CAN THE CBO SPELL IRA?

February 7, 2007

Is the share of income of the top 1 percent in the United States high and rising?  According to an analysis by the Congressional Budget Office (CBO) it is.  But that analysis is wrong, say Alan Reynolds, senior fellow at the Cato Institute, and David R. Henderson, research fellow at the Hoover Institution.

How does the CBO get its results?  By assumption, say Reynolds and Henderson:

  • Gary Burtless of the Brookings Institution notes that the CBO, unlike the IRS Statistics of Income (SOI) division and Fed economists, does not actually look at who owns capital.
  • If your tax return shows no income from capital, then, according to the CBO, you own no capital.
  • However, a huge and growing portion of capital owners in the United States earns dividends, interest and capital gains that never show up on tax returns because it is tax-sheltered.
  • The middle class owns a much higher fraction of its wealth in tax-sheltered assets than does the top 1 percent.

Andrew Bershadker of the Treasury Department and Paul A. Smith of the Fed compared the interest, dividends and capital gains reported by taxpayers aged 50 or more in 1990 and 2002.  They found that "for all ages, the share of (taxable) income arising from assets is strikingly (as much as 36 percent) lower in the 2002 cross section than in the 1990 cross section."

In short, taxpayers are moving savings out of the grip of tax collectors.  But high-income taxpayers are not allowed to contribute to an IRA or tax-free Roth account, and their contributions to other accounts are tightly limited.  As a result, about 95 percent of the top 1 percent's assets are still potentially taxable.  And that causes the CBO's method to show an increase in wealth of the top 1 percent.

Source: Alan Reynolds and David R. Henderson, "Can the CBO spell IRA?" Wall Street Journal, February 6, 2007.

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