When Taxes are Cut, What Does Regressive Mean?
How starting with a progressive tax system and cutting everyone’s taxes by the same percent gives you a regressive tax cut.
We all know what a regressive tax is: it’s one that takes a higher percentage of income from low-income people than from high-income people. So it seems straightforward to judge whether a tax cut is progressive or regressive. Is it?
Evan Soltas writes:
The Bush tax cuts were sharply regressive–that is, people with high incomes benefited far more as a percentage of their income.
And he gives a cite, to a 2008 Tax Policy Center study by Greg Leiserson and Jeffrey Rohaly. In it, they write:
In 2010, when the cuts are fully phased in, households in the middle fifth of the income distribution will receive an average tax reduction equal to 2.6 percent of after-tax income. Households in the top quintile–the 20 percent of the population with the highest incomes–will receive an average tax cut that is more than twice as large: 5.4 percent of income. Those in the bottom quintile will get an average cut equal to just 0.7 percent of income.
In the same piece, Leiserson and Rohaly explain why they think this is regressive:
A tax cut that gives all households the same percentage increase in after-tax income is distributionally neutral; it leaves the relative distribution of after-tax income unchanged. A tax cut that increases after-tax income proportionately more for lower-income households makes the tax system more progressive (or less regressive). One that increases after-tax income more for higher-income households makes the tax system less progressive (or more regressive).
By that standard, then, they show that all the Bush tax cuts combined were regressive.
But wait. Everyone, including Leiseron and Rohaly, recognizes that under the U.S. tax system, the higher your income, the higher a percentage of it you pay in federal taxes. In their Appendix, Table 1, for example, they show that average tax rate (including income taxes, payroll taxes, corporate income taxes, and estate taxes) is 5.3% of income for those in the bottom quintile, 13.0% of income for those in the second-from-bottom quintile, 19.1% for those in the middle quintile, 22.1% for the second-from-top quintile, and 28.6% for the top quintile. Within the top quintile, the average tax rate is 24.9% for the bottom of that top fifth, 26.0% for those in the 90th to 95th percentile, 28.1% for those in the 95th to 99th percentile, 32.8% for the top 1%, and 34.6% for the top 0.1%.
So . . . What would have happened had Bush come into office and got Congress to pass an across-the-board tax cut of 15%. That is, they add one provision to the law: calculate your taxes under the old tax system and subtract 15% to get your new liability. By Leiserson and Rohaly’s measure, the tax system would have become more regressive. Why? Because when the high-income people pay a higher % of their income in taxes than the low-income people do, a given % cut in tax liability results (assuming no induced behavioral changes) in a higher increase in percent of income retained for the higher-income people than for the lower-income people. It’s hard to cut taxes much for people who don’t pay much.
To be sure, Bush figured out how to do that: Have a “refundable” tax credit of $1,000 per child. “Refundable” doesn’t mean what you might think it means: it doesn’t mean you get a refund. It means that even if your tax liability without the tax credit would be zero, you still get a check from the Feds for $1,000 per child. But even that credit, which essentially, for those who get such a check, turns the tax system into a direct-subsidy system, wasn’t enough to make the tax cut “progressive” by Leiserson and Rohaly’s measure.
I hasten to add that I’m not saying that Leiserson and Rohaly’s measure is idiosyncratic. It may be widely used. Rather, I’m pointing out its pitfalls.
The bottom line is this: Start with any system of progressive taxation, cut everyone’s taxes by the same percent, and you will have implemented, by their standard, a regressive tax cut.