Why Progressivity in Tax Policy Is Not A Simple Matter

Policymakers and even policy analysts often consider the progressivity of specific proposals independently from the broader systems in which they operate. Consequently, they often leave the public with a misleading impression of how those proposals affect various income groups.

Here are four examples of how specific programs might appear to be regressive yet may not be when looked at more broadly:

Does making the child tax credit available to middle-income parents make it less progressive than if it benefits only low-income households?

Like the dependent exemption that preceded it, but was eliminated in 2017, the child tax credit (CTC) in part aims to provide government support for child rearing for all but the highest income households. The CTC recognizes that a family’s ability to pay tax declines as its size grows, almost no matter its income level. The earned income tax credit (EITC), on the other hand, has a very different goal. It aims to subsidize low-paid workers and it phases out at much lower income levels.

In isolation, increasing the more-targeted EITC looks more progressive than distributing the same additional dollars more widely through the CTC. Yet, the goal of legislators should center on the overall progressivity, efficiency, and fairness of the tax system, not each individual part. That includes distributing the total tax burden across families in a way that recognizes differences in their ability to pay, including the effects of family size. One can collect the same amount of tax from those, say, making more than $200,000 with or without a child credit by changing the relative distribution of taxes for households at that income level. Yet failure to adjust for family size would discriminate against households with children in favor of those without.

Was discouraging more low- and middle-income taxpayers from claiming the charitable deduction regressive?

By expanding a standard deduction that could be taken in lieu of itemized deductions, the 2017 Tax Cuts and Jobs Act (TCJA) discouraged most households from claiming the charitable deduction. After all, the standard deduction was more valuable for many families. Also, the higher standard deduction also benefitted lower-income families who didn’t itemize. Accordingly, those changes tended to be progressive, though by many measures the overall TCJA was not.

That doesn’t mean that limiting the charitable deduction to fewer than 10 percent of households represents good policy. Indeed, a charitable tax deduction for a small number of high-income households is politically unsustainable and discourages a more generous society. But, while it could be considered bad charitable and tax policy to limit a charitable deduction mainly to a few higher-income households, the way it was done was not necessarily regressive.

Should tax reform remove special exemptions for certain low-income people such as the elderly or the unemployed?

In its 1984 study leading to 1986 tax reform, Treasury urged Congress to repeal tax exemptions and deductions specifically for the elderly and the unemployed because they discriminated against other low-income households, including some who were worse off. Considered by themselves, these changes would have been regressive. Yet, Treasury and the Congress then targeted additional tax benefits to low-income families generally, thus adding to overall progressivity of the tax system.

Are state taxes regressive?

State taxes overall tend to impose higher average tax rates on lower income households than on those with higher incomes. Many state sales taxes, for instance, are assessed at a flat rate, while the consumption of taxed items comprise a much larger share of the income of lower-income households.

These taxes are regressive by a traditional measure that assesses whether the average rate of tax, or share of income paid in tax, falls—as income rises. But that can be misleading since it ignores the amount of tax people pay. Meanwhile, we often say spending is regressive if it grants larger amounts to those with higher incomes—for example, a larger educational grant for a higher-income student than for a low-income one would be considered regressive. But these are inconsistent measures, one looking at rates or shares and the other at amounts. One can’t determine the overall progressivity of a taxes and spending together when using inconsistent measures.

It turns out that much state spending such as funding for K-12 education tends to provide roughly equal benefits. And some programs, such as Medicaid, provide higher amounts of benefits to lower income families. Meanwhile, even the most regressive levy still usually requires higher income households to pay greater amounts of tax.

Thus, a measure of combined progressivity across tax and spending programs, defined by whether there is a net redistribution from those with more to those with less, suggests that higher taxes, even if regressive by the standard tax definition, typically create a progressive redistribution of income because of the additional spending they finance.

In sum, measuring progressivity one program at a time often misrepresents its full impact. It can lead to a variety of inefficiencies, as well as injustices among those who should be treated equally. Looking across multiple tax and spending programs almost always offers a superior way both to examine and design policy.

This column originally appeared on TaxVox on October 20, 2021.