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Relationship between personal income and adjusted gross income.

THIS ARTICLE presents estimates of 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 for 1988-90 and estimates of the "AGI gap" for 1959-90. The reconciliation estimates for 1959-88 have been revised in order to incorporate the results of the comprehensive revision of the national income and product accounts (NIPA's) released in December 1991, to reflect changes in the methodology used to estimate the reconciliation items (that is, the items that reconcile personal income to the IRS definition of AGI), and to reflect revisions in the IRS estimate of AGI for 1988.(1)

Tables 1-3 show the reconciliation between personal income and AGI, by type of income, for 1988-90. In these tables, the reconciliation items that convert personal income to the IRS definition of AGI are shown in two groups. The first group (lines 3-9) consists of the portion of personal income that is not included in AGI; the largest items in this group are transfer payments (line 3) and other labor income except fees (line 4). The second group (lines 11-15) consists of the portion of AGI that is not included in personal income; the largest items in this group are personal contributions for social insurance (line 11), net gain from sale of assets (line 12), and taxable private pension payments (line 13).

In addition to the reconciliation items, "intercomponent reallocations" are needed to arrive at comparable BEA and IRS estimates of AGI (see the appendix). The reallocations affecting the BEA-derived AGI are shown in lines 17-22 in tables 1-3, and those affecting the IRS-reported AGI are shown in lines 26-28. The AGI gap for a type of income (line 30) is the difference between the BEA-derived AGI for that type of income (line 23) and the reallocated IRS AGI for that of income (line 29). The percent distribution of the AGI gap by type of income is shown in line 31, and the "relative AGI gap" for a type of income, which is the AGI gap for that type of income (line 30) as a percentage of the BEA-derived AGI by that income type (line 23), is shown in line 32.

[TABULAR DATA 1, 2 & 3 OMITTED]

The first section of this article discusses the new and revised estimates of the AGI gap by type of income for 1959-90 and the sources of revision in the gap for 1959-88. The second section discusses the sources of revision in the reconciliation estimates for 1959-88.

The AGI Gap

The AGI gap can be considered an indicator of noncompliance with the Federal tax code because the BEA-derived AGI is based on estimates of personal income that are adjusted to include income that is unreported on individual income tax returns, whereas the IRS measure of AGI is based entirely on unaudited tax return data. However, the noncompliance reflected in the AGI gap is limited to the types of income that are included in personal income, which excludes income such as unreported capital gains and unreported illegal income. Thus, the AGI gap is not a measure of the size of the underground economy.(2) 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 the reconciliation items.

The relative AGI gap--the AGI gap as a percentage of the BEA-derived AGI--can be used as a rough indicator of the noncompliance rate in the reporting of income included in IRS AGI.

Trends by type of income for 1959-90

The new and revised estimates of the AGI gap and of the relative AGI gap by type of income for 1959-90 are shown in tables 4 and 5. Although the total relative AGI gap has remained fairly stable for most years, the relative AGI gaps by type of income show significantly different levels and trends.

[TABULAR DATA 4 & 5 OMITTED]

The relative AGI gap for wages and salaries is the lowest among the types of incomes shown in table 5, primarily because income tax withholding, at the source is required for wages and salaries. The relative gap for wages and salaries shows a declining trend for 1959-82 and then an increasing trend beginning with 1983. The uptrend in recent years should be interpreted with caution. Beginning with 1985, the wages and salaries gap has been affected by a lack of information needed to estimate the amount of employee contributions to deferred compensation agreements such as those allowed under IRS Code section 401(k). All such contributions are excluded from IRS AGI, but an unknown amount of these contributions has been included in the BEA-derived AGI for wages and salaries since 1985; this has resulted in an overestimation of the wages and salaries gap. BEA's estimates of wages and salaries are based on tabulations of the wages and salaries of employees covered by unemployment insurance; in 32 States, employers are required to include the amount of employee's salaries contributed to deferred compensation agreements as part of wages in their unemployment insurance reports.

