Paul L. Caron

Thursday, October 24, 2019

Kotlikoff: Tax Myths Of Warrenomics

Wall Street Journal op-ed:  Tax Myths of Warrenomics, by Laurence Kotlikoff (Boston University):

Economists Emmanuel Saez and Gabriel Zucman of the University of California, Berkeley are advising Elizabeth Warren’s presidential campaign and drawing generous media attention for their assertion that the U.S. tax system is flat—that the middle class and poor pay as great a share of their income in taxes as the rich. They’re wrong, and three huge mistakes underlie their analysis.

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. ...

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. ...

America’s progressive fiscal system, as well as the more even distribution of human wealth, makes spending inequality far smaller than wealth inequality. Nonetheless, average spending by top 1% households is miles higher than average spending by those in the bottom fifth. Like Messrs. Saez and Zucman and Ms. Warren, I am appalled by the degree of U.S. inequality and seek to reduce it. But if economists dramatically understate fiscal progressivity, it may encourage reforms that go far overboard.

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Why would cross-country comparisons yield any meaningful information? Why should we model our tax code or desired income/wealth distribution off of some other country?

Posted by: ruralcounsel | Oct 28, 2019 4:17:33 AM

Kotlikoff has a point, but the better approach would be to construct a distribution table showing income (or wealth) after all taxes and transfers and including all benefits from government services. In practice, this would involve a lot of assumptions and would not be so easy to do. The result would be what the actual distribution of income or wealth in the country is. How much taxes are paid at each level is not relevant, so Kotlikoff is off track on this. The distribution would just pose the question as to whether we think this distribution is appropriate. If not, then more progressive taxes should be imposed to make the distribution more equal. There is no "correct" benchmark as to what the distrubiton should look like. We could get some enlightenment by doing cross-country comparisons or observing how the distribution changes over time.

Posted by: Victor Thuronyi | Oct 24, 2019 10:09:16 AM