Who Bears the Lifetime Tax Burden?This book constructs a lifetime income (LI) general equilibrium General equilibrium theory is a branch of theoretical microeconomics. It seeks to explain production, consumption and prices in a whole economy.
General equilibrium tries to give an understanding of the whole economy using a bottom-up approach, starting with individual model of the U.S. economy to analyze the efficiency and equity effects of actual and prospective taxes. It employs more sophisticated methods than earlier computable general equilibrium Computable general equilibrium (CGE) models are a class of economic model that use actual economic data to estimate how an economy might react to changes in policy, technology or other external factors. models of tax incidence based on annual data. It reaches some different conclusions than the earlier work by the late Joseph Pechman on who bears the burden of taxes in this country. The book is comprised of nine chapters.
Chapter One is a somewhat lengthy but nonetheless crisp introduction and summary. The authors begin with a careful discussion of why LI rather than annual or life cycle income data are required for determining tax burdens. The procedure employed to calculate LI in this book requires five steps. First, from the Panel Study of Income Dynamics (PSID PSID Panel Study of Income Dynamics
PSID Panel Study on Income Dynamics
PSID Pounds per Square Inch Differential
PSID Photon Stimulated Ion Desorption
PSID Product Support Integration Directorate
PSID Private System Identification ) for the 1970-1987 period, wage functions are estimated and used to obtain wage profiles, which allows one to calculate the present value of potential LI. Individuals are then ranked by LI, and classified into twelve income groups. Second, within each LI group wage profiles are reestimated by age; also, age profiles are estimated for taxes and transfers. Third, Consumer Expenditure Survey The Consumer Expenditure Survey (CE) is a national account conducted by the Bureau of Labor Statistics of the United States Department of Labor and administered by the Census Bureau. data are used to estimate how individuals allocate consumption among specific goods and services In economics, economic output is divided into physical goods and intangible services. Consumption of goods and services is assumed to produce utility (unless the "good" is a "bad"). It is often used when referring to a Goods and Services Tax. . Fourth, a general equilibrium simulation model is constructed comprising nearly all U.S. taxes, seventeen industries (broken down by corporate and noncorporate sectors, by industry), and consumers. Each individual begins "life" with a given inheritance, a set of tax rates, wage profile, and a transfer profile. Each person plans a lifetime of labor supply, savings, demand for goods, and bequests. Industry's use of labor, capital, and intermediate inputs represent the supply side of the picture. The effects of tax changes on economic decisions are simulated through time. Welfare changes are computed using equivalent variations. Fifth, the effects of taxes are made by comparing the base case burden with that of a proportional tax Proportional Tax
An income tax that takes the same percentage of income from everyone regardless of how much (or little) an individual earns.
The US and Canada do not use this system. which raises the same revenue. The findings are that personal income taxes are moderately progressive, while sales and excise and payroll taxes are regressive. Capital taxes affect those with low and high incomes more than individuals in the middle of the income distribution. An unexpected result is that the corporate income tax is found to be regressive.
Chapter Two discusses the theoretical basis of the lifetime incidence model. Consumers have a CES utility function with a composite good In economics, demand for a good is often the focus as to a change in its price. A composite good is an abstraction used in economics that represents all consumption goods besides the one in question. that includes leisure and a composite consumption good. Consumers allocate their income across periods to maximize utility subject to a lifetime budget constraint A Budget Constraint represents the combinations of goods and services that a consumer can purchase given current prices and his income. Consumer theory uses the concepts of a budget constraint and a preference ordering to analyze consumer choices. . From the maximization process, one obtains leisure demand, labor supply and composite good demand curves. Composite good consumption is modeled as a Stone-Geary function of the (seventeen) individual consumption goods. The production side of the economy uses annual optimization. The market structure is perfectly competitive, and firms face constant returns to scale CES production functions. Income taxes are a linear function of income for each age and LI category. General equilibrium occurs when there is equilibrium in the goods and factor markets, and government spending Government spending or government expenditure consists of government purchases, which can be financed by seigniorage, taxes, or government borrowing. It is considered to be one of the major components of gross domestic product. equals revenue.
