U.S. Inequality and Fiscal Progressivity: An Intragenerational Accounting

Economic inequality is fundamentally about differences in spending power, i.e., the ability to engage in current and future consumption. The literature, though, has focused largely on wealth and income inequality, both of which can differ markedly from spending power-inequality due to government redistribution. This study measures inequality in spending power within specific age cohorts, holding constant household behavior. Segregating by cohort controls for growth and life-cycle effects, while assuming uniform household behavior controls for endogenous responses to the tax-transfer system as well as differences in preferences. We also study fiscal progressivity via a new measure – the lifetime net tax rate. We calculate spending power by running the 2016 Survey of Consumer Finances data plus imputed variables through the Fiscal Analyzer (TFA), a life-cycle, consumption-smoothing program that includes hard borrowing constraints and all major federal and state tax/transfer programs, whether cash or in-kind. Our findings are striking. First, inequality in income and, especially, wealth dramatically overstates inequality in spending power. For example, the richest 1 percent of 40-49 year-olds own 29.1 percent of their cohort’s net wealth, but account for only 11.8 percent of its remaining lifetime spending power (LSP). This cohort’s poorest quintile owns just 0.4 percent of the cohort’s wealth, but has 6.6 percent of cohort LSP. Among 20-29 year olds, whose expected human wealth is less dispersed, these discrepancies are even more dramatic. The richest 1 percent have 68.2 of the wealth, but only 9.7 percent of the spending power. The bottom quintile has slightly negative wealth, but 8.3 percent of spending power. 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 U.S. fiscal system is highly progressive once cohorts are old enough to have highly dispersed human wealth. Consider the bottom quintile of 40-49 year-olds. Their lifetime net tax rate (lifetime net taxes divided by lifetime resources) is substantially negative, -44.4 percent, while that of the top 1 percent in the same cohort is 34.7. Fourth, households’ rankings based on current income can differ substantially from their ranking based on lifetime resources. Fifth, current-year net tax rates substantially understate fiscal progressivity and, as our analysis of the 2017 Tax Cuts and Jobs Act shows, can significantly misstate a fiscal reform’s fairness.