Tax Myths of Warrenomics

Her advisers make three huge errors in denying the rich pay the government more.

By Laurence Kotlikoff. Excerpts:

"The biggest mistake is to focus on gross, not net, taxes. They ignore transfer payments, like Social Security, which are disproportionately paid to the poor. In doing so, they mistake language for economics."

"The flaw in their method is even more obvious when you consider that American tax laws incorporate benefit subsystems, and benefit laws incorporate tax subsystems. The federal personal income tax, for instance, includes the earned-income tax credit, a major transfer program. The Social Security benefit system includes the earnings test, a major tax. If the focus is on gross taxes, should the EITC be excluded and Social Security’s earnings test included? Economics can’t say. What it does say is look past the language and measure net, not gross, taxes.

Messrs. Saez and Zucman’s second mistake is measuring progressivity on a one-year rather than a remaining-lifetime basis. That ignores the fiscal system’s double taxation: Income earned, taxed and saved this year will be subject to future taxation on interest, dividends and capital gains. This omission disproportionately understates taxes for the rich, who save at a higher rate. The current-year focus also understates benefits paid to the poor, since future benefits are a bigger share of their resources.

Their third mistake is failing to adjust for age. The old have paid most of their lifetime taxes, which makes them now look like tax cheats, particularly those who saved out of previously highly taxed labor income. With changing demographics, this problem will deeply confuse tax progressivity comparisons over time."

"I’ll focus on 40-year-olds, but the results are similar for all age groups. Each dollar of pretax remaining lifetime resources of those in the top 1% of the resource distribution is, on average, taxed on net at a 34.5% rate. For those in the top quintile, the average net tax rate is 28.4%. For those in the bottom quintile, every dollar of pre-tax resources is matched by a 46.6% net subsidy. (The tax rises steadily to 4.2% for the second quintile, 12.6% for the third and 18.5% for the fourth.)

Thus, far from being flat, the net tax rate facing middle age Americans rises rapidly with their resources—from negative 46.4% for the bottom 20% to positive 34.5% for the top 1%. The average net rates for the current year only (not including future net taxes) for this cohort understate true progressivity. They range from negative 9.8% for the bottom 20% to positive 38.2% for the top 1%."

"Among 40-year-olds, the richest 1% own 34.1% of their cohort’s net wealth, but account for only 14.5% of its remaining lifetime spending. The poorest 20% own only 0.6% of the cohort’s wealth, but are expected to do 7.3% of its spending."