J. Gregory. "The Short-Run Distributional Effect of Tax Reform," Tax Notes. 

June 9, 1986. Arlington, VA: Tax Analysis, 1986. 

Bradford, David, "The Choice Between Income and Consumption Taxes." in New Dirutions 

in Fedua/ Tax Policy for the 1980's, Charls E. Walker and Mark A. Bloomfield. eds. 

Cambridge. MA: BaHinger. 1983. 

Chapoton. John E .• Testimony before the Senate Finance Committee. September 28. 1982. 

Feldstein, Martin, "Imputing Corporate Tax Liabilities to Individual Taxpayers. " Cambridge. 

MA: National Bureau of Economic Research. 1987. 

Goode, Richard. The Individual Income Tax. Washington. D.C.: The Brookings Institution. 

1976. 

Haig, Robert Murray, "TheConceptoflncome-EconomicandLegal Aspects." in Haig. ed .. The 

Fedual Income Tax. New York: Columbia University Press, 1921 . 

Harberger, Arnold C., "The Incidence of the Corporate Income Tax. " Journal of Political 

Economy. Vol. 70. June 1962. 

Joint Committee on Taxation. Tax Rtform Proposals: Rart Structures and Other Individual 

Income Tax Issues, August 12 . 1985. 

Musgrave; Richard A., Tht Theory of Public Finance. New York: McGraw-Hill, Inc., 1959. 

Pechman. Joseph A., Who Paid the Taxes. 1966-1985? Washington. D.C.: The Brookings 

Institution. 1985. 

Simons, Henry C. , Persona/Income Taxation: The Definition of Income as a Problem of Fiscal 

Policy. Chicago. IL: Chicago University Press, 1938. 

U.S. Census Bureau Technical Paper No. 50. Alternative Methods for Valuing Selected In-Kind 

Transftr Btnefits and Measuring Their Effect on Povmy. Washington . D.C.: Government 

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