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Relationship between personal income and adjusted gross income, 1987-88.

Relationship Between Personal Income and Adjusted Gross Income, 1987-88

The reconciliation of the Bureau of Economic Analysis (BEA) measure of personal income with the Internal Revenue Service (IRS) measure of adjusted gross income (AGI) by type of income is revised for 1987 and extended to 1988 in this article.(1) The reconciliation incorporates personal income estimates for 1987-88 released in the July 1990 national income and product accounts revision, a final estimate of AGI for 1987, and a preliminary estimate of AGI for 1988.

The reconciliation items (lines 3-9 and 11-15) in tables 1 and 2 allow the construction from personal income (line 1) of a BEA-derived AGI (line 22) that conforms to the definition of AGI (line 23). The reallocations of personal income and of the IRS measure of AGI necessary to show the reconciliation by type of income are shown in lines 17-21 and lines 25-27. The AGI gap--that is, the difference between BEA-derived AGI and the IRS measure of AGI--is shown in line 29. The percent distribution of the AGI gap by type of income and the AGI gap as a percentage of BEA-derived AGI are shown in lines 30 and 31, respectively. Line 32 shows AGI of IRS as a percentage of BEA-derived AGI.

The gap for each type of income for 1947-88 is shown in table 3. This year, a new column has been added to table 3--the combined AGI gap for personal interest and personal dividend incomes. The column was added because the difficulty in estimating a reallocation item (line 20) has reduced the accuracy of the BEA-derived AGI interest and dividend incomes. This item reallocates all taxable distributions of interest income of regulated investment companies--such as mutual funds--from personal interest income to personal dividend income. The reallocation is made because IRS requires that this interest income be reported as dividends; in personal income, this income is treated as interest. Despite the IRS requirement, there is considerable evidence that many taxpayers have inadvertently reported this income as interest. Because the amount of this misreporting is not known, the reallocation of all such income overstates the personal dividend income gap and understates the personal interest income gap.

AGI gap as a measure of noncompliance.--The AGI gap can be viewed as evidence of noncompliance with the tax code because BEA-derived AGI is based on estimates of personal income that are adjusted to include income unreported on individual income tax returns, whereas the IRS measure of AGI is based entirely on unaudited tax return data.(2) The noncompliance reflected in the gap is limited to that associated with types of income included in personal income; the gap does not reflect noncompliance associated with other types of income, such as unreported capital gains and unreported illegal income.(3) In addition to reflecting noncompliance, the AGI gap includes income earned by low-income individuals who are not required to file income tax returns, the net effect of errors in personal income and in the IRS measure of AGI, and gross errors and omissions in the estimates of reconciliation items.

Recent developments in the AGI gap.--The AGI gap as a percentage of BEA-derived AGI--a rough indicator of the rate of noncompliance--remained at about 11 percent for about 9 years prior to 1986 (table 3). In 1986, the AGI gap increased to 12.1 percent but declined to 10.6 percent and 10.3 percent in 1987 and 1988, respectively. However, changes in the AGI gap since 1985 should be interpreted with caution.

Beginning in 1985, the size of the AGI gap has been affected by the lack of information needed to estimate two reconciliation items. The first item omitted relates to employee contributions through salary reduction to deferred compensation agreements, such as those allowed under Internal Revenue Code section 401(k). All such contributions, including those made prior to 1985, are excluded from AGI, but an unknown amount has been included in the BEA-derived AGI for wages and salaries since 1985. These contributions are included in BEA's estimates of wages and salaries because the estimates are based on tabulations of the wages and salaries reported by the employers of employees covered by the Federal Unemployment Tax Act (FUTA); beginning in 1985, employers in 32 States were required to include these contributions in wages for FUTA purposes. (However, noncompliance with this reporting requirement may be widespread because the amount of unemployment insurance tax for most employers is not affected.)

The second item omitted from the reconciliation relates to the change in the tax code introduced by the Tax Reform Act of 1986 that affected the deductibility of passive activity losses beginning in 1987. The AGI of IRS reflects the change, but the BEA-derived AGI for proprietors' and rental incomes does not.

The increase in the AGI gap in 1985 and 1986 may reflect the omission related to salary reduction contributions; the decrease in 1987 and 1988 may reflect the omission related to passive activity losses. In addition, the effect of IRS efforts to reduce noncompliance is unknown. The BEA adjustments to include unreported income assume that there has been no change in the rate of noncompliance since 1982. Thus, the narrowing of the gap since 1986 also may reflect the result of the IRS efforts. [Tabular Data 1 to 3 Omited]

(1)Estimates for earlier years appear in the following issues of the Survey of Current Business; May 1986 (pp. 34-40) for 1947-82; May 1987 (pp. 18-20) for 1983; August 1988 (pp. 23-27) for 1984-85 and August 1989 (pp. 30-32) for 1986. In the national income and product accounts tables, the reconciliation appears in table 8.14. The measure of AGI for 1988 used for the reconciliation presented in this article differs from that used for table 8.14 of the July 1990 Survey; the IRS measure in this article is from a more recent IRS report. (2)See Roberth P. Parker, "Improved Adjustments for Misreporting of Tax Retu rn Informaton used to Estimate the National Income and Product Accounts, 1977," Survey 64 (June 1984): 17-19. (3)For a discussion of why the AGI gap is not a measure of the size of the underground economy, see Carol S. Carson, "The Underground Economy: An Introduction," Survery 64 (July 1984): 109.
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Author:Park, Thae S.
Publication:Survey of Current Business
Date:Aug 1, 1990
Previous Article:National income and product accounts: selected NIPA tables and reconciliation and other special tables.
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