U.S. TREASURY

DISTRIBUTIONAL ANALYSIS METHODOLOGY

by

Julie-Anne Cronin*

U.S. Department of the Treasury

OTA Paper 85 September 1999

OTA Papers is an occasional series of reports on the research, models, and data sets 

developed to inform and improve Treasury’s tax policy analysis. The papers are works in 

progress and subject to revision. Views and opinions expressed are those of the authors and 

do not necessarily represent official Treasury positions or policy. OTA Papers are distributed 

in order to document OTA analytic methods and data and invite discussion and suggestions 

for revision and improvement. Comments are welcome and should be directed to the authors. 

Office of Tax Analysis

U.S. Department of the Treasury

Washington, DC 20220

julie.anne.cronin@do.treas.gov

* Financial Economist, Office of Tax Analysis (OTA). This paper describes a methodology 

which has been developed and refined over time and represents the efforts of many OTA 

economists. The paper greatly benefitted from comments by James Nunns, as well as those by 

Jon Talisman, Len Burman, Lowell Dworin, Jim Cilke, David Joulfaian, Laura Kalambokidis, 

Virginia Myers, Susan Nelson, Donald Rousslang, and Paul Smith. 
Introduction 

One of the principal tasks undertaken by the Treasury Department’s Office of Tax Analysis (OTA) 

is the analysis of the distribution of tax burdens. OTA’s distributional analyses show how proposed 

changes in tax law would affect the distribution of after-tax income across families. They provide 

policy makers with guidance on the “fairness” of proposed changes in tax law. Distributional analyses 

do not address economic efficiency, simplicity, or other important aspects of good tax policy. 

A “fair” tax law is generally considered to be one under which individuals with equal abilities to pay 

taxes pay equal amounts, and individuals with greater abilities to pay taxes pay greater amounts. The 

controversy in measuring fairness begins with defining the personal attributes and resources that 

determine an individual’s ability to pay and continues with the determination of which individuals are 

actually burdened by a tax. Economists generally recognize that a tax is not always borne by the 

entity or individual upon whom it is levied, but there is not universal agreement concerning the 

incidence of all taxes. Even if there were universal agreement on all the theoretical issues concerning 

distributional analysis, the practical implementation of the theory, including data and measurement 

issues, may lead to somewhat different rankings of ability to pay and measures of fairness. 

Nonetheless, even though the quantitative results may not be perfect, the qualitative results of 

distributional analyses are still very informative, and are important to the decision-making process. 

Policy makers often want a general sense of how their proposed policies will affect the distribution 

of after-tax income. A tax law that is perceived as fair increases public support for and compliance 

with the law. Because distributional analysis frequently plays a significant role in the deliberation over 

tax proposals, it is important that the methodology for producing them be well-developed and wellunderstood. 

This paper provides a detailed description of, as well as the rationale behind, Treasury’s current 

distribution methodology.1 It also offers some insight into why Treasury’s distributional results 

sometimes differ from those of other government organizations, such as those produced by the Joint 

Committee on Taxation (JCT) and the Congressional Budget Office (CBO).2 While the primary 

purpose of this paper is to inform the users of Treasury’s distributional analyses, we also hope to 

further the discussion of distributional issues and elicit suggestions for further improvements to 

Treasury’s methodology. 

1 The last formal description of Treasury’s methodology is contained in Nunns (1995), but a number of 

technical improvements and extensions of Treasury’s distribution methodology have been made since that paper 

was written. 

2 Non-government organizations which routinely produce distributional analyses include the Tax 

Foundation, Citizens for Tax Justice, and the Center on Budget and Policy Priorities. 

1 
1. Overview of Treasury’s Distribution Methodology 

Distributional analysis has several components. The component choices affect the quantitative results 

of the analysis and, in some instances, the qualitative results as well. The major components of 

distributional analysis are: (i) the taxes included, (ii) the time period of analysis, (iii) the unit of 

analysis, (iv) the income measure, (v) the incidence assumptions, and (vi) the tax burden measures 

and presentation of results. This section provides an overview of Treasury’s component choices. 

Detailed descriptions are provided in sections 2 through 7. Treasury’s choices are guided by the 

objective of its distributional analyses, which is to show the annual change in total federal tax burdens 

between fully phased-in current law and fully phased-in proposed law for families classified by a broad 

income measure. 

Taxes Included: All federal taxes are included in Treasury’s analyses: individual and corporate 

income taxes, payroll taxes, excises and customs duties, and estate and gift taxes. Estate and gift 

taxes and customs duties were added in 1998. The inclusion of all federal taxes is an improvement 

in Treasury’s methodology because it allows a comprehensive analysis of all proposed tax changes. 

Time Period of Analysis: Treasury’s distributions are annual measures based on long-run, fully 

phased-in law but at income and demographic levels present in the succeeding calendar year (referred 

to as the “current” year). “Fully phased-in law” is generally the law as it will apply in real (inflation 

indexed) terms at the end of the Budget period. Proposed changes in tax law often include a mix of 

provisions: some temporary, some not indexed for inflation, some effective immediately, and others 

delayed or phased-in. Using fully phased-in law provides a measure of tax burdens under the law as 

it will operate at the end of the Budget planning horizon, which should most fully reflect the intended 

distributional consequences of legislation. 

Unit of Analysis: The family is the unit of analysis. Treasury uses families, as opposed to individuals 

or tax returns, because families generally operate as an economic unit. The actions of one family 

member affect the resources and welfare of the entire family unit. 

Income Measure: Treasury uses a broad-based, pre-tax post-transfer income measure referred to as 

Family Economic Income (FEI). Because it is a broad measure of income, FEI more effectively 

captures a family’s relative economic well-being than a measure that, for example, excludes some 

components of income such as nontaxable transfer income or employer-provided fringe benefits or 

income accruing in retirement accounts. 

Incidence Assumptions: Treasury assumes the individual income tax is borne by payors, the 

corporate income tax by capital income generally, payroll taxes (employer and employee shares) by 

labor income, and estate and gift taxes by decedents. Excise on purchases by businesses and customs 

duties are assumed to be borne by labor and capital income. Excises on purchases by consumers are 

assumed to be borne in proportion to relative consumption of the taxed good as well as by labor and 

capital income. 

2
Tax Burden Measures and Presentation of Results: Treasury distribution tables show families ranked 

by income quintiles. Quintile distributions have the advantage of separating the issue of rank from 

absolute income levels, thereby making it easier to compare Treasury’s distributions with those 

prepared by other organizations using differing income concepts. The tax burden measures included 

for each income class are: (i) the average change in tax burdens; (ii) the total change in tax burdens; 

(iii) the share of the total change in tax burdens; (iv) the percentage change in tax burdens; and (v) 

the percentage change in after-tax income. Of these, the last is the best measure of the change in a 

family’s well-being. 

The remainder of this paper describes each component of Treasury’s distribution methodology in 

greater detail. 

2. Taxes Included 

Generally, from the 1960s (when computer micro-simulation models were first used) through the 

mid-1980s, Treasury only included individual income taxes in its distributions.3 Since 1990, Treasury 

has included individual and corporate income taxes, payroll taxes, and excise taxes in its distribution 

tables. Customs duties and estate and gift taxes were added in 1998. The individual income tax 

represents the largest share of the total federal tax burden (47 percent at 2000 income levels), 

followed by payroll taxes (37 percent), the corporate income tax (11 percent), excises (including 

customs duties) (4 percent), and estate and gift taxes (1 percent). 

Including all federal taxes allows Treasury to measure the total federal tax burden and to analyze the 

distributional effect of a proposed change to any federal tax. As will be seen in Section 6, the 

distribution of tax burdens for the various federal taxes is not the same. As a result, omitting one or 

more taxes could affect the qualitative as well as the quantitative results drawn from a tax burden 

analysis. For example, the federal tax burden on the lowest income quintile is primarily due to the 

payroll tax. An analysis which omitted the payroll tax would yield the incorrect conclusion that the 

poor, on average, bear no federal tax burden.4 Likewise, an analysis which did not include the 

corporate income tax would underestimate the progressivity of the current federal tax law. 

As explained below, the term tax burden as used in this paper generally refers only to tax liabilities. 

Treasury’s measured tax burdens do not include the indirect costs of taxation such as losses in 

consumer and producer surplus and the cost of complying with and administering taxes. However, 

where possible, the effects of tax changes on consumer surplus are included (see section 6.1). 

3 Exceptions, all of which involve the inclusion of the corporate income tax as well as the individual 

income tax, include Treasury’s Blueprints for Basic Tax Reform (1977), Treasury’s Tax Reform for Fairness, 

Simplicity, and Economic Growth, volume 1 (Treasury I) (1984), and Nelson (1987). 

4 Treasury distribution tables do not offset the burden of payroll taxes by the present value of future 

benefits. Contributions are treated as taxes and distributions are treated as transfers. 

3 
3. Time Period of Analysis 

Baseline tax burdens are measured by tax liabilities in the succeeding calendar year (also referred to 

as the “current year”), as estimated by Treasury in the preparation of tax receipt forecasts for the 

Budget. Estimated liabilities are then adjusted to reflect the tax law as it would be in effect in the last 

year of the ten-year budget window. Specifically, expiring provisions are removed from the baseline,5 

and end-of-the-budget-period tax parameters are adjusted for inflation.6 

Treasury’s measure of proposed changes to current law are likewise measured in current year dollars 

but assuming the proposal is fully phased-in. As a result, Treasury does not typically include in its 

distribution tables any provisions which are due to expire before the end of the budget period. 

However, in cases where the major provisions of a tax bill expire prior to the end of the Budget 

period, the proposal is evaluated as if the provisions remained in effect. 

In general, Treasury’s methodology does not differentiate among proposals with different phase-in 

periods; only the value of the tax parameters in the last year of the budget period are reflected in 

Treasury analyses. Tax parameters are deflated from their end-of-the-budget-period value to their 

real value in current year dollars. For example, a calendar year 1999 proposal that included an 

unindexed credit valued at $500 in 2009 would have a real value of only $408 in 2000 dollars.7 

Table 1: Tax Burdens at 2000 Income Levels1 

2000 Law 2009 Law 

($B) ($B) 

Indvidual Income Tax $ 835 $ 853 

Corporate Income Tax $ 187 $ 190 

Payroll Tax $ 645 $ 662 

Excises and Customs Duties $ 86 $ 76 

Estate and Gift Taxes $ 29 $ 26 

Total $ 1,781 $ 1,807 

1. Tax law as of August 1999. 

5 There is one automatic exception to the expiring provision rule. As mandated by the 1990 Budget Act, 

Table 1 compares, at 2000 income 

levels for each federal tax, tax burdens 

measured under 2000 law and those 

measured under 2009 law. The 

adjustment (from 2000 law to 2009 

law) to the individual income tax 

primarily reflects the effect of 

unindexed provisions, while the 

adjustment to the corporate income 

tax reflects the expiration of the 

Puerto Rico economic activity and 

possessions tax credits in 2005. The 

2009 law payroll tax burden is higher 

taxes dedicated to trust funds (e.g. the Highway Trust Fund) are assumed to be extended for budget score keeping 

purposes. Revenue from dedicated excise are automatically included in Treasury receipt forecasts and the 

distribution baseline, and proposals to extend these excises are neither scored nor distributed. 

6 The (Budget forecast) CPI-U is used to deflate parameters. Prior to 1996, Treasury used a 5-year 

budget window and current-law parameters were not deflated from the end-of-the-budget window. 

