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Executive Summary
Distributional analysis plays an important role in the design of tax legislation. Typically distributional analysis compares annual taxes paid to annual income by annual income group. There are several shortcomings with distributional analysis based on annual taxes and annual income. In this paper, we compare annual distributional analysis to distributional analysis based on a five-year period and the lifetime for taxes on alcohol and cigarettes.
Annual measures of the incidence of taxation of consumption goods may differ from lifetime measures for several reasons. First, annual measures of income reflect temporary fluctuations that should have smaller effects on consumption than permanent changes in income. Second, annual measures of income differ from lifetime measures due to age-related differences in earnings. Third, consumption patterns of certain goods may reflect differing patterns across age groups. As a result, the ratio of taxes paid to income earned in any given year for an individual may be quite different than the ratio of cumulative taxes paid to cumulative income over an extended period for that person.
Surprisingly, the results of the study indicate that there is relatively little difference in the assessment of the regressivity of taxes on alcohol and cigarettes. Both annual and lifetime measures of tax incidence find these taxes to be regressive.
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