The relative AGI gaps for nonwage incomes that are subject to the requirements for filing information returns--personal dividend income, personal interest income, taxable pensions, taxable unemployment compensation, and taxable social security benefits--show a declining trend until 1988 but then start to increase sharply in 1989.(3)

The relative AGI gaps for proprietors' income and for rental income of persons, for which information returns are generally not required, are the highest among the types of income shown in table 5. The relative AGI gaps for these types of incomes show uptrends until the mid-1980's and downtrends thereafter. The downtrends appear to be attributable to a provision of the Tax Reform Act of 1986 that limits the deduction of passive activity losses against nonpassive income.

Revisions for 1959-88

Table 6 shows the revised and the previously published estimates of the AGI gap and of the relative AGI gap for 1959-88; it also shows the source of the revisions in the estimates of the AGI gap. Most of the revisions in the AGI gap resulted from revisions in the estimates of personal income that stemmed from the comprehensive NIPA revision. However, not all the revisions in personal income carried through to the BEA-derived AGI and to the AGI gap, because many of them resulted in offsetting revisions in the reconciliation items. Revisions in the AGI gap also resulted from revisions in the IRS measure of AGI and from revisions in the reconciliation items due to the incorporation of new source data and to new estimating procedures.

[TABULAR DATA 6 OMITTED]

The estimates of the AGI gap were revised down slightly for most years before 1979 and revised up for 1979-88. Except for 1988, the revisions in the AGI gap resulted entirely from revisions in the BEA-derived AGI-that is, from the revisions in personal income and in the reconciliation items. For the 1960's, the small downward revisions in the AGI gap generally reflected upward revisions in personal income that were smaller than those in the reconciliation items. For the 1970's, the small downward revisions generally reflected downward revisions in personal income that were larger than those in the reconciliation items. For the 1980's, the upward revisions in the AGI gap generally reflected substantial upward revisions in personal income--mainly in wages and salaries, nonfarm proprietors' income, personal dividend income, and personal interest income. For 1988, the upward revision in the AGI gap was largely due to an upward revision in the reconciliation items that was larger than a downward revision in the IRS measure of AGI.

Table 7 shows the revisions in the AGI gap by type of income for 1959-88. These revisions reflect the revisions in each major type of personal income, in the reconciliation items, in the intercomponent reallocation items, and in IRS AGI. The upward revisions in the AGI gap in recent years resulted largely from the upward revisions in the AGI gap for wages and salaries, nonfarm proprietors' income, personal dividend income, personal interest income, and taxable pensions and annuities.

[TABULAR DATA 7 OMITTED]

Sources of Revision in Reconciliation Estimates

Personal income

The revisions for each major type of personal income for 1959-88 are shown in table 8. The revisions reflect the definitional, classificational, and statistical changes that were incorporated in the comprehensive NIPA revision released in December 1991.(4)

[TABULAR DATA 8 OMITTED]

Prior to 1980, the revisions in the estimates of personal income were small, amounting to less than 1/2 percent. For the 1960's, upward revisions were largely in personal dividend income and personal interest income. For the 1970's, downward revisions were largely in proprietors' income and transfer payments.

Beginning with 1990, personal income was revised up substantially. The upward revisions were largely traceable to revisions in wages and salaries and nonfarm proprietors' income that largely stemmed from revisions in the adjustments for misreporting on tax returns(5) and to revisions in personal interest income that stemmed from a number of statistical changes. Other sources of the upward revisions included the following: In wages and salaries, the inclusion of wages and salaries of students working for public educational institutions and of other State and local government employees not covered by unemployment insurance; in other labor income, the revisions in the employer contributions to private group health insurance; in nonfarm proprietors' income, the revisions in the interest passed through by partnerships to their partners; in personal dividend income, the recognition of capital gains distributions of regulated investment companies as dividends; and in personal interest income, the revisions in imputed interest income included in personal income and the recognition of interest paid by persons to government. These upward revisions were partly offset by downward revisions that included the following: In nonfarm proprietors' income and in transfer payments, the reclassification of bad debt losses as financial transactions; in farm proprietors' income, the reclassification of Commodity Credit Corporation loans from nondefense purchases to financial transactions and the introduction of a new procedure for estimating the imputed rental value of farm dwellings; and in rental income of persons, downward revisions in rental receipts and upward revisions in interest expenses.