7 The FY2000 Budget forecast for the CPI-U deflator in 2000 is 170.6 and in 2009 is 209.3 

(170.6/209.3=.815). 

4 
because the wage cap on the OASDI portion of the payroll tax grows with average wages, which are 

expected to rise faster than inflation. 2009 law excises are lower because many excises are unit taxes 

which are not indexed for inflation. The estate tax burden is lower under 2009 law because the 

increase in the unified credit enacted by TRA97 is phasing in over the budget period. 

Treasury’s distribution tables show the distribution of tax burdens for the current population, given 

current income levels, but assuming fully phased-in law. One alternative to this methodology would 

be to use current-year tax law. Given the nature of proposed law changes, many of which are 

temporary, or have long phase-in periods or unindexed parameters, it is not clear that distributing 

changes in current-year tax burdens would accurately capture the distributional impact of a proposal. 

For example, most of the major proposals in the Taxpayer Relief Act of 1997 (including the new child 

credit, both new education credits, the reduction in the capital gains rate and the increase in the 

unified credit for the estate tax) were subject to phase-in periods of varying lengths, and several key 

parameters were not indexed for inflation. 

4. Unit of Analysis 

In order to measure the distribution of tax burdens, units must be ranked from the least well-off to 

the most well-off. The income measure, described in the following section, is one crucial aspect of 

a proper ranking. The unit of analysis is also very important. Treasury uses families as the unit of 

analysis. This choice is based on the observation that families generally operate as an economic unit, 

making common decisions and sharing resources. 

Treasury uses a family definition similar to that of the Census Bureau’s Current Population Survey 

(CPS). Treasury’s family includes the taxpayer, and his or her spouse and dependents (if any) living 

in the same household.8 A family may include two or more income tax filing units. All families are 

included, whether or not any member of the family files an income tax return. Dependents, along with 

their income, are attached to their larger family unit. Single (non-dependent) individuals are 

considered one-person families. The economic incomes of all members of a family are added together 

to compute the family's FEI. 

When ranking families, Treasury does not make an adjustment for family size.9 A family of four with 

an income of $50,000 is ranked the same as a family of one with an income of $50,000. By not 

adjusting for family size, one could argue that Treasury is making the implicit assumption that families 

8 Dependent college students living away from home are considered members of CPS and Treasury 

families. 

9 The JCT likewise does not adjust for the number of persons associated with a tax return. In contrast, 

the CBO and the Organization of Economic Cooperation and Development (OECD) have adjusted for unit size in 

some of their distributional analyses. The CBO has divided each family’s income by the poverty threshold for a 

family of its respective size (Kasten and Toder, 1995). The OECD has adjusted household income by dividing by 

the square root of the number of persons in the household (OECD, 1997). 

5 
benefit from perfect returns to scale; that is, the addition of a family member without additional 

income does not affect the family’s well-being. One alternative would be to rank units on a per capita 

basis by dividing family income by family size. This is equivalent to assuming that there are no returns 

to scale from living within a family unit. A family of four with an income of $100,000 would be 

ranked equivalently to a family of one with an income of $25,000. It is not clear whether the 

qualitative results of distributional analyses would be significantly affected by family size adjustments. 

5. Family Economic Income 

Central to the measurement of the distribution of tax burdens is the measurement of a family’s relative 

ability-to-pay. The ability-to-pay measure allows Treasury to rank families from the least well-off to 

the most well-off, and to use this ranking to group families into quintiles and percentiles of ability-topay. Treasury uses a very broad measure of income, Family Economic Income (FEI), to measure a 

family’s ability-to-pay. Treasury has been using a broad-based income concept for tax burden 

analyses since Blueprints for Basic Tax Reform (1977). 10 The importance of using a broad measure 

of income such as FEI for distributional analyses has been noted by leading tax economists. For 

example, Musgrave et. al (1974, p. 269) states: 

Total income, as noted before, was defined to include not only money income, but also certain

other items such as corporate source income other than dividends (i.e., corporation tax and

retained earnings), other capital gains, imputed rent, and so forth.

.........................................

For purposes of this study the broader or total income base is more appropriate. With the

entire corporation tax included in the numerator of the effective rate ratio, consistency calls

for inclusion of total corporate source income (and not only dividends) in the denominator.

More generally, total income is a better measure of taxable capacity and hence more suitable

for judging the equity of the tax structure.

State governments and research groups also use broad income measures in their distribution studies. 

For example, a study by the Tax Foundation (1989, p. 13) states: 

A critical initial assumption is how to define a family's economic income. The study's 

definition does not consist solely of money income to a family, although that is the appropriate 

starting point. A broader income concept is needed, to correspond with the broad definition 

of tax burden. The tax burden is considered to consist of taxes levied on businesses as well 

as taxes paid out of ‘money incomes.’ 

Likewise, both the JCT and the CBO recognize the need to use broad concepts of income to analyze 

10 Blueprints included distribution tables that used a concept nearly identical to FEI. FEI was used 

officially for the first time in Treasury's initial study for the 1986 Tax Reform, Tax Reform for Fairness, Simplicity, 

and Economic Growth, (Treasury I) (1984). Since that time, FEI has been continuously used by the Treasury to 

classify families in distribution tables. 

6 
the distributional effects of tax proposals. Although the JCT and CBO income concepts are not as 

broad as FEI, they both are considerably broader than adjusted gross income (AGI) as reported on 

federal income tax returns.11 

Because the income concept is fundamental to tax burden analysis, and because Treasury’s use of FEI 

is unique and at times has been a source of controversy, this section goes into great detail. It is 

divided into six subsections: (5.1) A conceptual description of FEI; (5.2) The relationship between 

FEI and Gross Domestic Product, (5.3) The relationship between FEI and Adjusted Gross Income; 

(5.4) Net rent on owner-occupied housing; (5.5) The individual tax model and consumption 

imputations; and (5.6) The distribution of FEI. 

5.1 A Conceptual Description of FEI 

Family Economic Income (FEI) is based on the Haig-Simons12 definition of income as consumption 

plus the change in net worth. That is, a family’s annual income is the amount it can spend during the 

year and still have the same net assets at the end of the period as it did at the beginning. Haig-Simons 

income is widely accepted by economists as the proper income concept for measuring "ability to 

pay."13 In accordance with the Haig-Simons definition, FEI measures income on a pre-tax, posttransfer basis, with returns to capital adjusted for inflation and accelerated tax cost recovery 

(depreciation, depletion, and amortization). It includes estimates of amounts unreported and 

underreported on tax returns and in survey data. FEI is also comprehensive with respect to the 

population; it includes the income of all families in the United States. However, FEI differs from the 

Haig-Simons concept in its measurement of pension and transfer income. 

With respect to pensions, adherence to the Haig-Simons definition would require that pension 

contributions and accruals be included in FEI, but not pension benefits. Under this definition, some 

families receiving pension benefits would have little or no income in the current year even though they 

would be paying income tax on the taxable portion of their benefits. To deal with the mismatch 

between the timing of pension income accruals and the tax due on benefits, Treasury includes pension 

11 JCT adds to AGI employer contributions for health and life insurance, the employer share of FICA 

taxes, the foreign earned income exclusion, tax-exempt interest, AMT preferences, nontaxable Social Security 

benefits, workers' compensation, and the insurance value of Medicare benefits (footnote 2, JCT (1997)). A 

description of CBO’s income measure can be found in Kasten and Toder (1995). 

12 See Haig (1921) and Simons (1938). 

13 Pechman and Okner (1974) states: “Economists define income as the amount an individual can spend 

during a particular time period and still have the same net assets (valued in money terms) at the end of the period 

as at the beginning. Another way of saying the same thing is that income is the amount of an individual's 

consumption outlays plus the increase (or minus the decrease) in his net worth during a particular time period. 

Although this definition is almost universally accepted by economists, no government or private agency provides 

regular estimates of income on the basis of this concept.” 

7 
benefits in FEI as well as pension contributions and real earnings on pension assets.14 

With respect to transfer income, all transfers, including payments-in-kind, are conceptually part of 

Haig-Simons income. FEI only includes cash transfers and food stamps. Non-cash transfers, in 

particular the value of Medicare and Medicaid benefits and housing subsidies, are excluded from FEI. 

This exclusion is due to both the difficulty of assigning a value of benefits to the recipient, and the 

difficulty of properly identifying recipients for some benefits. 

5.2 The Relationship Between FEI and Gross Domestic Product 

FEI is closely related to, and can be derived from, gross domestic product (GDP), the broadest and 

most widely used measure of the Nation’s economic output. Like FEI, GDP is broad-based, extends 

to all members of the U.S. population, is on a pre-tax basis, includes all corporate income, and 

includes income that is underreported on tax returns and in surveys. 

Starting with GDP, Table 2 shows the additions and subtractions necessary to arrive at FEI. GDP 

is based upon what is produced within the United States whereas FEI is based upon the income 

received by the U.S. population. Therefore, income payments from the rest of the world are included 

in FEI and income payments to the rest of the world are excluded. The largest exclusions in the table 

are for the consumption of fixed capital ($832 billion) and indirect business tax liability ($606 

billion).15 The largest addition ($463 billion) is the inclusion of government transfer payments (e.g. 

social security and welfare benefits). Government transfer payments and government net interest 

payments increase individual income but not the income of the country, so they are included in FEI 

but not GDP. Similarly, non-stock capital gains increase an individual’s net worth but do not 

represent an increase in current production, so they are included in FEI but not GDP.16 Finally, FEI 

does not include income not attributable to persons (that of nonprofit institutions). 

The FEI total derived in the table ($6,944 billion) is not equal to the estimated FEI total Treasury 

used in its 1996 level distribution tables ($6,330 billion). There have been two major technical 

corrections to FEI since 1996 which account for the majority of the discrepancy. Employer 

14 This approach, which has been in place since 1988, has the drawback of double-counting pension 

income. The mismatch between the timing of pension income accruals and the tax due on benefits might be better 

addressed by taking a longer term perspective of income and tax burden. As discussed in the conclusion, Treasury 

is currently studying the feasibility of multi-year income and tax burden measures. 

15 FEI does not currently include indirect business tax liability, even though indirect business taxes are 

distributed as part of federal excise taxes, and indirect business tax liability would be considered part of HaigSimons income. Conceptually, FEI, like Haig-Simons income, is a pre-tax, post-transfer measure. Because, 

indirect business tax payments such as excises (as explained in Section 6.6) reduce factor payments, the factor 

incomes observed under an excise tax are lower than those that would be observed on a pre-tax basis. To measure 

“pre-tax” income, Treasury should gross-up observed factor incomes to their pre-excise tax levels. 

16 Accrued capital gains on corporate stock also represent a change in net worth and an addition to 

income. Stock gains are included in GDP (and FEI) as part of pre-tax corporate profits. 

8 
contributions for social insurance were added and Treasury’s measure of unreported income was 

targeted to the NIPA. In addition, state and local tax refunds (prior year income) were removed from 

FEI and the self-employed health deduction was added back to income. In total, these technical 

corrections add $540 billion to the 1996 level estimate of FEI, bringing the technically correct 

estimate to $6,870 billion. The remaining difference of $74 billion (1.1 percent of the actual figure) 

is an estimation error which arises because the “current year” level of FEI is forecast in the prior year 

(the 1996 level of FEI was forecast at the beginning of 1995). 

