The verdict is in on the Bush tax cuts: the rich are getting richer and the middle class is getting squeezed. Says who? The non-partisan Congressional Budget Office, that's who. The findings were quickly covered everywhere. A few headlines:
Report Finds Tax Cuts Heavily Favor the Wealthy (New York Times)
Shifts to the Middle (
The rich got richer, and you didn't (New York Daily News)
Middle class feeling pinch from tax cuts, government study says (Seattle Times)
2001 tax cut burden fell on middle class, says study (Chicago Sun Times)
Tax burden growing heavier for middle class (USA Today)
What would you conclude if you read those headlines? An unavoidable conclusion was that the rich got a tax cut and taxes on the middle class went up. And if you read the actual articles you'd find more bad news for the middle class in both relative and absolute terms:
People in the very top income categories fared better by almost any measure, according to the report. The average after-tax income for people in the top 1 percent of income earners climbed 10.1 percent, while that of those in the middle 20 percent climbed 2.3 percent, and that of those in the bottom fifth only 1.6 percent. (New York Times)
The CBO study, due to be released today, found that the wealthiest 20 percent, whose incomes averaged $182,700 in 2001, saw their share of federal taxes drop from 64.4 percent of total tax payments in 2001 to 63.5 percent this year. (MSNBC)
Never mind that these stories and their headlines confuse rising taxes with a rising share of the total burden. And never mind that the CBO study relies on treating voters in different quintiles as if they're locked in there for life. There's a much bigger problem.
Reading these stories, you'd assume the CBO had studied the economic situation of taxpayers today and compared it to their situation before taxes were cut. But that is not what the CBO study did.
The CBO study is a forecast based on 2001 incomes. The study assumes income grows at a constant rate after 2001 and then estimated what would happen under the tax legislation that has occurred since then. The study did not take account of any changes in behavior on the part of taxpayers or corporations in response to lower tax rates on income or dividends. The study did not take account of the recession or any actual reality that has occurred since 2001.
To say it another way, the CBO study could have been written in 2001 if we had known then which changes in the tax code would be enacted. It is a mechanical simulation, a hypothetical forecast that explicitly ignores what has happened between then and now.
So statements such as "the very top income categories fared better" or "the wealthiest 20 percent, whose incomes averaged $182,700 in 2001, saw their share of federal taxes drop" are fantasies unsupported by the study. They may turn out to be true when we have the benefit of the actual data or they may not.
In short, the media has totally misinterpreted the findings and their significance. The mistake could have been avoided by reading just the preface of the actual study. Here's how it opens:
This Congressional Budget Office (CBO) paper, prepared at the request of the Ranking Members of the Senate Budget Committee, the Senate Finance Committee, the House Budget Committee, the House Ways and Means Committee, and the Joint Economic Committee, examines how effective federal tax rates will change over the coming decade under current law-that is, if the provisions of tax laws enacted in 2001, 2002, and 2003 phase in, phase out, and "sunset" as scheduled.
Notice the tense: "will change," not "changed." That's partly because the CBO was forecasting effective tax rates through 2014. But it's also because they don't have any data past 2001. The preface continues:
The paper uses the same methodology that CBO employed in its earlier estimates of effective tax rates, most recently in Effective Federal Tax Rates, 1997 to 2000 (August 2003) and Effective Federal Tax Rates: 1979-2001 (April 2004).
The reader might be comforted by the soothing phrase "the same methodology," but look at the dates-the earlier studies were done for tax rates of three years and earlier before each study. The CBO won't be able to assess the impact on taxpayers in 2004 until 2007. I'm looking forward to it.
Russell Roberts is Professor of Economics and Smith Distinguished Scholar at the Mercatus Center at George Mason University and a research fellow at Stanford University's Hoover Institution. He blogs with Don Boudreaux at CafeHayek.com.