Income Inequality in the United States: A Comment by demandside

IncomeInequalityintheUnitedStates: AComment∗

Thomas Piketty (ParisSchoolofEconomics)

Emmanuel Saez (UCBerkeley)

Gabriel Zucman (ParisSchoolofEconomicsandUCBerkeley)

September16,2024

Abstract

AutenandSplinter(2024)provideestimatesofincomeinequalityintheUnitedStates, startingwithincomeobservedintaxreturnsandmakingadjustmentstoaccountfor untaxedincome.Weuncoveranempiricalissueintheallocationofuntaxedincome. Thegrowingamountofpartnershipincomeexemptfromtaxation(duetoincreasingly generousﬁscaldepreciationrules)isallocatedbyAutenandSplinter(2023)nottoowners ofpartnershipsbuttoownersofsoleproprietorships,whoaremuchlessrich.Thiscreates abiasinthelevelandriseofthetop1%incomeshare.Wetracetheremainingdiﬀerence withthetop1%incomeshareofPiketty,SaezandZucman(2018)toassumptionsmade byAutenandSplinter(2024)aboutthedistributionofuntaxedbusinessincome,untaxed capitalincome,andnon-cash,notionalincome.Afterclarifyingtheseassumptionsand confrontingthemtoexistingevidence,theAutenandSplinter(2024)estimatesbecome similarinlevelandtrendtothoseofPiketty,SaezandZucman(2018).

∗ ThomasPiketty:piketty@psemail.eu;EmmanuelSaez:esaez@berkeley.edu;GabrielZucman:zucman@berkeley.edu.WethankAndyAtkeson,JohnIselin,WojciechKopczuk,MichaelLove,DanielReck,John Sabelhaus,DannyYagan,OwenZidar,andEricZwickforhelpfuldiscussionsandcomments,andGeraldAuten andDavidSplinterforhelpingusunderstandtheirmethodologyandprovidingadditionalresults.

1Introduction

AutenandSplinter(2024),henceforthAS,provideestimatesofincomeinequalityintheUnited States.FollowingPiketty,Saez,andZucman(2018),henceforthPSZ,ASstartwithincome observedintaxreturnsandmakeadjustmentstoaccountforuntaxedincome.Incontrastto PSZ,ASconcludethatthetop1%incomesharehasnotincreasedmuchsince1980.Becausethe concentrationoftaxedincomehasincreaseddramatically(anon-controversialfact),ASmust assumethatuntaxedincomehasbecomemuchmoreequallydistributedtoobtaintheirresults.1 Giventheimportanceofthequestion,clarityisneededinunderstandingwhatfeaturesofAS’s methodologydeliverthisresult.2

WebegininSection2byuncoveringaquantitativelylargeissueinAS’sallocationofuntaxed income.PartnershipsareoneofthemaintypeofprivatebusinessintheUnitedStates(see,e.g., CampbellandRobbins,2023).Abouthalfofpartnershipincomeislegallyexemptfromtaxation in2019duetogenerousdepreciationrulesinthetaxcode.AnanalysisofAS’scodereveals thatthisexcesspartnershipdepreciationisallocatedbyASnottopartnershipowners,butto ownersofsoleproprietorships,whoaremuchlessrich.Becauseexcesspartnershipdepreciation hasincreasedalotsincethelate1970s,thisleadstoabiasintheriseofthetop1%income share.3

Section3clariﬁesthecoresetofassumptionsusedbyAStodistributeuntaxedincome, usingaconceptualframeworkallowingforrigorousquantitativecomparisons.Forthemain categoriesofuntaxedincome,webackoutthesharesofuntaxedincomegoingtothetop1% inAS,confrontthesesharestoexistingevidence,contrastthemtothecorrespondingsharesin PSZ,andexplainwhatmethodologicalchoicesunderlythediﬀerences.Threemainsourcesof likelybiasintheriseofthetop1%incomeshareinASemerge.

Theﬁrstinvolvesprivatebusinessincome.Whiletaxedbusinessincomeishighlyandincreasinglyconcentrated,ASassumethatuntaxedbusinessincomeismuchmoreequallydistributed,withlittletrend.Inadditiontotheissueinvolvingpartnerships—thelargestsourceof biasinAS’smethodology—anothercontributingfactoristhetreatmentofS-corporations,the

1 Theshareofﬁscalincome(excludingcapitalgains)earnedbythetop1%hasincreasedfrom8.0%in1979 to17.6%in2019(PikettyandSaez,2003,updated).Whenincludingrealizedcapitalgains,theriseinthetop 1%shareisslightlylarger(inpercentagepoints),from10.0%in1979to21.1%in2019.

2 SaezandZucman(2020)examinedapreviousversionofAS(AutenandSplinter,2019).Thiscomment examinesthefinalpublishedversionofASandfocusesonnewissues,asthemethodologyinASdiffersmarkedly fromAutenandSplinter(2019),eventhoughthebottomlinefindingsaresimilar.