Table 2: The Relationship between FEI and GDP in 1996 

($B)

GDP1 $ 7,662 

plus 

receipts of factor incomes from the rest of the world 1 $ 236 

subsidies less current surplus of government enterprises1 $ 22 

less 

payments of factor incomes to the rest of the world1 $ 223 

consumption of fixed capital1 $ 832 

indirect business tax and nontax liability1 $ 606 

Equals National Income1 $ 6,256 

plus 

government transfer payments $ 463 

federal, state and local net interest payments to U.S. persons and businesses1 $ 157 

real accruals of non-stock gains $ 26 

pension benefits $ 357 

less 

income attributable to nonprofit institutions1,2 $ 317 

Equals FEI $ 6,944 

1. The source for these figures is the August 1998, Survey of Current Business. 

2. Includes compensation of employees and net interest income (the detail for the latter was provided by 

the Bureau of Economic Analysis). 

5.3 The Relationship Between FEI and Adjusted Gross Income 

FEI can also be described by the additions, subtractions, and adjustments made to AGI to arrive at 

FEI. At 2000 income levels, $5.6 trillion (67.1 percent) of FEI is included in AGI, and $2.8 trillion 

9
(32.9 percent) is (net) additions, subtractions, and adjustments to AGI. The major differences 

between FEI and AGI can be categorized into six types: (i) unreported and underreported income 

included in FEI but not AGI; (ii) adjustments from a realization-based AGI to an accrual-based FEI 

valuation of assets; (iii) income items excluded from the definition of gross income under the tax 

code but included in FEI; (iv) costs of earning income not deductible for tax purposes but deducted 

in computing FEI; (v) adjustments to exclude income earned and losses incurred in other years; and 

(vi) adjustments for inflation and real economic depreciation. 

Unreported and underreported income. AGI excludes the income of persons who do not file income 

tax returns.17 It also excludes income that is unreported or underreported by filers, either due to error 

or noncompliance. FEI includes imputations for the income of nonfilers and the unreported and 

underreported income of filers. The aggregate amount of total unreported and underreported income 

in FEI is benchmarked, by type (e.g. sole proprietorship income), to the National Income and Product 

Accounts (NIPA).18 At 2000 income levels, FEI included $31 billion of imputed AGI of nonfilers and 

$713 billion of unreported and underreported income of filers. The largest single category of the 

latter is attributable to sole proprietors. 

Accrual-based valuation of assets. Unlike AGI, which only includes realized income from assets, FEI 

measures accrued income, a family’s change in net worth. Accruals represent income to the holder 

whether or not they are realized. In computing FEI, it is assumed that real accruals on stock capital 

gains are due to current corporate retained earnings. Therefore, the adjustment from realizations in 

AGI to real accruals in FEI is made by subtracting realizations of capital gains on stocks and adding 

pre-tax corporate profits (net of dividends paid) adjusted for accelerated tax cost recovery 

(depreciation, depletion, and amortization) and the inflationary component of corporate debt. 

For gains on other (non-stock) assets, Treasury uses a single adjustment factor to convert realized 

gains on these assets to real accruals. There is not sufficient data to properly benchmark the nonstock capital gain basis, or to allocate real accruals to families who do not have current realizations 

of gains on non-stock assets. Because of the adjustment to an accrual basis, the timing of income tax 

liabilities on capital gains realizations may not match income accruals from capital gains as measured 

in FEI.19 

Income excluded under the tax code. FEI includes a number of items which clearly represent income 

17 In 2000, the respective filing thresholds for single and joint filers (below the age of 65) are forecast to 

be $7,200 and $12,950. Families below these thresholds but who qualify for the earned income tax credit (EITC) 

may choose to file to obtain a refund. 

18 See Park (1996 and 1997) for a discussion and presentation of the difference between AGI as derived 

from the NIPA and AGI as reported to the Internal Revenue Service. 

19 Similar mismatches occur due to other timing differences of income between AGI and FEI. For 

example, taxes that accrue on tax favored pension contributions and accumulated assets are not paid until the 

pension benefits are received. 

10 
to the recipient but are not included in AGI. With respect to labor earnings, these items include: 

employee 401(k) contributions, IRA and Keogh deductions, the foreign earned income exclusion, the 

self-employed health deduction, and employer-provided fringe benefits (including military benefits 

and the employer share of payroll taxes). With respect to capital income, these items include: AMT 

income preferences, real (non-corporate) earnings on IRAs, Keoghs, pensions and life insurance, tax 

exempt interest, and imputed rent on owner-occupied housing. With respect to transfer income, these 

items include: nontaxable Social Security benefits, Supplemental Security Income (SSI), Temporary 

Assistance for Needy Families (TANF), general assistance, other support, food stamps, Low Income 

Housing Energy Assistance (LIHEA), veterans' compensation, and workers' compensation.20 

Costs of earning income. FEI excludes all costs of earning income, whether or not they are allowable 

as deductions under the tax code.21 Employee business expenses and moving expenses are subtracted 

from labor earnings in FEI to the extent that they are disallowed as deductions in AGI, and disallowed 

passive losses are subtracted from capital income in FEI. 

Income earned and losses incurred in other years. FEI also excludes income or losses incurred in 

other years. As a result net operating loss carryforwards are added back, and state and local tax 

refunds are subtracted. 

Inflation and real economic depreciation. Finally, FEI also adjusts the capital component of noncorporate business income in AGI for accelerated tax cost recovery and adjusts all non-corporate 

interest income and expenses for inflation. 

The relationship between FEI and AGI at 2000 income levels is given in Table 3. 

5.4 Net Rent on Owner-occupied Housing 

Net imputed rent on owner-occupied housing is the net income (positive or negative) a homeowner 

would receive if he or she rented to him or herself. It is a component of GDP and is included in 

FEI.22 The inclusion is necessary to insure comparable rankings by “well-being” (income) between 

homeowners and renters. Net imputed rent is gross rent minus the costs of home ownership 

(mortgage interest payments, property taxes, depreciation, maintenance, and repairs). As a result of 

the costs of home ownership, net imputed rent on owner-occupied housing is a very small component 

of FEI, only 0.5 percent of the total (at 2000 levels). 

20 All of these items are adjusted to totals from administrative data to correct for underreporting in AGI 

and survey data. 

21 For non-itemizers, OTA imputes the costs of earning income (see Section 5.5 below for further 

discussion). 

22 The inclusion of net imputed rent as a component of income is not unique to Treasury analyses. For 

example, Feenberg et. al (1997), Pechman (1985), and the Tax Foundation (1989) include net rent in their income 

measures. 

11 
Table 3: The Relationship between FEI and AGI in 2000 

($B)

AGI $ 5,649 

plus 

unreported and underreported income (includes AGI of nonfilers) $ 744 

adjustment from a realization to an accrual-based valuation of assets $ 127 

income not included in AGI 

labor income $ 974 

capital income $ 335 

transfer income $ 460 

costs of earning income disallowed in AGI - $ 44 

adjustments to exclude income earned/losses incurred in previous years $ 58 

adjustments for inflation and economic depreciation on non-corporate assets $ 115 

Equals FEI $ 8,419 

5.5 The Individual Tax Model and Consumption Imputation 

The Individual Tax Model (ITM) is the basic tool of Treasury’s distributional analyses.23 FEI is 

computed on the ITM and individual income and payroll tax changes are simulated directly on the 

ITM. The distributions of corporate income and estate and gift taxes are derived from the ITM’s 

capital income distribution, and the distribution of excise taxes is derived from the ITM’s factor 

income and consumption distributions. 

The base ITM file is the Statistics of Income (SOI) annual stratified random sample of individual 

income tax returns. The SOI Division of the IRS collects entries from each sampled return’s form 

1040EZ, 1040A, or 1040 including attached schedules and supporting forms. OTA then creates a 

set of imputations based on the SOI tax data. For example, to simulate the response to a proposal that 

changes the treatment of itemized deductions, non-itemizers must have the option to itemize. 

Because non-itemizers do not report itemized deduction expenses, OTA imputes itemized deduction 

expenses to non-itemizers. Other SOI-based ITM imputations include: wage and self-employment 

earnings attributable to each spouse for two-earner joint returns; employee pension plan participation; 

and social security income for tax returns with AGIs below the inclusion threshold. Such imputations 

23 See Cilke (1994) for a more complete description of Treasury’s ITM. 

12 
are based on information returns (forms W-2 and SSA-1099) matched to the tax returns. 

The base tax file is augmented by files containing other demographic and economic data. The age 

of each taxpayer is added using an exact match of date of birth from social security records. Family 

structure, non-filers, and non-taxable sources of income are obtained from a statistical match with the 

CPS.24 

Finally, the following additional imputations are added to the merged SOI-CPS files: consumption 

(described below); pre-tax corporate income; earnings on pensions, life insurance and IRA accounts; 

accruals of non-corporate capital gains; employer contributions to health insurance and pensions; 

military benefits; net rent on owner-occupied housing; and underreported and unreported income. 

These imputations are made using data or targets from the Bureau of Labor Statistics’ Consumer 

Expenditure Survey (CEX), the SOI, the NIPA, the CPS, the Federal Reserve Board’s Survey of 

Consumer Finances (SCF), the Department of Housing and Urban Development’s American Housing 

Survey (AHS), the Department of Health and Human Services’ National Medical Expenditure Survey 

(NMES), and the IRS’s Taxpayer Compliance Measurement Program (TCMP). 

In addition to its detailed data base, the ITM consists of an extensive set of computer programs which 

are used to simulate individual income tax liabilities and changes in these liabilities for every year in 

the budget window. The Office of Management and Budget (OMB) provides Treasury with an 

economic forecast of income levels, employment, price levels, and interest rates which are then used 

to extrapolate the ITM over the ten-year budget window, and thus ensure that Treasury’s model is 

consistent with OMB’s forecast of national income, employment, and inflation. 

Consumption imputations. In order to assess the burden of relative price changes caused by excises, 

the ITM also includes an imputation of each family’s consumption of goods and services. The only 

source of detailed consumption information is the CEX. Unfortunately, it has documented problems 

with regard to underreporting of income, and the accuracy of its consumption rates (consumption 

relative to income), particularly for low- and high-income households, have been questioned.25 Table 

4, reproduced from Sabelhaus (1998), shows very low-income families in the CEX spending over 

twice their income and very high-income families spending only 67 percent of their income. While 

a somewhat skewed distribution of consumption rates is consistent with life-cycle income and 

consumption patterns, other evidence suggests that the high degree of skewness in the CEX cannot 

be completely explained by life-cycle effects. Sabelhaus and Groen (1998), for example, find the 

24 In preparation for the merge between the SOI and CPS data, tax filing units are constructed from the 

CPS file, and adjusted gross income and tax status are calculated. The CPS and SOI files are partitioned into 

groups according to filing status, the presence of wage income, and the presence of children. The files are then 

statistically merged by partition, and families formed based on relationships from the CPS records. Future ITM 

models will not depend on the CPS to form statistical families for taxpayers. Beginning with the 1995 filing year, 

SOI’s annual cross-section of individual income tax returns is family based; it includes the returns of dependent 

filers and spouses that file separately. 

25 See the JCT (1993, part III), Sabelhaus (1998), and Sabelhaus and Groen (1998). 

13 
same pattern of consumption rates within age-specific cohorts. Further, when the authors considered

income fluctuations across time (using the Panel Survey

of Income and Dynamics) they found that “almost all” Table 4: Consumption Rates in the CEX

movements were within one or two deciles of a family’s 

original decile ranking. In their study, a family whose 

permanent income placed it in the bottom decile had a 

69.6 percent chance of being in the bottom decile in any 

given year and a 23.8 percent chance of being in the 

second lowest decile. Thus, it appears that low-income 

families could not sustain consumption levels well 

above their income levels. 

