If you follow my writings, you’ll know that I often write about matters of personal finance using my company’s economics-based, personal financial planning software. What you may not know is that, together with UC Berkeley economist, Alan Auerbach, and other economists in academe, the Federal Reserve Bank of Altanta, my graduate students, and my company’s software engineers, I’ve developed a research version of the program. The research machine is call The Fiscal Analyzer (TFA). We’re using it study inequality, fiscal progressivity and work disincentives.
Over the years, research on TFA or its underlying computation engine has been funded by the National Institute of Aging (part of NIH), the Goodman Institute, the Seale Foundation, the Sloan Foundation, Economic Security Planning, Inc., Boston University, and the Federal Reserve Bank of Atlanta.
A defining feature of TFA is its inclusion of every major federal and state fiscal program in fine detail. It also considers future as well as current taxes households will pay and benefits they’ll receive. This lifetime as opposed to snapshot perspective gives us a picture of our fiscal policy that goes far beyond what standard static tax and benefit studies, be they government or non-profit, provide.
I used TFA a year back to write a Wall Street Journal column setting the record straight about our nation’s fiscal progressivity. The analysis of Senator Warren’s economic advisors to the contrary, our fiscal system is highly progressive. Moreover, inequality, measured properly on the basis of what people get to spend is much smaller than wealth inequality suggests. The reasons are that spending is financed by current and future labor earnings as well as current net wealth. And regardless of how pre-tax resources are distributed, the government (federal and state) can redistribute to dramatically mitigate or exacerbate inequality. Hence, studying inequality without taking into account fiscal policy is akin to assessing medical outcomes ignoring the availability and definitive use of modern medicine.
These points are quantitatively important. Take, for example, forty yer olds. The richest 1 percent of forty year households — the 1 percent with the highest resources, where resources are measured as the sum of human (the present value of future labor earnings) plus non-human wealth — have 34.1 percent of the cohort’s total non-human wealth, but account for only 14.5 percent of the cohort’s total remaining lifetime spending. The poorest quintile of forty year olds own just 0.6 percent of the cohort’s wealth, but account for 7.3 percent of its remaining lifetime spending.
These and similar findings for other cohorts tell us that things are much less unequal and our fiscal policy is much fairer than many imagine. But measuring things correctly doesn’t mean the resulting picture is pretty. Yes, spending inequality is not as bad as wealth inequality. But it’s still horrific. Over a half million of our countrymen sleep on the street night after night while the richest of us want for nothing. Part of the reason America’s poor are in such terrible economic shape, COVID-19 aside, is our country’s decade’s long policy of locking the poor into poverty by confronting them with massive work disincentives. The Wall Street Journal devoted an editorial to describing our TFA-based findings, including the fact that those at the bottom rung of the economic ladder lose 70 cents or more of every extra dollar earned either due to higher taxes or reduced benefits. Unfortunately, the Tax Cut and Jobs Act of 2017 did essentially nothing to eliminate the poverty trap nor, indeed, lower effective marginal remaining lifetime net tax rates for Americans in general — marginal rates that are typically 45 percent.
The above is all by way of setting the stage for describing the impact, as calculated by my graduate student, Yifan Ye, and myself, using TFA, of Vice President Biden’s fiscal reforms. There are individual as well as overall impacts. TFA gets at the individual (micro) impacts. We’ve used a separate research tool, which Yifan and I have co-developed with an international team of economists, called the Global Gaidar Model (GGM). The GGM has been funded by Boston University, the Gaidar Institute in Moscow, the Goodman Institute, and the Sloan Foundation. The GGM is what we economists call a CGE — a computable general equilibrium model. CGE’s are large scale models that simulate how economies transition through time in response to changing demographics, fiscal policies, productivity growth rates, and other major economic impacts. The GGM is, we believe, the only extant global growth model. It features all the countries of the world compressed into 17 regions. The major countries, like the US, Russia, and China are their own regions. Western Europe, the Middle East, the UK, and Japan plus Hong Kong and South Korea are examples of other regions. The GGM lets us understand how the vice president’s fiscal reforms, particularly his planned increase in the corporate tax rate from 21 percent to 28 percent will impact US economic growth going forward.
Biden’s Fiscal Reforms
The vice president proposes
- Taxing all labor income above $400,000 (with this threshold unindexed for inflation) at Social Security’s 12.4 percent employer plus employee FICA payroll tax rate.
- Increasing the top income-tax bracket to 39.6 percent.
