Consumption taxes in the initial steady state reflect two elements of the existing tax structure. First we impose an 8.8 percent tax on consumption expenditures consistent with values reported in the National Income and Product Accounts on indirect business and excise revenues. However, because contributions to both defined benefit and defined contribution pension plans receive consumption tax treatment, we levy an additional 2.5 percent tax on household consumption goods expenditures to account for the indirect taxation of labor compensation in the form of pension benefits (Auerbach 1996). This 2.5 percent tax replaces the wage tax that otherwise would apply to labor compensation in the form of fringe benefits electronic-loan.com.
Social Security, Medicare and Disability
The model has a social insurance system that incorporates social security Old-Age and Survivors Insurance (OASI), Social Security Disability Insurance (DI), and public health insurance taking the form of Medicare (Ш).
OASI benefits are calculated according to the progressive statutory bend-point formula. U.S. Social Security benefits are based on a measure of average indexed monthly earnings (АГМЕ) over a 35-year work history. The AIME is converted into a primary insurance amount (PIA) in accordance with a progressive formula. In particular, the 1996 benefit formula has two bend points. The PIA is calculated as 90 percent of the first $437 of AIME, 32 percent of the next $2,198 of AIME, and 15 percent of AIME above $2,198. We approximate the benefit formula with a sixth-order polynomial which is applied to the dollar-scaled AIME generated by the model.
This polynomial approximation is very accurate with a R2 = 0.99 (Figure 1). We achieve replacement values between 25 and 75 percent for the lifetime richest and lifetime poorest, respectively. Since approximately 50 percent of Social Security benefits are paid to survivors and spouses, we multiply benefits by a factor of two. An earmarked tax applied to wage income up to a limit of $62,700—the earnings ceiling in 1996—is used to pay for OASI benefits. Define = wjt(Ejt-ljt) as the wage income earned by the ./-type agent who is age s in year t. Also define a/65, as the average indexed annual earnings for the j-type agent age 65 at time t. Labor income earned before turning age 65 is adjusted upward by the growth rate of the economy in calculating 365 r Payroll taxes at time t—with retirement benefits modeled as negative taxes—equals
where PVB ‘(■) = Э PVB(-)/ ды and PVTf(‘) = d PVT\-)j. The net marginal tax rates under the perception linkage are shown in Figure 2 by income class and age. These tax rates are typically relatively higher for both richer and younger agents. The higher rates for richer agents reflect the progressive manner in which social security benefits are calculated. The higher rates for younger agents reflect the compound interest effect of being required to save in a social security system whose internal rate of return is less than after-tax rate of return to capital (reported below).
Notice that the net tax rates are generally quite large and positive even for the lifetime poor because the after-tax rate of return to capital is higher than the internal rates of return faced by these agents. Rich agents whose labor income exceeds the payroll tax (e.g., class 12 in select years) face a zero marginal tax rate.