Background Paper No. 2
Executive Summary The Congressional Budget Office (CBO) conducts taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. distribution studies that produce estimates of income inequality and tax progressivity. These results indicate that income inequality increased and tax progressivity decreased during the 1980s. However, an analysis of the empirical procedures employed by the CBO strongly suggests that its results are not unbiased estimates of the actual distribution of income and taxes. Further, the analysis reveals that the experimental design employed by the CBO does enable users to identify the factors that cause income inequality and tax progressivity to change over time.
The validity of the results obtained by the CBO is threatened by a number of factors. Specifically, the CBO overestimates the extent of, and change in, income inequality because it inadequately controls for: (1) changes in income mix, (2) inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. , (3) implicit taxes, and (4) regional cost of living differences. Similarly, the CBO understates the extent of tax progressivity because it improperly measures social security taxes and implicit taxes. Further, because the CBO does not control for demographic changes, it is not possible to determine whether changes in income inequality and tax progressivity occurred because of changes in household incomesShare