Reconciliation items

The items that are used to reconcile personal income with the IRS definition of AGI for 1959-88 have also been revised (table 9). These revisions result from the comprehensive NIPA revision and from the incorporation of new source data and of improved procedures for estimating the reconciliation items. As mentioned before, the revisions in the reconciliation items that result from the comprehensive NIPA revision are offsets to revisions in personal income and, thus, have no effect on the AGI gap. In contrast, the revisions in the reconciliation items that result from the incorporation of new source data and new estimating procedures do affect the AGI gap.

[TABULAR DATA 9 OMITTED]

The revisions in transfer payments resulted partly from the comprehensive NIPA revision, mainly the reclassification of bad debt losses as financial transactions as shown in table 8, and partly from the revisions in the nontaxable portion of the pensions of Federal and State and local government employees.

The revisions in other labor income, imputed income in personal income (primarily rental and interest incomes), and investment income retained by life insurance carriers and private noninsured pension funds resulted from the comprehensive NIPA revision. Some of these revisions are highlighted in table 8 as employer contributions to group health insurance and as imputed interest income.

The revisions in investment income received by nonprofit institutions and in investment income retained by fiduciaries resulted from the incorporation of new source data. However, these revisions do not affect personal income, because the components of personal income that include these types of income are derived as aggregates. Separate estimates of income of nonprofit institutions and fiduciaries are prepared only for reconciliation purposes.

The revisions in accounting differences between the NIPA's and tax regulations resulted partly from the following NIPA comprehensive revisions: Reclassification of bad debt losses as financial transactions and revisions in interest passed through by partnerships to their partners (both highlighted in table 8); and revisions in capital consumption adjustments. The revisions in accounting differences also resulted from new source data and improved procedures for estimating the difference between the NIPA estimates and the IRS estimates of the change in farm inventories for farm proprietors' income and of depreciation for farm proprietors' income and for rental income of persons.(6)

The revisions in "other personal income exempt or excluded" resulted mostly from improved procedures for estimating the tax-exempt interest received by individuals and for estimating the adjustment for S-corporation dividends.(7) The revisions in the tax-exempt interest received by individuals incorporated revised flow-of-funds data and the adjustment for tax-exempt interest passed through by regulated investment companies to individuals. The revisions in "other personal income exempt or excluded" also resulted from the revisions in tax-exempt military pay and allowances and from the inclusion, beginning with 1987, of the Federal Government employee portion of contributions to the thrift Savings plan.(8)

The revisions in personal contributions for social insurance resulted from the comprehensive NIPA revision. These revisions were small, mostly reflecting the reclassification of the Panama Canal Commission from a government enterprise to a foreign entity.

The revisions in taxable private pensions resulted from the incorporation of new source data from IRS Form 5500, Annual Return/Report of Employee Benefit Plan, filed by administrators or sponsors of employee benefit plans, and from the elimination of payments to individual retirement accounts and Keogh plans from the estimates of private pension benefits.

The revisions in "other reconciliation items" that resulted from the comprehensive NIPA revision primarily reflected the recognition of capital gains distributions of regulated investment companies as dividends (see table 8). The revisions also resulted from the incorporation of new source data for foreign source income included in IRS AGI but not in personal income and from the inclusion of supplemental unemployment benefits from company-financed unemployment trust funds in wages and salaries.

Intercomponent reallocation

Two of the intercomponent reallocations (see appendix) were affected by the 1991 comprehensive revision of the NIPA's: The fees component of other labor income, and capital gains dividends.