In order to build a more consistent relationship between 

consumption and income, Treasury recently began to 

derive aggregate consumption by income class using tax 

data and estimates of aggregate savings from the 

NIPA.26 The CEX is still used to apportion aggregate 

consumption within an income class across particular 

Expenditure -

Income Class Income Ratio 

Less than $10,000 2.07 

$10,000 to $20,000 1.31 

$20,000 to $30,000 1.08 

$30,000 to $40,000 0.91 

$40,000 to $50,000 0.85 

$50,000 to $75,000 0.80 

$75,000 to $100,000 0.70 

$100,000 or More 0.67 

Less than $100,000 0.94 

All consumer units 0.90 

categories of goods. 

Derived aggregate consumption is equal to FEI 

minus personal taxes and net private savings as 

illustrated in Table 5. FEI, income, payroll, and 

estate and gift tax estimates are Treasury derived. 

The state and local income tax estimate is the 

1997 NIPA estimate ($164.3 billion) extrapolated 

to 2000 levels.27 Treasury uses the distribution of 

deductions for state and local income taxes 

(including the imputations for non-itemizers) less 

refunds from the ITM to distribute the NIPA state 

and local income tax estimate to families by 

income class. The net private savings amount is 

the sum of OMB’s 1998 Winter Budget forecasts 

for personal savings and retained corporate 

earnings. Net private savings is distributed to 

families in proportion to their level of capital 

26 The JCT (1993) advocates a somewhat similar procedure: using the Survey of Consumer Finances to 

Source: Table 4 Sabelhaus (1998) 

Table 5: Aggregate Consumption in 2000 

($B) 

FEI $ 8,419 

minus 

individual income tax - $ 853 

corporate income tax - $ 190 

payroll tax - $ 662 

estate and gift taxes - $ 26 

state and local income taxes - $ 206 

Equals Disposable FEI $ 6,483 

minus 

net private savings - $ 188 

Equals Aggregate Consumption $ 6,295 

calculate savings rates and then imputing consumption based on those savings rates. 

27 State and local income taxes grew from $131.2 billion in 1994 to $164.3 billion in 1997 (about 25 

percent, Table 3.3, Survey of Current Business, August 1998). This growth rate was used to extrapolate the 1997 

state and local income tax figure to a 2000 level figure. 

14 
----- ----- ----- -----

income.28 The resulting distribution of aggregate consumption is shown in Table 6 (following page). 

Treasury’s derived savings rate (savings as a percentage of disposable FEI) rises from 0.8 percent for 

the lowest income quintile to 4.7 percent for the highest income quintile and 8.4 percent for the top 

1 percent of families. 

Kennickell and Starr-McCluer (1996), using the 1983 and 1989 SCF, derive savings rates from 

income and wealth data and find a similar pattern of savings behavior, although their average savings 

rate of 12.2 percent is much higher than Treasury’s average rate. Direct comparison between the two 

studies is complicated by the fact that the years of analysis are different, Treasury’s income measure 

is broader, the income classes are defined differently, and Treasury’s rates are expressed in terms of 

disposable income. Table 7 facilitates the comparison by indexing each of the derived savings rates 

by income class to the average rate for all families and by showing the share of families in each of the 

income classes. The result illustrates a similar pattern of savings rates using the two approaches. 

Treasury’s savings rate for the lowest quintile is higher than the Kennickell and Starr-McCluer rate 

at least in part because Treasury’s tables exclude families with negative incomes, who typically have 

large dissavings, from the lowest quintile.29 

Table 7: KSM and Treasury Savings Rates Indexed to their Respective Average Rate 

Treasury KSM 

Savings Savings 

Share of Rate Share of Rate 

FEI Quintile families Index SCF Income families Index 

Lowest1 19.4 0.3 Below $10K 17.3 0.1 

Second to Fourth 60.0 0.8 $10K to $50K 66.4 0.6 

Highest 20.0 1.6 Over $50 K 16.4 1.7 

All families 100.0 1.0 All families 100.0 1.0 

2000 levels 1989 levels 

Source for KSM figures: Tables 1 and 4, Kennickell and Starr-McCluer (1996) 

1. Families with negative incomes are excluded from the lowest quintile but included in 

the total line. Quintiles begin at FEI of: Second $17,988; Third $34,844; Fourth $59,019; 

Highest $100,767; Top 10% $140,581; Top 5% $189,835; Top 1% $462,053. 

28 For persons with negative FEI, or FEI less than (positive) personal tax liability, Treasury allows an 

initial dissavings equal to the sum of negative FEI plus personal tax liability or, in the latter case, the difference 

between income and (positive) personal tax liability. 

29 Treasury excludes negative income families (0.6 percent of all families) from the lowest quintile 

because they typically have large amounts of negative capital income and in other ways are not similar to the 

typical low-income family. 

15 
Table 6: Distribution of FEI, Personal Taxes, Disposable FEI, Consumption, and Savings in 2000 

Total Disposable 

Family Economic FEI1 Personal Taxes1 FEI 

Income Quintile ($B) ($B) (% of FEI) ($B) ($B) (% of DFEI) ($B) (% of DFEI) 

Consumption Savings 

Lowest2 226 13 5.8 213 211 99.2 2 0.8 

Second 602 71 11.9 531 521 98.2 9 1.8 

Third 1,062 190 17.9 872 851 97.6 21 2.4 

Fourth 1,790 377 21.1 1,413 1,379 97.6 34 2.4 

Highest 4,771 1,280 26.8 3,491 3,326 95.3 165 4.7 

Total2 8,419 1,936 23.0 6,483 6,295 97.1 188 2.9 

Top 10% 3,407 960 28.2 2,446 2,308 94.3 138 5.7 

Top 5% 2,479 725 29.3 1,754 1,638 93.4 116 6.6 

Top 1% 1,247 401 32.1 846 775 91.6 71 8.4 

1. Personal taxes include individual income, corporate income, payroll (employer and employee shares), state and local income, and 

estate and gift taxes. 

2. Families with negative incomes are excluded from the lowest quintile but included in the total line. Quintiles begin at FEI of: 

Second $17,988; Third $34,844; Fourth $59,019; Highest $100,767; Top 10% $140,581; Top 5% $189,835; Top 1% $462,053. 
------- ------- 

5.6 The Distribution of FEI 

Table 8 shows the distribution of families and FEI at both 1996 and 2000 income levels. The 

distributions are presented for two different years to facilitate comparisons with the text which 

includes references to both 1996 and 2000 level data. FEI is concentrated among high-income 

families. At 2000 levels, the lowest quintile of families in the income distribution receives only 2.7 

percent of total FEI and the bottom 60 percent of families receives less than 25 percent of total FEI, 

whereas the highest quintile of families receives 56.7 percent of total FEI. 

Family Economic Families Family Economic Income Families Family Economic Income 

Income Quintile (millions) ($B) (%) (millions) ($B) (%) 

2000 levels -------

Table 8: Distribution of Family Economic Income (FEI) at 1996 and 2000 levels1 

1996 levels -------

Lowest2 21.4 185 2.9 22.4 226 2.7 

Second 21.9 492 7.8 23.0 602 7.2 

Third 21.9 844 13.3 23.0 1,062 12.6 

Fourth 21.9 1,364 21.5 23.0 1,790 21.3 

Highest 21.9 3,473 54.9 23.0 4,771 56.7 

Total2 109.4 6,330 100.0 115.2 8,419 100.0 

Top 10% 10.9 2,465 38.9 11.5 3,407 40.5 

Top 5% 5.5 1,787 28.2 5.8 2,480 29.5 

Top 1% 1.1 905 14.3 1.2 1,247 14.8 

1. The total FEI levels for the two years should not be construed as representing growth in FEI over this period; the 

definition of FEI is not the same for the two periods. The 1996 level figures do not include the employer share of 

payroll taxes, nor do they adjust for state income tax refunds and the self-employed health deduction, and the 1996 

unreported income amounts are not targeted to the National Income and Product Accounts (see Section 5.2). 

2. Families with negative incomes are excluded from the lowest quintile but included in the total line. Quintiles at 1996 

levels begin at FEI of: Second $15,604; Third $29,717; Fourth $48,660; Highest $79,056; Top 10% $108,704; 

Top 5% $145,412; Top 1% $349,438. Quintiles at 2000 levels begin at FEI of: Second $17,988; Third $34,844; 

Fourth $59,019; Highest $100,767; Top 10% $140,581; Top 5% $189,835; Top 1% $462,053. 

FEI compared to Cash Income. Although FEI is a broad income concept, its distribution across 

income quintiles is not substantially different than the distribution of other relatively broad income 

concepts, such as the cash income concept used by CBO. Table 9 shows the distribution of FEI and 

a family’s cash income at 2000 income levels.30 Because FEI is a broader income concept, the lower 

limits of the FEI quintiles are higher than those of the cash income quintiles. Total cash income for 

all families is $7,007 billion compared to $8,419 billion of FEI. Nonetheless, the respective income 

shares are very similar, with FEI showing a slightly larger share of income at the top of the 

30 Cash income in the table is Treasury derived but based upon the CBO concept. 

17 
distribution than cash income because FEI includes total pre-tax corporate profits and non-stock 

gains, pensions, IRAs, Keoghs, and life insurance on an accrual basis. (As discussed below, capital 

income is concentrated at the upper end of the income distribution.) The top quintile of households 

as ranked by FEI has a 56.7 percent share of FEI while the top quintile of families as ranked by cash 

income has a 55.5 percent share of cash income. 

Table 9: Cash Income Compared to FEI in 2000 

Income Family Economic Income Family Cash Income1 

Quintile Lower Limit Share Lower Limit Share 

Lowest $0 2.7 $0 2.9 

Second $17,988 7.2 $16,426 7.7 

Third $34,844 12.6 $30,964 13.1 

Fourth $59,019 21.3 $49,862 21.1 

Highest $100,767 56.7 $81,967 55.5 

Top 10% $140,581 40.5 $115,239 39.7 

Top 5% $189,835 29.5 $154,900 28.8 

Top 1% $462,053 14.8 $346,555 15.1 

1. Cash Income consists of wages and salaries, net income from a business or farm, taxable and taxexempt interest, dividends, rental income, realized capital gains, cash transfers from the government, 

and retirement benefits. Employer contributions for payroll taxes and the federal corporate income 

tax is added to place cash income on a pre-tax basis. 

FEI factor income distributions. The components of FEI can be divided into labor earnings, returns 

to capital, and transfer payments. At 2000 income levels, FEI totals $8.4 trillion, of which $6.0 

trillion (71 percent) is labor earnings, $1.9 trillion (22 percent) is returns to capital, and $0.6 trillion 

(7 percent) is transfer payments. Labor earnings include wages before taxes and before employee 

contributions (e.g. 401(k) contributions); employer-provided fringe benefits (primarily health 

insurance, pension contributions, and the employer share of payroll taxes);31 and the labor component 

of self-employment income (from sole proprietorships, partnerships, and subchapter S corporations). 

Returns to capital include real (inflation adjusted) net interest income; pre-tax corporate profits 

(adjusted for inflation and accelerated tax cost recovery); real accruals of non-stock capital gains; the 

capital component of non-corporate business income (adjusted for inflation and accelerated tax cost 

recovery); pension and IRA benefits; real earnings on retirement (pension, IRA, and Keogh) and life 

insurance assets; and imputed rent on owner-occupied housing. Transfer payments include Social 

Security benefits, SSI, TANF, LIHEA, veterans' compensation, workers' compensation, 

31 The employer share of payroll taxes and the self-employed health deduction were added to FEI in 1997 

as technical corrections. 