- Providing a Social Security benefit increase whose value depends on your birth year. The benefit, which is uniform, i.e., independent of you own benefit or earnings history, will be provided to beneficiaries who live beyond age 77. The benefit will fully phase in by age 82 and equal 5 percent of the full retirement benefit that someone in your birth-year cohort would receive where they to earn average annual wages during your birth year’s working years.
- Reinstating the Pease limitation on itemized deductions for high-income households.
- Capping the value of deductions for high-income households at 28 percent.
- Making childless individuals under 65 eligible for the EITC.
- Expanding and making refundable the child-tax credit.
- Increasing Social Security’s Special Minimum benefit.
- Raising the corporate tax rate to 28 percent.
Additional provisions of the vice president’s proposal involve a first-time home buyer’s credit, credits for new manufacturing investments, increases in the estate tax, minimum taxes of foreign-source corporate income, taxing financial risk, eliminating step-up in basis, replacing deductions for retirement contributions with a refundable credit, and raising capital gain and dividend taxation for those with incomes above $1 million. We have yet to model these additional provisions in TFA, but I include the Urban Institute Tax Policy Center’s estimate of their aggregate revenue impact in assessing the ten-year net revenue impact of the entirety of the vice president’s tax and benefit proposals.
Our study’s specific findings are detailed below. But the general findings can be summarized as follows.
Vice President Biden’s tax and benefit reforms are highly progressive. They represent a very major net tax hike on the rich. Indeed, for the top 1 percent, the average lifetime net tax rate rises by 17 percent. The reforms provide small net benefits to the poor and middle class — benefits that could well be largely effaced by an outflow of capital associated with raising the corporate income tax. The reforms will, on average, put the richest and most productive workers in our economy in an extremely high marginal lifetime net tax bracket. This may deter the rich from working or working as hard as they would otherwise do. It may also induce them to spend more resources avoiding taxes. Our simulated outflow of capital will, according to the GGM, reduce output and wages over time by almost 2 percent. The progressive provision of extra Social Security benefits to those who live to age 78 and beyond may be of considerable assistance to the long-lived poor.
My bottom line: the country is short revenue to a terrible degree. Vice President Biden’s plan has the rich pay more, indeed quite a lot more. He also collects considerably more revenue from corporations at the risk of reducing investment, output, and wages in the US. His plan helps families with children and the long-lived, particularly the poor long-lived.
Could one achieve the vice president’s reform goals without the potential adverse work incentives and impact on the economy? Absolutely. Taxing the wealth of the rich, not their labor earnings, would achieve that goal. This can be achieved by a cash flow tax that exempts saving as well as labor earnings. I discuss such a cash flow tax in You’re Hired, a book I wrote in 2016. It was written in the vain hope that the Trump administration would follow its suggestions.
- Biden’s tax-benefit reforms are highly progressive and age-dependent. This primarily reflects the Social-Security FICA taxation of labor income above $400,000 and the fact the older high-wage earners will only face this increased taxation for a limited number of years. The reforms are more geared toward raising net taxation of the rich than they are in helping the middle class or poor.
- Across all age groups, the top 1 percent face an average lifetime tax hike of $1.6 million. Lifetime tax hike references the present value increase in all future taxes net of all future benefits. For the top 5 percent and top 20 percent, the average tax hikes are $436 thousand and $115 thousand, respectively. All those in lower resource distribution quintiles experience, on average, a reduction in lifetime net taxes (equivalently, an increase in lifetime net benefits). But the lifetime gain to the middle class and poor is small — less than $6,000.
- The Biden tax-benefit plan will, on average, raise the lifetime spending of the poorest 20 percent, regardless of age, by over 1 percent. For those younger than 40, the increase is almost 3 percent. The plan reduces the lifetime spending of the super rich — the top 1 percent — by 6 percent. That’s across all ages. For the super rich under 40, the percentage spending reduction is over 12 percent. The reason for this heavier lifetime burden on the top 1 percent of the young rich is that the young rich will pay far higher Social Security taxes for their entire remaining working years, which are much longer than those of the older rich.
- Consider 30-39 year olds. Average lifetime net taxes for those in the lowest quintile of their cohort’s resource distribution — the poorest 20 percent — decline by $13.9 thousand. For those in the top 1 percent, there’s a $2.0 million increase. For the poorest 20 percent of those age 50-59, there’s a $2 thousand reduction in lifetime net taxes. For the top 1 percent of 50-59 year olds, the increase is $2.8 million. Among 70-79 year olds the comparable net tax changes are negative $4.3 thousand and positive $347 thousand.