The fees component--directors' fees, judicial fees to witnesses and jurors, compensation of prisoners, and fees to justices of the peace--of other labor income (line 17, tables 1-3) is reallocated from other labor income to nonfarm proprietors' income. In the previous reconciliations, these fees were allocated to wages and salaries. The treatment of these fees as nonfarm proprietors' income is based on the IRS instruction that these fees must be reported on tax returns either as business income or as miscellaneous taxable income. Capital gains dividends from regulated investment companies are treated as personal dividend income in the comprehensive NIPA revision. However, these capital gains are tabulated as part of capital gains in AGI. Thus, to derive the BEA-derived AGI, BEA reallocated capital gains dividends from personal dividend income to capital gains (line 22, tables 1-3), which are included in the "income not included in personal income" column of tables 1-3. The revised NIPA treatment of capital gains dividends does not affect the AGI gap for dividend income, because these dividends are reallocated to capital gains in the reconciliation.

Appendix

The derivation of the AGI gap by type of income requires the reallocation of certain components of NIPA personal income and of IRS AGI in order to make the two classifications of income comparable. The reallocations affecting the components of the BEA-derived AGI are shown in lines 17-22 in tables 1-3; the reallocations affecting the components of IRS AGI are shown in lines 26-28. This appendix explains the reasons for the reallocations.

Reallocations affecting components of BEA-derived AGI.--Two of these reallocation items--the fees component of other labor income (line 17) and capital gains dividends from regulated investment companies (line 22)--were described in the previous section because they were among the sources of revision in the reconciliations for 1959-88. The following paragraphs describe the remaining items.

Partnership income retained by fiduciaries (line 18) is reallocated from other personal income to farm and nonfarm proprietors' incomes because partnership income is not a NIPA income component. Interest received by, but not related to business operations of, nonfinancial proprietors and partnerships (line 19) is reallocated from personal interest income to nonfarm proprietors' income. Such interest is tabulated by IRS as part of the income of proprietors and partnerships, but it is treated in the NIPA's as personal interest income.

The interest distributions excluding tax-exempt distributions by regulated investment companies line 20), such as mutual funds, are reallocated from personal interest income to personal dividend income because IRS instructions require that they be reported as dividends, whereas they are classified as personal interest income in the NIPA's (see footnote 3 in the text).

Taxable disability income payments (line 21) are reallocated from taxable pensions to wages and salaries because some of these payments are reported as wages on tax returns but are included as pensions in personal income. The Tax Reform Act of 1976 provided a disability income exclusion under which a taxpayer who retired on disability before age 65 was entitled to exclude limited amounts of disability payments from gross income if such payments were reported as wages for 1977-83. Beginning with 1984, taxable disability income payments are reported as wages until the retiree reaches the minimum retirement age, and then they are reported as pensions.

Reallocations affecting components of IRS AGI.--The IRS estate or trust income (line 26) is reallocated from other personal income to farm proprietors' income, nonfarm proprietors' income, rental income of persons, and personal interest income to be consistent with the treatment of estate and trust income in the NIPA's.

The IRS partnership income (line 27) is reallocated between farm and nonfarm proprietors' income because IRS does not provide tabulations of this detail for partnership income reported on individual income tax returns.