18 
unemployment compensation, other general cash assistance, and food stamps.32 

Table 10 shows the percentage distribution of FEI factor incomes. Two columns appear under each 

factor income component. The first column shows the percent of each quintile’s total FEI attributable 

to the factor income, and the second column shows the distribution of the factor income across 

income quintiles. For example, 44.9 percent of the lowest income quintile’s total FEI is from labor, 

6.1 percent from capital, and 49.0 percent from transfers. Although transfer income represents 

almost half the income received by the lowest income quintile, the lowest income quintile’s share of 

total transfer income is only 19.2 percent, an amount that is lower than that received by the second 

and third quintiles (25.8 and 23.0 percent respectively). 

Capital income is concentrated in the upper end of the income distribution. The highest income 

quintile receives 73.2 percent of all capital income whereas the bottom 60 percent of families receive 

14.1 percent of all capital income. Labor income is also concentrated in the upper end of the 

distribution but to a lesser degree. The highest income quintile receives 55.6 percent of all labor 

income whereas the bottom 60 percent of families receives 20.7 percent of all labor income. In 

contrast, transfer income is more evenly distributed across income classes, ranging from shares of 

14.8 percent for the highest income quintile to 25.8 percent for the second lowest income quintile. 

Table 10: Percentage Distribution of FEI Factor Incomes in 2000 

FEI 

Family Economic As a percent Percent As a percent Percent As a percent Percent Percent 

Income Quintile of Total FEI Distribution of Total FEI Distribution of Total FEI Distribution Distribution 

Labor Income Capital Income Transfer Income 

Lowest1 44.9 1.7 6.1 0.7 49.0 19.2 2.7 

Second 62.3 6.3 13.0 4.2 24.8 25.8 7.2 

Third 71.4 12.7 16.1 9.2 12.5 23.0 12.6 

Fourth 78.9 23.6 15.6 15.1 5.5 17.0 21.3 

Highest 69.7 55.6 28.5 73.2 1.8 14.8 56.7 

Total1 71.1 100.0 22.1 100.0 6.9 100.0 100.0 

Top 10% 65.0 37.0 33.6 61.5 1.4 8.3 40.5 

Top 5% 60.1 24.9 38.8 51.8 1.1 4.8 29.4 

Top 1% 52.3 10.9 47.1 31.6 0.5 1.2 14.8 

1. Families with negative incomes are excluded from the lowest quintile but included in the total line. Quintiles begin 

at FEI of: Second $17,988; Third $34,844; Fourth $59,019; Highest $100,767; Top 10% $140,581; 

Top 5% $189,835; Top 1% $462,053. 

32 Food stamps are included in FEI although all other forms of non-cash transfer payments (e.g. 

subsidized housing) are not. Food stamps are included because they serve as a close cash substitute although 

recipients may not value food stamps at their full face (dollar) value. 

19 
Labor income is the largest source of income for all income quintiles except for the lowest; over 60 

percent of all income is from labor in the top four income quintiles and over 70 percent for the third 

and fourth income quintiles. Capital income is a significant source (over 15 percent) of income for 

the third and fourth income quintiles and becomes an increasingly significant source of income as 

income rises. For the top quintile, 28.5 percent of all income is from capital sources, and for the top 

1 percent the capital income component rises to 47.1 percent. 

6. Incidence Assumptions 

In general, Treasury assumes the individual income tax is borne by payors, the corporate income tax 

by capital income generally, and payroll taxes (employer and employee shares) by labor (wages and 

self-employment income included in the payroll tax base). Excise on purchases by businesses and 

customs duties are assumed to be borne by labor and capital income. Excises on purchases by 

consumers are assumed to be borne in proportion to relative consumption of the taxed good as well 

as by labor and capital income. Treasury assumes estate and gift taxes are borne by decedents. More 

detailed descriptions of the incidence assumptions for each tax are below in separate subsections. The 

next subsection (6.1) provides a description of the difference between tax burden estimates and 

revenue estimates. 

6.1 The Difference Between Tax Burden Estimates and Revenue Estimates 

Incidence assumptions include not only assumptions about who bears the burden of a particular tax, 

but also how much burden or benefit is conferred. For a proposed change in tax law, Treasury 

distributional analyses reflect the fact that the resulting change in tax burden for a given year is not 

necessarily equivalent to the expected change in tax liability for that year. This difference in 

Treasury’s distribution and revenue estimating methodologies is fully consistent with the different 

purposes served by revenue estimates and distributional analyses. 

Revenue estimates are measures of the change in government receipts due to a tax proposal. 

Consider the change in tax receipts due to a capital gains tax cut as illustrated in Figure 6.1a. The 

figure shows the “demand” (DD) for 

realized capital gains. If the tax rate is t0 

then the amount of gains realized is g0. As 

20 

Tax 

Rate 

0 g0 g1 g*

t1 

t0 A 

C B

Change in tax receipts due to a capital gains tax cut 

(+) 

(-) 

Figure 6.1a 

Realized Capital Gains 

D 

D 

the tax rate on realized gains falls, the 

amount of capital gains realized increases, 

until at a tax rate of zero, an amount of 

capital gains equal to g* is realized. If the 

capital gains tax rate is reduced from t0 to t1 

government receipts are reduced by lower 

tax payments on the current-law level of 

capital gains realizations but increased by 

the taxes paid on additional realizations 
induced by the tax cut. The reduction in government receipts on current realizations is illustrated in 

Figure 6.1a by the shaded rectangle t1t0AC, and the increase in government receipts due to increased 

realizations by the shaded rectangle g0CBg1. The estimated net effect of these two changes in 

government receipts equals Treasury’s revenue estimate for a capital gains tax cut. 

In contrast, Treasury’s distribution estimates are intended to measure the change in tax burden due

to a tax proposal. The burden, or benefit, of a tax proposal may not be properly measured by the

change in tax payments; such is the case with a capital gains tax cut. In figure 6.1b, the total tax

burden of a capital gains tax at rate t0 is represented by the area 0t0Ag*. The burden has two sources:

the tax liability, represented by rectangle 0t0Ag0 and a dead weight loss, represented by triangle

g0Ag*. If the capital gains tax rate is

reduced from t0 to t1, both the amount of

tax due on current-law realizations and the

Tax 

Rate 

Realized Capital Gains 

0 g0 g1 g*

t1 

t0 A 

B 

C 

Change in tax burden due to a capital gains tax cut 

(-) 

Figure 6.1b 

(-) 

D 

D 

amount of dead weight loss is reduced. 

The total reduction in tax burden is equal 

to the shaded region t1t0AB. Treasury’s 

distribution estimate would only include 

the reduction in tax liability on current-law 

realizations (t1t0AC), and not the additional 

reduction in dead-weight loss (CAB).33 

Thus, Treasury would underestimate the 

amount of tax relief arising from a 

reduction in the capital gains tax rate. 

Clearly, however, the tax collected on induced realizations (g0CBg1), although part of the revenue 

estimate because it represents a change in government receipts, does not represent a change in tax 

burden. Under both rates (t0 and t1) area g0CBg1 is part of the tax burden. At rate t0, it is part of the 

dead weight loss, and at rate t1 it is part of taxes collected. 

6.2 Individual Income Tax 

Individual income taxes are assumed to be borne by payors. The distribution of individual income 

taxes to families by family economic income class is based on tabulations from the ITM. For many 

but not all provisions, the change in tax liabilities based on long run fully phased in law is equivalent 

to the change in burden used for Treasury distributional analysis. Provisions for which this is not the 

case include capital gains (discussed above), tax preferred savings vehicles, and voluntary speedups 

of tax payments, such as those induced by rolling over a front-loaded IRA into a back-loaded IRA. 

33 As a separate but related issue, the baseline burden of capital gains is not complete. The existence of a 

tax on capital gains produces a lock-in effect which has an associated burden (described above as dead weight loss 

and, for tax rate t0, illustrated by triangle g0Ag* in Figure 6.1b). Treasury does not include the burden of this lockin effect in the baseline, nor does Treasury measure the benefit (burden) of provisions that would reduce (increase) 

the lock-in. 

21 
Tax-preferred savings vehicles. For proposed changes, Treasury measures the tax benefit from 

participation in individual retirement accounts and similar tax-preferred savings vehicles as the present 

value of the tax savings from one year’s contributions.34 In general, a dollar of savings generates a 

stream of expected future income and an associated stream of expected future income tax liabilities. 

If the savings vehicle is tax-preferred, then the stream of expected future tax liabilities is lower and 

a dollar saved realizes a higher after-tax return. Treasury measures the tax benefit as the difference 

between the present discounted value of the after-tax return on the amount saved in a tax-preferred 

savings vehicle and the same amount saved in a taxable savings vehicle.35 It is assumed the 

contribution is kept in the account until it must be distributed, or for retirement accounts, is kept until 

age 65 and then distributed in equal amounts over the taxpayer’s expected remaining lifetime. Thus, 

Treasury’s measure represents the present value of the additional consumption the taxpayer can 

undertake as a result of the tax preference for one year’s contributions. 

As an illustration, consider the case of a $1 pre-tax contribution made to a back-loaded versus a 

front-loaded IRA, as shown in Table 11. In the table, r is the rate of return and the discount rate, t 

is the marginal income tax rate (assumed to be constant over the entire period), the contribution is 

made in year 0, and the distribution is in year n. The table shows that the lifetime tax benefit of a $1 

pre-tax contribution to a back-loaded IRA is the same as a $1 pre-tax contribution to a front-loaded 

IRA. In both cases, the participating taxpayer receives tax-free earnings over the entire period and 

pays a present discounted value of tax equal to t. 

Table 11: Cumulative Value and Annual Tax liability on a $1 Pre-tax Contribution to Alternative Savings Vehicles1 

Savings Vehicle Year 0 Year 1 Year 2 Year n2 

Taxable Cumulative Value 

Annual tax liability 

1-t (1-t)(1+r(1-t)) (1-t)(1+r(1-t))2 (1-t)(1+r(1-t))n 

t (1-t)rt (1-t)(1+r(1-t))rt (1-t)(1+r(1-t))n-1rt 

Front-loaded IRA Cumulative Value 

Annual tax liability 

1 (1+r) (1+r)2 (1-t)(1+r)n 

0 0 0 t(1+r)n 

Back-loaded IRA Cumulative Value 

Annual tax liability 

1-t (1-t)(1+r) (1-t)(1+r)2 (1-t)(1+r)n 

t 0 0 0 

1. In the table, r is the rate of return and the discount rate, t is the marginal income tax rate, the contribution is made in year 0, and the distribution is 

in year n. 

2. For IRAs, assumes withdrawal is made in year n with no penalty. For the taxable account and front-loaded IRAs, the cumulative value is net of 

taxes paid. 

34 In the baseline, Treasury measures the burden of existing tax-preferred savings vehicles on a cash-flow 

basis, not on the present value of current year contributions. 

35 This difference takes into account amounts in the tax-preferred account that would otherwise have 

received tax-preferred treatment. For example, if IRAs were expanded, the additional contributions to IRAs might 

otherwise have been invested in tax-exempt bonds or other tax-preferred forms. 

