U.S. Inequality, Fiscal Progressivity, and Work Disincentives

Alan J. auerbach, Laurence J. Kotlikoff, Darryl Koehler

This study combines the 2013 Federal Reserve Survey of Consumer Finances data and the Fiscal Analyzer, a highly detailed life-cycle consumption-smoothing program, to a) measure ultimate economic inequality – inequality in lifetime spending power – within cohorts, b) assess fiscal progressivity within cohorts, c) calculate marginal remaining lifetime net tax rates, taking into account all major federal and state tax and transfer policies, d) evaluate the ability of current income to correctly classify households as rich, middle class, and poor, e) determine whether current-year average net tax rates accurately capture actual fiscal progressivity, and f) determine whether current-year marginal tax rates on labor supply accurately capture actual remaining lifetime marginal net tax rates.

We find far less inequality in spending power than in wealth or labor earnings due to the fiscal system’s high degree of progressivity. But U.S. fiscal redistribution generally comes with very high work disincentives for households of all ages, regardless of income class. There is, however, substantial dispersion in marginal net tax rates, which seems hard to reconcile with standard norms of optimal taxation. We also find that current income is a very poor proxy for remaining lifetime resources and that current-year net tax rates can provide a highly distorted picture of true fiscal progressivity and work disincentives.