Estimating the Distributional Impact of Policy Reforms

Distribution analysis quantifies how a policy change will differentially impact families depending on their economic and demographic characteristics like income, wealth, age, race, family size, or state of residence.¹ Typically, distribution analysis involves the following steps:

1. Simulation: Using a microsimulation model, simulate the effects of a counterfactual policy reform at the individual level, possibly imposing assumptions about economic incidence. 
2. Categorization: Assign each individual unit into a group based on some dimension like income or age.
3. Calculating summary measures: By group, calculate summary measures of the policy reform’s effect.

This page describes how we approach each step in this process. Our current focus is tax policy; this page will be updated as The Budget Lab expands the range of topics it covers and produces distribution analysis in a different policy context. The code for the calculations described below can be found here.

Simulation

We use our tax microsimulation model to estimate the micro-level impact of tax policy reform. The tax unit—the group of people who, if required by law, would file a tax return together—is the unit of analysis in our distributional estimates. We exclude tax returns filed by those who are dependents of other tax units.

The incidence of individual income taxes and payroll taxes are assumed to fall entirely on individuals. For corporate tax changes, we assume that 100 percent of the new tax burden falls on owners of capital in the first year of enactment, then phases down such that by year ten of a policy change and afterwards, capital’s share of the burden is 80 percent and labor’s share is 20 percent. We make no distinction between causes of changes in corporate tax liability: for example, a dollar of revenue raised from a corporate tax rate increase is distributed identically to a dollar of revenue raised from changes in the tax treatment of capital expenditures.

We do not currently distribute estate tax changes or other off-model estimates related to taxes. While our model code produces additional distribution estimates which account for assumed financing costs when a policy reform increases the deficit, these results are experimental and are not currently reported in our official analyses.

Categorization

We currently report distribution estimates by age and income. To rank tax units by age, we use the age of primary earner for joint returns. To rank tax units by income, we define income as AGI plus above-the-line deductions, nontaxable interest, nontaxable pension income (including Social Security benefits), and employer-side payroll taxes. Income percentile thresholds are calculated with respect to positive income only and are weighted by the number of nondependent adults. Note that this measure does not reflect near-cash income from transfer programs like SNAP, disproportionately understating income for lower-income families and thus overstating (the absolute value of) percent change in after-tax income at the low end of the distribution.

Calculating summary measures

There are many ways to measure the impact of a policy change. We currently report the following metrics:

•  Average tax change. In dollars, relative to current law, how much more (or less) on average does a group owe in taxes under the reform?
• Share with a tax cut or tax increase. Relative to current law, what percent of tax units see their tax liability fall? What percent experience a tax increase?
• Average tax change among those with a tax cut or tax increase. Among those whose taxes fall under the reform, what is the average tax cut? Similarly, what’s the average tax increase for tax units who owe more?
• Percent change in after-tax income. By how much does a tax unit’s net-of-tax income change under the reform in relative terms?
• Share of total tax change. How much of the total budgetary effect of the reform is allocated to a given group?