22 
Note, however, that the timing of tax payments is not the same for the two savings vehicles. A $1 

contribution made to a back-loaded IRA is taxed in the year the contribution is made (year 0) whereas 

for a front-loaded IRA the same amount of tax, plus the earnings on the tax, is not collected until 

distribution in year n. As a result, measuring tax benefits by the change in tax liabilities in a single 

year would erroneously understate the tax benefits of both accounts and measure one account (frontloaded IRAs) as conferring a greater tax benefit. 

Voluntary speedups of tax payments. Treasury does not include voluntary tax payments induced by 

changes in tax law in its measure of tax burden. If a taxpayer voluntarily initiates a taxable event 

because of a change in tax law, the taxpayer must be at least as well off taking the action and paying 

tax as would have been the case if no action had been taken. One example of voluntary payments not 

representing burdens is the TRA97 rollover provision for Roth IRAs. The provision allows taxpayers 

with front-loaded IRAs to roll them into back-loaded Roth IRAs. 

Because contributions to back-loaded IRAs are not deductible, a taxpayer switching to a back-loaded 

IRA must pay tax on the amount rolled over in the year of the rollover.36 Note, however, that if the 

taxpayer’s marginal income tax rate were the same in the current year as in the expected year of 

distribution, and if his or her discount rate were equal to the rate of return on the IRA, then the 

discounted present value of the tax liability on the front-loaded IRA would be equivalent to the 

current year tax liability owed due to the rollover. Therefore, if a taxpayer chooses to rollover from 

a front-loaded into a back-loaded IRA, the tax liability incurred from the rollover must be lower than 

(or at most equal to) the present discounted value of the tax liability the taxpayer would have owed 

if he or she had maintained the front-loaded IRA. This would occur if the taxpayer expected to be 

in a higher marginal tax bracket in later years, or if he or she had a discount rate that was lower than 

the rate of return. 

Current law distribution of federal taxes. Table 12 shows the percentage distribution of federal taxes 

and federal taxes as a percent of FEI at 2000 income levels. Total federal taxes are fairly progressive, 

ranging from a combined effective rate of 5.9 percent for the bottom quintile of families to 24.6 

percent for the top quintile. The highest quintile pays 65.1 percent of the total tax burden relative 

to its 56.7 percent share of total FEI. The lowest income quintile pays 0.7 percent of the total tax 

burden relative to its 2.7 percent share of total FEI. 

The distribution of the individual income tax. The individual income tax is quite progressive. Its 

effective rate rises from -2.4 percent for the lowest income quintile to 13.7 percent for the highest 

quintile and 20.2 percent for the top 1 percent of families. The negative effective rate in the lowest 

income quintile is due almost entirely to the refundable portion of the earned income tax credit 

(EITC). 

36 TRA97 allowed taxpayers who made such rollovers by December 31, 1998 to spread the income tax 

payments on the rollover over four years. 

23 
---------- 

---------- 

----------

----------

Table 12: Distribution of Federal Taxes Under Current Law in 2000 

Total 

Family Economic Federal Individual Corporate Estate 

Income Quintile1 Taxes Income Income Payroll Excises1 and Gift 

Lowest2 0.7 -0.6 1.1 2.3 2.0 0.0 

Second 3.9 0.5 4.3 7.9 6.7 0.0 

Third 10.2 6.9 9.2 14.9 12.8 0.0 

Fourth 19.9 16.3 14.9 26.4 22.1 0.8 

Highest 65.1 76.6 70.6 48.3 56.3 99.2 

Total2 100.0 100.0 100.0 100.0 100.0 100.0 

Top 10% 48.5 61.3 59.1 28.2 39.6 96.2 

Top 5% 36.5 49.1 49.7 15.4 28.4 91.0 

Top 1% 20.1 29.5 30.3 4.0 13.9 64.2 

Lowest2 5.9 -2.4 0.9 6.7 0.7 0.0 

Second 11.7 0.8 1.4 8.7 0.8 0.0 

Third 17.4 5.6 1.6 9.3 0.9 0.0 

Fourth 20.1 7.8 1.6 9.8 0.9 0.0 

Highest 24.6 13.7 2.8 6.7 0.9 0.5 

Total2 21.5 10.1 2.3 7.9 0.9 0.3 

Top 10% 25.7 15.4 3.3 5.5 0.9 0.7 

Top 5% 26.6 16.9 3.8 4.1 0.9 0.9 

Top 1% 29.1 20.2 4.6 2.1 0.9 1.3 

Percent Distribution 

As a Percent of Income 

1. Includes customs duties. 

2. Families with negative incomes are excluded from the lowest quintile but included in the total line. Quintiles begin at FEI of: 

Second $17,988; Third $34,844; Fourth $59,019; Highest $100,767; Top 10% $140,581; Top 5% $189,835; Top 1% $462,053. 

24
6.4 Corporate Income Tax 

Treasury assumes changes in the corporate income tax are borne by all (positive) capital income.37 

This assumption is supported by both the seminal literature on corporate tax incidence as well as more 

recent research. In a well-known study, Harberger (1962) uses a two-sector, two-good, general 

equilibrium model to show how a partial factor tax may be shifted to other factors. In his model, 

factors are freely mobile but fixed, and the economy is closed. The extent to which the tax on 

corporate capital is shifted to all capital (both corporate and noncorporate) or labor depends on the 

relative elasticities of substitution between capital and labor in the two sectors, the elasticity of 

demand for the corporate good, and the intensity of factor use in each sector. Using reasonable 

parameter assumptions,38 Harberger concludes that, in the long run, a tax levied on corporate capital 

will be borne by capital income generally and will not be shifted to labor. More recent extensions of 

Harberger’s work generally support his incidence conclusions (see for example Gravelle and Kotlikoff 

(1993) and the open economy extension by Gravelle (1994)).39 

The distribution of the corporate income tax is one area where Treasury, CBO and JCT have used 

different incidence assumptions. In a 1987 publication, CBO (1987b) presented separate 

distributional results based on whether the corporate income tax was assumed to be borne by labor 

or capital. At the time, CBO reasoned that labor might bear part of the burden of the corporate 

income tax in an open economy setting, or if the corporate tax led to a decline in savings, reducing 

productivity and wages. Kasten et. al (1994) describes CBO’s incidence assumption as assigning 

half the burden of the corporate income tax to labor income and half to capital income. In their most 

recent analyses, CBO has distributed the corporate income tax to all capital income (see for example 

the OBRA93 distribution in Kasten and Toder (1995) and CBO (1998)). 

In the past, JCT has distributed the burden of the corporate income tax to owners of corporate capital 

(JCT 1993). These JCT analyses focused on the 5-year budget period, and took the view that 5 years 

was too short a time period for the corporate income tax to be shifted beyond those directly liable for 

the tax, the owners of corporate capital. More recently, JCT has opted not to include the corporate 

income tax in its distributional analyses “due to the uncertainty concerning the incidence of the tax” 

(footnote 3, JCT 1997). 

Table 13 illustrates how different the distribution of the corporate income tax would appear under 

alternative incidence assumptions. The first column shows the short-run incidence where the burden 

37 Treasury has maintained this assumption since 1990, although some earlier Treasury studies 

(including Nelson, 1987) took a shorter run view and distributed the corporate income tax to corporate 

shareholders. 

38 Harberger concludes that the greater relative elasticity of substitution between capital and labor in the 

corporate sector relative to the noncorporate sector dominates any output effect which might otherwise shift some 

of the burden of the tax to labor (assuming the corporate sector is labor intensive). 

39 For a more complete review of the literature on corporate tax incidence, see CBO (1996). 

25 
is borne by owners of corporate capital. The second column shows the long run incidence (used by 

Treasury and recently by CBO) where all capital income bears the burden. The third column shows 

the distribution under the 

assumption that labor would 

bear half the burden. All three 

distributions are progressive 

throughout the income distribution. The short-run incidence 

assumption is the most progressive, 88.6 percent of corporate 

capital income is held by 

families in the top income quintile. In contrast, 70.6 percent of 

all positive capital income is 

held by families in the top 

income quintile, and a distribution based on the burden 

being divided equally between 

labor and capital would assign 

63.1 percent of the total burden 1. Families with negative incomes are excluded from the lowest quintile but to families in the top income included in the total line. Quintiles begin at FEI of: Second $17,988;

quintile. Third $34,844; Fourth $59,019; Highest $100,767; Top 10% $140,581; 

Top 5% $189,835; Top 1% $462,053. 

Measuring the burden of the corporate income tax. In general, Treasury measures the current-year 

change in the corporate tax burden by the change in the current-year corporate tax liability, assuming 

fully-phased in, long-run law. Exceptions include investment incentives such as accelerated 

depreciation or expensing. These investments, undertaken in the current year, give rise to a stream 

of future tax benefits and cannot be properly measured by a single year’s benefits. Instead, the tax 

benefit is measured as the sum of the present values of tax savings in each year due to the current 

year’s investment. 

The distribution of the corporate income tax. As shown in Table 12, the average effective corporate 

income tax rate for the highest income quintile (2.8 percent) is more than three times higher than that 

of the lowest quintile (0.9 percent). 

6.5 Payroll Tax 

Payroll taxes are broadly assessed on wages and self-employment income. Because of nearly 

universal coverage and because aggregate labor supply is very inelastic, Treasury assumes that labor 

bears the entire burden of the payroll tax, both the employee and the employer shares.40 

Corporate All Positive Half Capital 

Family Economic Capital Capital Half Labor 

Income Quintile Income Income Income 

(%) (%) (%) 

Table 13: Corporate Tax Incidence in 2000 

Lowest1 0.4 1.1 1.4 

Second 1.2 4.3 5.3 

Third 3.0 9.2 10.9 

Fourth 6.5 14.9 19.2 

Highest 88.6 70.6 63.1 

Total1 100.0 100.0 100.0 

Top 10% 81.5 59.1 48.1 

Top 5% 72.9 49.7 37.3 

Top 1% 48.3 30.3 20.6 

40 This incidence assumption is followed by JCT, CBO, and Pechman (1985) among others. 

26 
The payroll tax has three components. The hospital insurance (HI) component applies to all wages 

and self-employment income. The old-age, survivors, and disability insurance (OASDI) component 

is capped at a relatively high level of wage income ($76,200 in 2000), and the unemployment 

insurance (UI) component is capped at a relatively low level of wage income ($7,000). 

The distribution of the payroll tax. Although the statutory rate for all but very low and very high 

income wage earners is flat (15.3 percent combined employer and employee rate on wages in excess 

of $7,000 but below $76,200), the payroll tax is mildly progressive (not proportional or regressive 

as is generally assumed) through the first four FEI quintiles. As shown in Table 10, labor income as 

a share of total income rises through the first four income quintiles; a flat rate applied to a component 

of income whose share of income grows as income increases produces a progressive distribution. 

Table 12 shows the effective rate on the payroll tax rising from 6.7 percent in the first quintile to 9.8 

percent in the fourth quintile. The payroll tax becomes regressive after the fourth quintile for two 

reasons. First, the OASDI wage cap lowers the statutory payroll tax rate for wage earners over the 

cap and second, the share of labor income as a percent of total income falls in the top quintile as the 

share of capital income increases. The effective rate for payroll taxes falls to 6.7 percent for the top 

quintile, 5.5 percent for the top 10 percent of families and only 2.1 percent for the top 1 percent of 

families. 

Treasury does not offset the burden of payroll taxes by the present value of future benefits. The 

contributions are treated as taxes and the benefits as transfer payments.41 Likewise, Treasury does 

not include the incidence of benefits financed by income, excise, or estate and gift taxes. 

