U.S. inequality and fiscal progressivity: An intragenerational accounting

What is this research about and why did you do it?

This paper sought to address several limitations in the existing literature on inequality. First, inequality has typically been measured in a particular dimension (e.g., wealth inequality, income equality, etc.) rather than with respect to overall economic resources. Second, inequality measures often ignore the full impact of tax and transfer systems. Third, inequality is typically measured based on a single economic snapshot, ignoring the evolution of resources over the life cycle. Finally, inequality measures commonly aggregate individuals of different ages, ignoring differences due to age and cohort effects. We address all of these limitations in the literature.

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How did you answer this question?

Using data from the Survey of Consumer Finances, augmented by information from the American Community Survey and the Current Population Survey, we calculate remaining lifetime resources (wealth plus the present value of projected labour income) both before and after taxes and transfers, under the assumption of consumption smoothing subject to borrowing constraints. We refer to the latter value as lifetime spending power (LSP). The calculation of LSP is done through the Fiscal Analyzer, a program that calculates feasible spending paths over all joint spousal mortality outcomes and incorporates extremely detailed rules regarding US federal and state tax and transfers programs.

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What did you find?

First, inequality in income and, especially, wealth dramatically overstate inequality in lifetime spending power. (See figure below.) Second, inequality in current-spending-power (CSP) – spending in the current year arising under the household’s possibly constrained consumption-smoothing plan – differs from LSP, sometimes importantly, due to credit constraints, in-kind government benefits, and other factors. Third, the US fiscal system is highly progressive. Fourth, households’ rankings based on current income can differ substantially from their rankings based on lifetime resources.  Finally, current-year net tax rates substantially understate lifetime fiscal progressivity and can significantly misstate a fiscal reform’s fairness.

Share of Net Wealth and Lifetime Spending Power by Resource Percentile, Ages 40 - 49

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What implications does this have for the study (research and teaching) of wealth concentration or economic inequality?

Measurement of inequality should incorporate the powerful effects of the tax and transfer system in reducing inequality, and should take a life-cycle perspective to aggregate wealth and labour income and to incorporate patterns of income and the tax and transfer system over time. This is especially important for age-dependent spending programs such as old-age pensions and health care, for which annual values for a population cross section provide little information about lifetime progressivity.

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What are the next steps in your agenda?

We are using the same data and software to calculate effective marginal net tax rates for labour income, taking careful account of the impact of increments to income on taxes and the receipt of transfer payments.

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Citation and related resources

Auerbach, A. J., Kotlikoff, L. J., and Koehler, D. 2023. “US Inequality and Fiscal Progressivity: An Intragenerational Accounting.” Journal of Political Economy 131(5).

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 Related resources:

Auerbach, A. J., and Kotlikoff, L.J. 2023. “Inequality, Taxes and Government Benefits: The Real Picture.” Milken Institute Review, April.