CONTRIBUTOR

*This column is co-authored with Alan Auerbach, Professor of Economics at the University of California at Berkeley.*

Yes, it’s true. The presidential follies have featured policy discussions amidst the name-calling. Inequality is the Democrats’ top concern. Their solution — higher taxes on the rich and more benefits for the poor. The Republicans worry most about growth. They favor lowering taxes to spur work and investment and cutting benefits to make up lost revenue.

Remarkably, this debate has proceeded with no comprehensive measures of U.S. inequality, fiscal progressivity, and work disincentives. In a just-released, co-authored study, we provide the first real picture of these issues.

But don’t we already know this? Surely, the rich have a disproportionate share of total wealth and income. Indeed, but the government also levies taxes and provides benefits. In the extreme, the fiscal system could redistribute enough to leave everyone with exactly the same spending power notwithstanding great wealth and income differences.

One glance at Trump’s $250 million yacht tells you spending inequality remains extremely high. But exactly how large is spending-power inequality? And to what extent does the fiscal system reduce it?

Learning the answers was a multi-year undertaking. It required calculating lifetime spending for a representative sample of U.S. households accounting, in meticulous detail, for all the taxes they will pay and benefits they will receive over the rest of their days. The list includes the personal income tax (in all its gory detail), FICA taxes, the corporate income tax, the estate tax, state income taxes, state sales taxes, Medicare Part B premiums, Social Security benefits (eight kinds), Medicare benefits, SSI benefits, welfare (TANF) benefits, Medicaid benefits, and disability benefits.

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Our data are the Federal Reserve’s 2013 Survey of Consumer Finances (SCF). To calculate lifetime spending, we ran the SCF data through a computer program called The Fiscal Analyzer (TFA). TFA calculates the present value of the annual spending the household can sustain given its resources (current wealth and projected labor earnings), its taxes and benefits, and limits on its borrowing capacity.

What a household can spend over time depends on what it pays in taxes and receives in benefits. But these taxes and benefits depend on the path of the household’s income, which depends, in part, on its past spending. So there’s a chicken and egg problem — the path of spending depends on the path of net taxes (taxes net of benefits) and the path of net taxes depends on the path of spending. TFA uses advanced computational methods to solve this “simultaneity problem.”

Our focus on lifetime spending inequality is motivated by both economic theory and common sense. Our economic wellbeing depends not just on what we spend this minute, hour, week, or even this year. It depends on what we can expect to spend through the rest of our lives. One big unknown here is lifespan. TFA handles this by considering all possible household survivor paths and appropriately weighting the spending along each path by its probability. To ensure we don’t undercount the spending of the rich, bequests left at the end of each survivor path are treated as part of the household’s spending, and the estate taxes it pays on each path are included in the household’s lifetime net taxes (taxes paid net of benefits received).

One final methodological point: Since we are comparing lifetime spending inequality, it makes no sense comparing households of different ages, with very different lifespans. Hence, we look at age cohorts, in this case ten-year age cohorts.

So what did we learn?

First, spending inequality – what we really care about — is far smaller than wealth inequality. This is true no matter the cohort you consider. Take forty year-olds, for example. Those in the top 1 percent of the resource distribution have 18.9 of the wealth, but account for only 9.2 percent of the spending. In contrast, the 20 percent at the bottom (the lowest quintile) have only 2.1 percent of wealth but 6.9 percent of total spending.

The fact that spending inequality is dramatically smaller than wealth inequality results from our highly progressive fiscal system. The top 1 percent of forty year-olds face a net tax, on average, of 45.0 percent. This means that the present value of their spending is reduced by the fiscal system to 65 percent of the present value of their resources. The average net tax rate of the top 20 percent is 32.5 percent. For the bottom 20 percent, the average net tax rate is negative 34.2 percent. They get to spend 34.2 percent more than they have thanks to government policy.

To be clear, spending inequality remains highly unequal. Our point is that the fiscal system, taken as a whole, does materially reduce inequality, not in what people own or earn, but what they get to spend. But the scope to equalize spending power by taxing the top 1 percent at a much higher rate is limited by their numbers. Indeed, among 40-year olds, confiscating all the remaining spending power of the top 1 percent (raising their average net tax rate to 100 percent) and giving it to the lowest quintile, would leave the poorest 20 percent with 16.1 of their cohort’s total spending power, i.e., still less than 20 percent. And this assumes the jobs and incomes of those workers aren’t adversely affected by such a policy.

What about work incentives?

Unfortunately, our plethora of independently designed taxes and benefits (with their income and asset tests) has left most households with high to very high marginal remaining lifetime net marginal tax rates. Among the 40-49 year-olds, median marginal remaining lifetime net tax rates (henceforth referenced simply as marginal net tax rates) range are roughly 40 percent in each of the lower three quintiles, close to 50 percent in the fourth highest resource quintile, and above 50 percent in the top quintile. Median marginal net tax rates for those in the top 5 percent and 1 percent of the resource distribution are 65.5 and 68.0 percent, respectively.

How can the super rich be paying close to 70 percent at the margin? Didn’t Warren Buffett say he’s paying just 17 percent in taxes? Warren is missing a lot of taxes in his calculation, which, by the way, is an average, not a marginal tax. If the rich earn more money this year, they will pay about 45 percent in extra federal and state-income taxes. But not all of the extra earnings will be immediately spent. Some will be saved for future spending. And that saving will generate asset income, which will generate additional corporate and explicit personal income taxes. In addition, the extra spending due to the extra earnings requires the payment over time of more sales taxes. In short, our system entails both multiple direct and indirect taxation of earnings, which hits the rich particularly hard precisely because they save more

So Warren is far off base, although he’s not alone. Here’s another key thing we learned about marginal taxation. There is enormous variation in net marginal taxes across households with the same or similar resources. Among the lowest quintile of 40 to 49 year-olds, the minimum remaining lifetime marginal net tax rate is minus 17.9 percent, and the maximum is 933.7 percent! Among the highest quintile in this age group, the minimum marginal net tax is 49.2 percent and the maximum is 74.7 percent. This variation is not only capricious and unfair. It’s highly inefficient.

One final major finding. Our standard means of judging whether a household is rich or poor is based on a snapshot of current income. But this classification can produce huge mistakes. For example, only 71.2 percent of 40 to 49 year olds who are actually in the third resource quintile would be so classified based on current income. Or take the poorest 20 percent of those 60-69. Current-income classification misses 35.1 percent of such households.

Current-year net tax rates (this year’s net taxes divided by this year’s income) can dramatically misstate the economically relevant remaining lifetime net tax rates. Consequently, relying on average current-year net tax rates to assess fiscal progressivity, as is standard practice, can be far off the mark. Take, for example, the first and second resource quintiles of the 40-49 year-old cohort. Their average lifetime net tax rates are – 34.2 percent and 5.7 percent, respectively. But the corresponding current-year average net tax rates are -22.5 percent and 17.4 percent, respectively. Current-year marginal net tax rates can also differ very substantially from their appropriate counterparts.

Facts are hard things. They upset prior views and demand attention. The facts here should change views. Inequality, properly measured, is lower than generally believed. Our fiscal system, properly measured, is highly progressive. And, via our high marginal taxes, we are providing incentives to Americans to work less and earn less than would otherwise be true. Finally, traditional measures of inequality, progressivity, and work disincentives, while far easier to produce, produce highly distorted pictures of all three issues.

Laurence Kotlikoff is the co-author of NY Times Best Seller,

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