6.6 Excises and Customs Duties 

In general, excises on purchases by individuals are assumed to be borne in proportion to relative 

consumption of the taxed good and proportionately by labor and capital income. Excises on 

purchases by businesses and customs duties are assumed to be borne proportionately by labor and 

capital income. Before this methodology is explained in greater detail and illustrated by example, 

some general issues concerning the distribution of excises are addressed, specifically: the treatment 

of purchases by businesses and customs duties, and price level changes and income and payroll tax 

offsets. 

6.6.1 Purchases by Businesses and Customs Duties 

The major federal excise taxes apply to purchases of gasoline, air transportation, tobacco, diesel fuel, 

alcohol, and telephone services. Excises generally apply to all purchases, including those made 

41 In contrast, some analysts have considered the net distribution of payroll taxes and benefits. For 

example, Feldstein and Samwick (1992) calculate net marginal social security tax rates (the difference between the 

social security tax of 11.2 cents per dollar of earnings and the present value of the net benefits to which an 

additional dollar of earnings entitles the individual) and find that these net marginal rates are negative for some 

low-income individuals. 

27 
directly by families in their role as consumers as well as those made by businesses who use the taxed 

good or service to produce other goods and services. In order to separate the treatment of excises 

on production inputs from other excises, Treasury splits the purchases of goods subject to excises 

into purchases by businesses and purchases by consumers. These splits, given in Table 14, are similar 

to those used by CBO (1987a). Under current law, the taxed goods and services that are used 

extensively as intermediate inputs (diesel fuel, gasoline, air transportation, and telephone services) 

are used to produce a wide range of goods. Thus, Treasury assumes that the incidence of excises on 

purchases by businesses is the same as that of a broad-based consumption tax. 

For example, the $19.1 billion excise tax on Table 14: Purchasers of Goods Subject to Excises 

gasoline (at 2000 income levels and 2009 

law) is split into $14.3 (75 percent of $19.1) 

billion of tax on purchases by consumers and 

$4.8 (25 percent of $19.1) billion of tax on 

purchases by businesses. The latter is treated 

as a $4.8 billion broad-based consumption 

tax which, as explained below, is distributed 

to factor incomes (positive capital and labor 

income). Because total factor incomes are 

$7,929 billion (2000 income levels), the 

equivalent broad-based consumption tax rate 

arising from the gasoline excise is only 0.06 

percent. 

Like excises on purchases by businesses, customs duties are levied on a wide range of goods and are 

assumed to have the same incidence as a broad-based consumption tax. 

6.6.2 Constant Price Level and Income and Payroll Tax Offsets 

To maintain consistency with the Budget forecast of GDP, Treasury’s distributional analyses assume 

that changes in excise taxes and customs duties do not change the price level.42 For small changes 

in excises, the price level is not likely to be affected. For larger changes, such as a broad-based 

consumption tax, the effect on the price level would be largely dependent on changes in money 

supply. 

Because the price level is constant, an excise tax change creates a wedge (equal to the amount of the 

tax) between the price received by producers and the price paid by consumers. As a result, factor 

incomes and the direct taxes on those factor incomes fall. Likewise, current-law excises reduce 

Purchases by Purchases by 

Businesses Consumers 

Excise good (%) (%) 

alcohol 20 80 

air transportation 55 45 

diesel fuel 90 10 

gasoline 25 75 

telephone services 50 50 

tobacco 0 100 

other 100 0 

42 Prior to 1998, Treasury assumed that excises on purchases by individuals were borne by the purchaser 

and excises on purchases by businesses were borne in proportion to total consumption. Under this methodology, it 

was also assumed that the price level rose, and that transfer payments and income tax parameters were indexed for 

this price level change. These assumptions were consistent with those of CBO (Kasten and Toder, 1995). 

28 
observed factor incomes and thus, the current-law individual income, corporate income, and payroll 

tax liabilities due on these incomes. In the baseline, these income and payroll tax offsets are shown 

as part of the income and payroll tax distributions, not as part of the excise tax distribution.43 

Distributions of proposed excise tax changes, however, do include income and payroll tax offsets. 

The standard offset (used in revenue estimates) is 25 percent of the pre-offset amount (10.625 

percent each for individual income and payroll taxes, and 3.75 percent for corporate income taxes). 

For example, a proposed increase in the excise tax on alcohol of $10 billion would be offset by a $2.5 

billion reduction in individual income, corporate income and payroll taxes, for a net increase in tax 

burdens of $7.5 billion. 

6.6.3 Distributing Excise Taxes and Customs Duties: Method and Illustration 

Although the aggregate price level is held constant, excise taxes on purchases by consumers still have 

relative price effects. For example, a tax on alcohol raises the tax-inclusive price of alcohol relative 

to the price of all other goods, which must fall slightly to maintain a constant price level. Consumers 

are burdened (or benefit) to the extent their consumption of the taxed good relative to their 

consumption of all other goods is higher (or lower) than that of the average family. In total, the net 

price effect is zero, leaving the price level unchanged and the average family with neither a burden 

nor a benefit from the change in relative prices. 

As an example, consider the imposition of an excise tax on alcoholic beverages as illustrated in figures 

6.6.3a and 6.6.3b. The figures assume the cross-price elasticity between alcoholic beverages and all 

other goods is zero, and the own-price elasticity for alcoholic beverages and for all other goods is 

one. These restrictive assumptions are not necessary but facilitate illustration. 

The imposition of the alcoholic beverages excise causes the supply curve to shift backward (from S0 

to S1 in figure 6.6.3a) in the alcoholic beverages market. Because of the unit elasticity, total 

expenditures in the alcoholic beverages market do not change, but part of those expenditures (the 

shaded rectangle p0p1ac) are remitted to the government as excise taxes. In addition, the price of 

alcoholic beverages rises (from p0 to p1) and the quantity produced and consumed falls (from q0 to 

q1). Factors (labor and capital) migrate from the alcoholic beverages industry to the production of 

all other goods, increasing the supply in that market. The increase in supply in the “other” goods 

market causes the price in that market to fall (from p0 to p1) and the quantity consumed to rise (from 

q0 to q1). Total expenditures in the “other” goods market remains fixed and thus GDP is not affected. 

Whether or not a family is adversely (or positively) affected by the relative price change depends on 

its share of the total consumption of alcoholic beverages relative to its share of the total consumption 

of all other goods. However, because GDP is unaffected, factor incomes must fall by the amount of 

43 The decision to exclude the excise tax offsets from the baseline excise tax distribution is largely one of 

presentation. Alternatively, Treasury could base the income and payroll tax distributions on “pre-excise” tax factor 

incomes, and include the excise tax offsets in the baseline excise tax distribution. The baseline distribution of all 

Federal taxes would not be affected by the change. 

29 
the excise. So, all families with positive capital or labor income are adversely affected by the fall in 

factor incomes. 

Although the very restrictive assumptions (of zero cross price elasticity and unitary own-price 

elasticity) are not necessary, Treasury does assume that any change in total expenditures in the taxed 

market will be exactly offset in the market for all other goods. 

P 

Alcoholic Beverages 0 

Excise tax burden: 

Figure 6.6.3a 

So 

S1 

D 

q1 qo 

po 

p1 

a 

c 

b 

alcoholic beverages market 

P 

All Other Goods 0 

Excise tax burden: 

Figure 6.6.3b 

S1 

So 

D 

qo q1 

p1 

po 

c 

b 

a 

all other goods market 

In the case where taxed goods are purchased by businesses (including broad-based consumption 

taxes), there are no relative price effects (on consumption goods). Because the aggregate price level 

and GDP are fixed, prices faced by consumers do not change, but the net-of-tax price received by 

producers falls and, as a result, factor payments fall. 

For all of these taxes (excises on purchases by consumers, indirect business taxes, customs duties, 

and broad-based consumption taxes) because factor incomes fall, income and payroll tax liabilities 

will also fall, partially offsetting the burden of an excise tax. 

Numerical Illustration. Consider a proposed $10 billion excise tax on alcoholic beverages. As listed 

in Table 14, Treasury assumes that 80 percent of alcohol purchases are made by consumers and 20 

percent by businesses (e.g., as part of expenditures for business meals and entertainment). The $10 

billion tax would therefore be split into an $8 billion tax on purchases by consumers and a $2 billion 

tax on purchases by businesses. 

The price effect from the $8 billion tax on consumers would increase the cost of consuming alcoholic 

beverages by $8 billion (proportionately distributed to families according to their respective 

consumption of alcoholic beverages) as shown in column 1 of Table 15, and an $8 billion reduction 

in the cost of consuming all other goods (column 2). The net price effect is shown in column 3. 

Because lower and middle-income families’ share of alcoholic beverage consumption is greater than 

their share of all other good consumption, the net price effect for them is positive, giving them a net 

consumption burden from the excise tax increase. 

30
----- 

--------- 

-----

----------

Table 15: Illustration of a Proposed $10 Billion Tax on Alcoholic Beverages in 2000 

Tax on Consumer Purchases 

Factor Tax on Total Income and Change in 

Family Economic Income Total Business Pre-Offset Payroll Tax Net After-Tax 

Income Quintile Alcohol All other Net Effect Purchases Tax Offset Burden1 Income2 

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) 

Price Effect 

Lowest3 435 -265 170 124 294 31 325 -22 303 -0.14 

Second 990 -657 333 463 796 116 912 -106 805 -0.15 

Third 1,418 -1,076 342 946 1,288 236 1,524 -266 1,258 -0.14 

Fourth 1,886 -1,750 135 1,717 1,852 429 2,281 -510 1,772 -0.12 

Highest 3,262 -4,245 -983 4,740 3,757 1,185 4,942 -1,592 3,350 -0.09 

Total3 8,000 -8,000 0 8,000 8,000 2,000 10,000 -2,500 7,500 -0.11 

Top 10% 2,067 -2,949 -882 3,396 2,514 849 3,363 -1,173 2,190 -0.09 

Top 5% 1,333 -2,095 -762 2,479 1,717 620 2,336 -872 1,465 -0.08 

Top 1% 496 -994 -498 1,254 756 313 1,069 -470 599 -0.07 

in millions of dollars 

1. The change in Federal taxes is estimated at 2000 income levels but assuming long run (2009) law. The change in Federal taxes is less than the change in the excise tax alone 

because, as a result of the excise tax increase, labor and capital incomes are assumed to fall and, therefore, income and payroll taxes would also decrease. 

2. After-tax income is Family Economic Income less current Federal taxes. 

3. Families with negative incomes are excluded from the lowest quintile but included in the total line. Quintiles begin at FEI of: Second $17,988; Third $34,844; Fourth $59,019; 

Highest $100,767; Top 10% $140,581; Top 5% $189,835; Top 1% $462,053. 
Columns 4 and 6 show the factor income effects. An $8 billion factor income effect is attributed to 

purchases by consumers and a $2 billion factor income effect is attributed to purchases by businesses. 

The percent distributions in these columns are the same and equal to the percent distribution of labor 

and positive capital income. The total of the two columns adds to the total amount of excise tax 

collected (the pre-(tax)offset amount, column 7). 

The income and payroll tax offset is shown in column 8. The net burden of the price effect, factor 

income effects, and payroll and income tax offsets is shown in column 9. Column 10 shows the 

resulting percentage change in after-tax income. An increase in the alcohol excise would be 

regressive; the reduction in after-tax incomes would be highest for low-income families and lowest 

for high-income families. 

6.7 Estate and Gift Taxes 

Estate and gift taxes were added to Treasury’s distributional analyses in 1998. With this addition, 

Treasury can address the distributional implications of any proposed change in federal taxation. 