"Other reallocations" (line 28) includes several reallocations not shown separately. Before 1963, the IRS business or profession net profit is allocated between farm and nonfarm proprietors' income because IRS did not tabulate farm proprietors' income separately. For 1958--65, the dividends distributed by small business corporations is reallocated from partnership income to personal dividend income because small business corporations' dividends were tabulated by IRS as partnership income on the basis that the two types of business organizations were treated alike under tax laws. For 1957-65, some wages that were not subject to withholding were reported on IRS Form 1040A and tabulated by IRS as other income; this other income is reallocated to wages. For 1964-65, estate or trust income was tabulated as part of other income in IRS AGI; this amount is reallocated as described for line 26. For 1961, wage earners who had $200 or less of dividends and interest could report the combined amount of these incomes as a single figure; this combined amount is reallocated between personal interest income and personal dividend income. (1.) Revised estimates of the reconciliation for total personal income and for 1959-88 will be published this summer in National Income and Product Accounts of the United States: Volume 2, 1959-88. Revised estimates of the reconciliation by type of income arc available for 1959-90 for information on ordering these estimates, write to the Government Division (BE-57), Bureau of Economic Analysis, U.S. Department of Commerce, Washington, DC 20230, or call (202) 523-0576. Revised estimates of the reconciliation for 1947-58 will be available later this year. (2.) 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," Survey of Current Business 64 (July 1984): 109. (3.) Beginning with 1984, a small portion of the incomes in this group has been subject to tax withholding. Withholding is automatic for taxable pensions unless the recipient elects not to have tax withheld. Withholding is required for interest and dividends if the recipient fails to furnish a correct taxpayer identification number or has interest or dividends that were underreported on past returns.

For personal interest income and personal dividend income, tables 4 and 5 show separate and combined AGI gaps and relative AGI gaps. The combined gap for personal interest income and personal dividend income is shown because of the difficulty in recent years of accurately deriving separate gaps. The difficulty relates to the reconciliation item for distributions from regulated investment companies (line 20, tables 1-3). These distributions are classified as interest in personal income. However, IRS instructs taxpayers to report these distributions as dividends, rather than as interest, on their tax returns. Despite such instructions, there is considerable evidence that some taxpayers have inadvertently reported the distributions as interest. Because the amount of this misreporting is not known and because the entire amount of the distributions in personal income is reallocated to personal dividend income in reconciliation, the AGI gap for personal dividend income is overstated, and the AGI gap for personal interest income is understated. (4.) These changes were described in the September and December 1991 issues of the Survey; the revised estimates for 1987-90 were presented in "National Income and Product Accounts Tables, 1987-90" in the January 1992 Survey. (5.) For information about these adjustments, see "Improved Adjustments for Misreporting of Tax Return Information Used To Estimate the National Income and Product Accounts, 1977," Survey 64 (June 1984): 17-25. (6.) For example, the revision in line 8, "differences in accounting treatment between NIPA's and tax regulations, net," for 1988 consists of the following:
 Amount of revision
 [Billions of dollars]
Gains on livestock and IRS Code section 1231 gains 0
Excess of interest accrued over interest paid -3.5


Inventory valuation adjustment for nonfarm

noncorporate business -.1

Depletion on domestic minerals, bad debt, tax-exempt

cooperation income, and guaranteed payment to
 partners -4.1
Other nonfarm proprietor's income adjustments -13.8


Change in farm inventory (the excess of BEA estimates

over IRS estimates) -7.2

Excess of the IRS depreciation over the NIPA measures of

historical-cost depreciation for farm proprietors'
 income and for rental income of persons 9.0
Capital consumption adjustments -8.7


Investment income of individual retirement accounts
 and Keogh funds .5
 Total accounting differences -28.0


(7.) This adjustment is included as a reconciliation item because dividends of small business corporations (corporations filing IRS Form 1120s) have been tabulated at different times by IRS as dividends, as partnership income and as small business corporation income. In the NIPA's, dividends from small business corporations are included in personal dividend income for all years their retained earnings are included in corporate profits and are added as a separate reconciliation item (line 14, tables 1-3) in calculating the BEA-derived AGI. (8.) For example, the revision in line 9, "other personal income exempt or excluded from adjusted gross income," for 1988 consists of the following: (footnote continues on the next page)
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Title Annotation:1989-90 estimates and 1959-88 revisions
Author:Park, Thae S.
Publication:Survey of Current Business
Date:May 1, 1992
Words:3836
Previous Article:National income and product accounts.
Next Article:U.S. affiliates of foreign companies: operations in 1990.
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