Chapter Three reviews data sources. The benchmark year for the model is 1984. Production data are primarily from the Survey of Current Business and the Economic Report of the President The Economic Report of the President is a document published by the President of the United States' Council of Economic Advisers (CEA). Released in February of each year, the report reviews what economic activity was of impact in the previous year, outlines the economic goals for . Chapter Four shows how LI is calculated. The unit of account is the individual. The PSID sample is restricted to households where the head individual and their spouse (if any) are intact from 1970-1987. Clearly this restriction leads to a biased sample A biased sample is a statistical sample of a population where some members of the population are less likely to be included than others. An extreme form of biased sampling occurs when certain members of the population are totally excluded from the sample (that is, they have zero . The wage functions estimated with the PSID sample are limited to those that earned positive wages. A Heckman correction for this possible bias was employed, but not found to be significant. An economic lifetime in the model is 60 years (age 20 through 79). Individuals have 4000 hours of time endowment per year. The net-of-tax rate of return is set at 4%. The value of leisure is assumed to equal the net wage, contrary to a long literature which shows that people value their leisure at up to one half of their wage. The average household income when two persons work is the average of the two individual incomes. The profiles calculated for each LI group are found to be more equal than profiles calculated from annual income data.
Chapter Five focuses on consumption patterns by age. Surprisingly, the data show that the share of discretionary income Discretionary Income
The amount of an individual's income available for spending after the essentials have been taken care of.
Essentials are things like food, clothing, and shelter. going to health care does not change with age. Federal data for 1986 show that health care consumption shares of total consumption expenditures rise monotonically with age .
Chapters Six and Seven calibrate To adjust or bring into balance. Scanners, CRTs and similar peripherals may require periodic adjustment. Unlike digital devices, the electronic components within these analog devices may change from their original specification. See color calibration and tweak. the parameters and models, and provide the simulations and results, respectively. Chapter Eight does sensitivity tests of the results. In the base case, the authors use a wage elasticity of labor supply of .11, based on work by Hausman. T. MaCurdy and others  have found the Hausman analysis to be overly restrictive. MaCurdy shows that the wage elasticity is not significantly different from zero. When the authors lower the wage elasticity to .03, they find that the excess burden of all taxes declines by 30%. A second (of eight) sensitivity test relaxes the minimum purchase requirement associated with the Stone-Geary model. This leads to a 50% gain in efficiency compared to the base case. If (lower income) persons do not have to buy minimum amounts of goods, the personal income tax induces a switch towards leisure; thus, labor taxes are more distortionary. The upshot is that the choice of a Stone-Geary biases the welfare burden of taxes upward. This problem is exacerbated by the misestimate mis·es·ti·mate
tr.v. mis·es·ti·mat·ed, mis·es·ti·mat·ing, mis·es·ti·mates
To estimate incorrectly.
mis·es of the wage elasticity of labor supply. Chapter Nine tests the effect of the Tax Reform Act of 1986 on the model and finds little new information. A uniform consumption or value added tax value added tax n (BRIT) → impuesto sobre el valor añadido or agregado (LAM)
value added tax n (Brit (VAT) is also tested. Interestingly, the authors find that if the VAT replaced the sales, excise, payroll, or corporate income tax, the lower income persons would be helped the most.
This book is clearly and carefully written. It represents a great deal of work, and makes numerous contributions to tax incidence analysis. By overstating the wage elasticity of labor supply, imposing the Stone-Geary functional form, and restricting the sample of consumers to intact households only, I believe the excess burden estimates are heavily biased. But this is an empirical question that the Fullerton and Rogers model can easily be altered to test. I strongly recommend this book to all students interested in determining the burden of our taxes.
Douglas M. Brown Georgetown University Georgetown University, in the Georgetown section of Washington, D.C.; Jesuit; coeducational; founded 1789 by John Carroll, chartered 1815, inc. 1844. Its law and medical schools are noteworthy, and its archives are especially rich in letters and manuscripts by and
1. Torrey, Barbara and Eva Jacobs, "More than Loose Change: Household Health Spending in the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. and Canada." Health Affairs, Spring 1993, 126-31.
2. MaCurdy, Thomas; Green, Davis and Harry Paarsch, "Assessing Empirical Approaches for Analyzing Taxes and Labor Supply." The Journal of Human Resources, Summer 1990, 415-90.