Estate and gift taxes are assumed to be borne by decedents. To the extent that the family income of 

decedents and heirs are comparable, assuming estate and gift taxes are borne by decedents as opposed 

to heirs will not greatly affect their distribution. This assumption is also consistent with Treasury’s 

treatment of other taxes on capital, which are assumed to be borne by the current owners of capital 

income. The JCT does not currently include estate and gift taxes in their distributions. However, 

JCT’s 1993 study examines estate and gift tax incidence and assumes these taxes are borne by 

decedents.44 

Treasury’s basic strategy for distributing the estate tax is to consider what burden would be assessed 

to a taxpayer if he or she were to die in the current year (assuming end-of-the-budget-period estate 

tax law45) and what the probability is that he or she would die in the current tax year. In other 

words, Treasury applies the probability of death to an estimate of the estate tax burden should death 

occur. 

Treasury approximates each family’s stock of wealth by grossing up its capital income flows into a 

measure of its capital stock. Capital income is a component of FEI and, as discussed in section 5, 

includes interest income (taxable and tax exempt), accrued capital gains (stock and non-stock), real 

earnings on IRAs, Keoghs, pensions and life insurance, rental income (including imputed rental 

income from owner-occupied housing), and the capital component of sole proprietor, partnership and 

subchapter S corporation income. The rate used to gross up the capital income flows into a stock 

44 Feenberg, Mitrusi, and Poterba (1997) also make this assumption. 

45 As a consequence of using end-of-the-budget-period law, Treasury’s current-law distribution of the 

estate tax includes the fully phased-in increase in the unified credit enacted under TRA97, deflated to 2000 levels. 

32 
of wealth is 7 percent.46 Once a stock of wealth is estimated for each family, it is used to calculate 

the family’s estate tax liability should death occur. Fully phased-in estate tax law is applied with two 

specific adjustments, one for expected charitable contributions and a second for the presence of a 

surviving spouse. 

In the case of a surviving spouse, Treasury assumes that no estate tax liability will be incurred. Estate 

tax law provides for an unlimited spousal deduction which allows estates with a surviving spouse to 

avoid the estate tax by bequesting the value of the estate, in excess of the unified credit amount, to 

the surviving spouse. 

The estate tax allows an unlimited deduction for charitable bequests. The adjustment for expected 

charitable contributions varies by the size of the estate. In 1992, approximately 2.1 million adults died 

in the United States. Sixty thousand (2.8 percent) filed an estate tax return and 27 thousand (1.3 

percent) had taxable estates.47 Considering only the 1992 estates of decedents who were not married, 

tabulations from the 1992 estate tax file indicate that estates of less than $5 million bequested, on 

average, less than 10 percent of the estate to charity; estates of $10 to $20 million bequested an 

average 18 percent of the estate to charity; and estates in excess of $20 million bequested an average 

45 percent of the estate to charity. Treasury’s application of estate tax law reflects this pattern of 

charitable bequest rates. Once the conditional estate tax liability is calculated for each family, 

Treasury applies mortality rates to the conditional liability to arrive at the expected estate tax 

burden.48 Finally, Treasury’s simulated, family-level estimate of expected estate and gift tax liability 

is adjusted to the aggregate revenue estimate of estate and gift tax liability under fully phased in 

current law. 

The distribution of estate and gift taxes. As can be seen in Table 12, the estate and gift tax is highly 

progressive. Over 99 percent of the estate tax burden falls on the top quintile of families, with 64.2 

percent on the top 1 percent of families. 

7. Tax Burden Measures and Presentation of Results 

The tax burden measures included in Treasury distribution tables for each income class are: (i) the 

average change in federal tax burdens; (ii) the total change in federal tax burdens; (iii) the share of 

the total change in federal tax burdens; (iv) the percentage change in federal tax burden; and (v) the 

46 The 7 percent figure is the ratio of capital income to wealth as estimated using 1982 estate tax returns. 

The capital income measure is that reported on the decedent’s 1981 income tax return and the wealth measure 

comes directly from the decedent’s 1982 estate tax return. 

47 These figures were taken from Joulfaian (1998, Tables 7 and 8) which includes a more complete 

description and history of the estate tax and more detail on the 1992 estate tax file. 

48 The mortality rates Treasury currently uses vary by age but not by other attributes which may be 

important, such as income or gender. 

33 
percentage change in after-tax income. As shown in Atrostic and Nunns (1991), widely used tax 

burden measures, like those included in Treasury distribution tables, can give contradictory results. 

In their paper, the authors use a hypothetical change in tax burdens to show that a given proposal can 

appear progressive when considering only the total change in tax burdens (the third column in 

Treasury’s tables) or the percentage change in tax burdens (the second to last column in Treasury’s 

tables) but regressive when considering the percentage change in after-tax income (the last column 

in Treasury’s tables). 

The only tax burden measure with some theoretical basis is the percentage change in after-tax income. 

It alone provides some indication of a family’s change in welfare, because after-tax income represents 

the family’s consumption possibilities in either the current or future years. In contrast, the share of 

the total change in tax burdens, which is often quoted in the popular press, does not convey 

information on a family’s relative welfare gains because it does not recognize the importance of a 

family’s initial welfare position. For example, consider a tax proposal to allow all families a $500 

(refundable) tax credit (allowed against the AMT). With 115.2 million families, the cost would be 

roughly $57.6 billion and each quintile of families would have an equal share of the tax relief ($11.5 

billion). The welfare changes across families, however, would not be the same. In the lowest income 

quintile, the average after-tax FEI is less than $10,000 but in the highest income quintile it is over 

$150,000. An increase in after-tax income of over 5 percent for the lowest income families is 

arguably more welfare-enhancing than an increase in after-tax income of less than a third of 1 percent 

for the highest income families. 

Treasury distribution tables show families ranked by income quintiles. Table 16, which shows the 

distributional results for the hypothetical $10 billion tax on alcoholic beverages, is an example of 

Treasury’s standard table. In the table, the population of all families is ranked by income and then 

the population is divided into fifths. The first quintile contains the lowest income families (excluding 

a small number of families with negative incomes who are nevertheless included in the totals). 

In the past, Treasury has also presented tables by fixed-dollar breaks. In a fixed-dollar table, families 

are sorted by the level of their dollar income. The CBO presents its tables by quintile classes as well 

as fixed-dollar breaks. The JCT presents tables by fixed-dollar breaks. The major difference between 

quintile and fixed-dollar tables is that a quintile table emphasizes rank and therefore a family’s relative 

income position, whereas a fixed-dollar table emphasizes nominal income levels. As a result, fixeddollar tables may not always clearly convey a family’s relative position in the total income 

distribution. 

Quintile tables also facilitate comparisons of tables using different income measures. For example, 

if families were ranked the same under alternative income definitions, the resulting quintile 

assignments would be the same under the two definitions even if the absolute levels of one definition 

were significantly higher. As a result, some measures of tax burden, such as the share of the total 

change in federal tax burdens, would be the same in the two tables even though the income definitions 

were different. Other measures, such as the percentage change in after-tax income, would still differ 

because they depend on income levels as well as rankings. 

34
Table 16: $10 Billion Tax on Alcoholic Beverages1 

(2000 Income Levels) 

Family Economic 

Quintile2 

Number Current 

of Average Percent Federal After-Tax 

Families Tax Amount3 Distribution Taxes4 Income5 

(millions) ($) ($M) (%) (%) (%) 

Total Tax Change Percent Change in: 

Change 

Lowest6 22.4 14 303 4.0 2.27 -0.14 

Second 23.0 35 805 10.7 1.15 -0.15 

Third 23.0 55 1,258 16.8 0.68 -0.14 

Fourth 23.0 77 1,772 23.6 0.49 -0.12 

Highest 23.0 145 3,350 44.7 0.29 -0.09 

Total6 115.2 65 7,500 100.0 0.42 -0.11 

Top 10% 11.5 190 2,190 29.2 0.25 -0.09 

Top 5% 5.8 254 1,465 19.5 0.22 -0.08 

Top 1% 1.2 515 599 8.0 0.16 -0.07 

Department of the Treasury 

Office of Tax Analysis 

(1) This tables distributes the estimated change in tax burden due to a proposed $10 billion tax on alcoholic beverages. 

(2) Family Economic Income (FEI) is a broad-based income concept. FEI is constructed by adding to AGI unreported and underreported income; IRA and Keogh deductions; nontaxable transfer payments such as Social Security and AFDC; employerprovided fringe benefits; inside build-up on pensions, IRAs, Keoghs, and life insurance; tax-exempt interest; and imputed rent 

on owner-occupied housing. Capital gains are computed on an accrual basis, adjusted for inflation to the extent that reliable 

data allow. Inflationary losses of lenders are subtracted and gains of borrowers are added. There is also an adjustment for 

accelerated depreciation of noncorporate businesses. FEI is shown on a family rather than a tax-return basis. The economic 

incomes of all members of a family unit are added to arrive at the family's economic income used in the distributions. 

(3) The change in Federal taxes is estimated at 2000 income levels but assuming long run (2009) law. 

(4) The taxes included are individual and corporate income, payroll (Social Security and unemployment), excises, customs duties, 

and estate and gift taxes. The individual income tax is assumed to be borne by payors, the corporate income tax by capital 

generally, payroll taxes (employer and employee shares) by labor (wages and self-employment income), excises on purchases 

by individuals in proportion to relative consumption of the taxed good and proportionately by labor and capital and excises 

on purchases by businesses and customs duties proportionately to labor and capital, and the estate tax by decedents. 

Federal taxes are estimated at 2000 income levels but assuming 2009 law and, therefore, exclude provisions that expire prior 

to the end of the Budget period and are adjusted for the effects of unindexed parameters. 

(5) After-tax income is Family Economic Income less current Federal taxes. 

(6) Families with negative incomes are excluded from the lowest quintile but included in the total line. 

NOTE: Quintiles begin at FEI of: Second $17,988; Third $34,844; Fourth $59,019; Highest $100,767; 

Top 10% $140,581; Top 5% $189,835; Top 1% $462,053. 

35
Concluding Remarks 

This paper describes Treasury’s current distribution methodology, including the most recent 

improvements. Further improvements are under consideration. 

Foremost, Treasury is presently studying whether to supplement or replace the current single-year 

income measure with one which measures individuals’ income over a longer time period, such as 

the ten-year Budget period. Such a measure would be able to capture some life-cycle effects, 

such as low current-year/high lifetime incomes associated with schooling. It would also allow us 

to better identify the lifetime poor and thus better assess improvements in vertical equity. 

Likewise, Treasury is also considering the feasibility of measuring the impact of a proposed 

change in tax law on individuals’ tax liability over a time period longer than a year. For example, 

although a child credit may not affect a childless couple’s current-year tax liability, such a 

proposal could lower expected future tax liabilities if the couple plans to have children. Similarly, 

education tax credits and lower capital gains rates may hold future rather than current benefits for 

some individuals. A multi- year measure of changes in tax burdens would also allow Treasury to 

capture the differences among provisions with varying phase-in rates or phase-in levels, indexed 

and unindexed provisions, and temporary versus permanent provisions. 

Finally, Treasury is also studying the sensitivity of its analyses to family size and other 

demographic characteristics. We would like to know the extent to which a per capita or adultequivalent distribution would give the same qualitative results as a distribution (like the current 

one) that does not adjust for family size. Because families change composition over time (because 

of births and deaths, marriage and divorce, and other changes), adult equivalency measures 

become necessary if multi-year income and tax measures are used. 

36
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