August 13, 2004

Cautionary Notes for Comparing CBO?s Household Data to Standard Tax Data

Fiscal Fact No. 12

Today’s report by the Congressional Budget Office (CBO) on the changing effective tax rates of American households has inadvertently caused as much confusion as it has clarified. The primary reasons for this confusion is that the CBO analysis defines “income” and “taxpayer” so differently from the way they are normally used in tax policy discussions.

Unit of Measurement The typical unit of measurement in tax policy debates is a “taxpayer” or “tax filer”, while the unit of measurement in the CBO study is a “household”. This year, there are roughly 135 million tax filers but only 109 million households. A household can contain individuals who are not related (such as roommates or cohabitating couples) filing multiple tax returns, while tax filers are always related (such as a married couple filing jointly) and file one return. By combining the incomes of unrelated individuals, the CBO study could be showing more “high-income” families than tax return data might show.

By relying on household data rather than income tax data, the CBO report includes roughly 14 million households that do not earn enough to file a tax return. Comparing these non-payers to regular taxpayers paints a distorted picture of who benefits and who does not from income tax cuts. Clearly, these families could not benefit from an income tax cut because they don’t file a tax return in the first place.

Income Measurement The CBO report measures “income” in a way that makes everyone appear wealthier. The usual basis of measurement in tax policy is Adjusted Gross Income – simply the bottom line amount on Page 1 of a taxpayer’s 1040 form. The unit of measurement in the CBO report is “comprehensive household income”, a concept that is very unfamiliar to typical taxpayers, reporters and lawmakers.

This definition of “income” includes: cash income (such as salaries, wages, dividends, and interest); taxes paid by businesses (corporate income taxes and employees’ share of Social Security, Medicare, and federal unemployment insurance taxes); employees’ contributions to 401(k) retirement plans; and in-kind benefits (Medicare, Medicaid, employer-paid health insurance premiums, food stamps, school lunches and housing assistance).

Under this expanded definition of income, a family with an adjusted gross income of $75,000 could have a comprehensive household income of well over $100,000, appearing to be far wealthier than their earnings would suggest.

As a result, the study’s estimates of taxes paid have the appearance of being unusually small.

It is by no means incorrect to count “extras” like health benefits as income in the broad economic sense. However, individuals typically consider taxes as something paid out of actual earnings, not out of an amount of “economic income”—a definition better suited to academic study.

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