- Across all age groups, Biden’s reforms would reduce remaining lifetime net taxes by $5.5 thousand, on average, for the 1st quintile, by $4.5 thousand, on average, for the 2nd quintile, by $4.5 thousand, on average, for the 3rd quintile, and by $2.9 thousand for the fourth quintile. Only the top quintile would experience, on average, a rise in lifetime net taxation, with the average increase equaling $114.8 thousand. For those in the top 5 percent the lifetime net tax hike averages $436.1 thousand. For those in the top 1 percent, it averages $1.7 million.
- The average percentage changes in lifetime spending across all age cohorts is 1.2 percent in the 1st quintile, 0.7 percent in the second quintile, 0.4 percent in the third quintile, 0.2 percent in the fourth quintile, negative 2.3 percent in the top quintile, negative 3.9 percent among the top 5 percent, and negative 5.9 percent among the top 1 percent. Those hit hardest are the richest 1 percent of 20-29 year olds and 30-39 year olds. Their lifetime spending reductions are 13.1 and 12.3 percent, respectively.
- Percentage reductions in lifetime net tax taxes also differ substantially by age and resource level. For those 30-39, the percentage changes are -5.2 percent, -8.5 percent, -1.8 percent, -.8 percent, 5.5 percent, 10.7 percent, and 18.7 percent, respectively, for quintiles 1 through 5 and the top 5 percent and top 1 percent. For those age 50-59, the corresponding percentage changes are -0.5 percent, -1.7 percent, -26.1 percent, .1 percent, 10.7 percent, 15.0 percent, and 18.7 percent. The -26.1 percent figure reflects the close to zero initial net taxes paid by this cohort and quintile group under current law.
- Across all age groups the percentage changes in lifetime net taxes are -1.7 percent for the poorest quintile, -4.2 percent for the second quintile, -7.1 percent for the third quintile, -1.1 percent for the fourth quintile, 7.7 percent for the 5th quintile, 11.9 percent for the top 5 percent, and 17.1 percent for the top 1 percent. Absent Biden’s Social Security reforms, these values would be -1.3 percent, -2.0 percent, -1.6 percent, 0.2 percent, 3.2 percent, 4.6 percent, and 6.1 percent. Hence, for the rich, the Social Security reforms, particularly the FICA tax increases, are the major feature of the reform.
- The Biden reforms would significantly raise marginal net tax rates (MNTR) facing the rich. Under current law, median MNTRs across all age groups are 49.7 percent, 42.3 percent, 41.0 percent, 43.5 percent, 46.3 percent, 50.3 percent, and 55.2 percent, respectively, for the 1st through 5th quintiles and the top 5 percent and top 1 percent. Under Biden’s reforms, these values would equal 48.8 percent, 41.5 percent, 40.6 percent, 43.7 percent, 46.9 percent, 52.9 percent, and 62.6 percent.
- For certain rich workers in high tax states, the Biden plan augers median tax rates as high as 70 percent. Super high marginal net taxation of the rich may materially limit their labor supply in much the same manner as it reduces the labor supply of the poor. Or it may lead the rich to engage more intensively on tax avoidance.
- In the GGM, as in the real world, capitals flows freely around the world. Hence, the model predict a loss in capital in the US in response to the vice president’s proposed one third increase in the corporate tax rate — from 21 percent to 28 percent.
- The long-run loss to the US capital stock is roughly 6 percent and the long-run decline in output is roughly 2 percent. The GGM also predicts a roughly 2 percentage-point reduction in wages of US workers, with a larger reduction in the wages of high-skilled workers. Changes of this magnitude could significantly offset the micro gains to low-wage and middle-wage workers of Biden’s fiscal reforms.
- Increasing the corporate income tax per the vice president’s proposal spells a minor — a roughly 0.30 percent decline in long-run federal revenues.
Estimated Revenue Impact
- Combining our findings from the TFA, simulating the GGM, and revenue estimates from the Urban Institute of particular provisions not yet included in the TFA, our estimate is that the vice president’s reforms will raise $1.9 trillion in extra revenue over 10 years.
- This includes a 1.8 percent reduction in annual revenues ($668 billion over ten years) due to the contraction of the economy predicted by GGM of approximate 1.8 percent per year. Leaving aside this economic contraction effect, our revenue estimate is only about $200 billion above that of the Tax Policy Center.