3 IselinandReck(2024),inanotherrecentcommentonASfocusingontaxevasion,alsomentionsthisand note(footnote8,p.8):“ThisissuewaspointedouttousbyGabrielZucmanwhenweapproachedhimwith somequestionsaboutthemethodsinPSZforthiscomment.”Ourcommentzoomsinonthisissue.

othermaintypeofprivatebusinessintheUnitedStates.ASallocatethegrowingamountofScorporationuntaxedincometotheownersofC-corporations,whoarelessrichasC-corporations canbeownedbypensionfunds.Thetreatmentofuntaxedprivatebusinessincomeexplains 40%oftheASvs.PSZdivergenceintheriseofthetop1%pre-taxincomesharebetween1979 and2019.4

Second,ASmakequestionableassumptionstoallocateuntaxedcapitalincome.Tax-exempt investmentincomeearnedinretirementaccountsisallocatedbyAStofundedand unfunded pensionwealth,eventhoughunfundedpensionplansbydeﬁnitionhavenoassets.Corporate retainedearningsareprimarilyallocatedbyAStopeoplereportingdividendincome,even thoughhigh-dividend-payingcorporations,everythingelseequal,havelowretainedearnings. Thesechoicesexplain20%ofthediﬀerencewithPSZ,whobasetheirallocationofuntaxed capitalincomeonwealthdistributionsreconciledacrossmultiplesources.

Last,ASallocatenon-cash,notionalincomecomponentsinwaysthatreducetheleveland riseininequality.InAS,publicgoodsexpendituresareallocatedlikealargeuniversalbasic incomeequalto9%ofnationalincome—essentiallyerasingpoverty—andthegovernmentdeficit istreatedlikeaprogressivetax.Otherinequalitystudies(includingPSZ)leavethesenon-cash componentsoutofthepicture,i.e.,assumetheydonotaffectinequality.InAS,regressive consumptiontaxesareassumedtoboostthepre-taxincomesofthepoor,withoutaffecting theirpost-taxincome.InPSZ,followingthestandardunderstandingofconsumptiontaxes, thesetaxesdonotaffectpre-taxincomesbutreducethepost-taxincomeofthepoor.The treatmentofnon-cash,notionalincomeexplainsmostoftheremainingdifferencewithPSZ.

2ExcessFiscalDepreciationandItsDistribution

2.1TheSizeofExcessFiscalDepreciation

ToestimatetheeconomicincomeofbusinessesintheNationalIncomeandProductAccounts, theBureauofEconomicAnalysis(BEA)startswiththetaxreturnsofthesebusinessesand makesadjustmentstoconverttaxableincomeintoeconomicincome.Theseadjustmentsare necessarytoprovideaconsistentmeasureofaggregateincomethatisnotaﬀectedbychanges inthetaxlaw.Akeyadjustmentistheadjustmentfordepreciation.BEAreplacesthedepreciationreportedbybusinessesintheirtaxreturnsbyitsestimateoftheirtrueeconomic depreciation.Thisadjustmentisparticularlylargefornon-corporatebusinesses(partnerships

4 Diﬀerencesintheallocationofbusinessincometaxevasionexplainanadditional10%andarelessimportant for1979–2019trendsthaninearlierversionsofAS.IselinandReck(2024)analyzethisissueindetail.

andsoleproprietorships),whichdeducted $642billionindepreciationandamortizationfortax purposesin2019,buthadonly $278billionineconomicdepreciation.Partnershipsandsole proprietorshipsthushad $642– $278= $364billioninexcessﬁscaldepreciation,theequivalent of2.1%ofnationalincome.5

AlthoughBEAlumpstogetherpartnershipsandsoleproprietorshipsinmostofitsseries,it turnsoutthatcombiningBEAlineswithvariousIRSaggregates(whichunderlieBEA’stotals) allowstoseparatetheexcessdepreciationofpartnershipsfromthatofsoleproprietorships,to within1%accuracy.Table1detailsthiscomputationfortheyear2019.Slightlymorethan 100%ofthetotalexcessfiscaldepreciationofnon-corporatebusinessesturnsouttocomefrom partnerships.Specifically,excessfiscaldepreciationamountedto $411billionin2019(2.4%of nationalincome)forpartnerships,whileitwasslightlynegative(-0.3%ofnationalincome)for soleproprietorships.AppendixAprovidescompletedetails.

Theexcessfiscaldepreciationofpartnershipsisprimarilyduetorulesinthetaxcodeallowing businessestodepreciateassetsquicklyandbroadly,suchasthefullexpensingofmachineryand equipment(100%depreciationinyear1),accelerateddepreciationrulesintheoilandgas industry(wherepartnershipsareover-represented),relativelyfastdepreciationofrealestate, andgenerousamortizationrules(allowingbusinesses,e.g.,towriteoffcontractsandgoodwill). AppendixBprovidescasestudiesandquantifiesthemainsourcesofpartnershipdepreciation. Abouthalfoftheexcessfiscaldepreciationofpartnershipsowestofullexpensingprovisionsin 2019.

Forsoleproprietorships,depreciationintaxreturnsisslightlylowerthaneconomicdepreciationbecausedepreciationofresidentialrealestateusedbysoleproprietors(forbusiness useofone’shome)isstrictlylimitedinthetaxcode.6 Moreover,incontrasttopartnerships, soleproprietorshipsmakelittleinvestmentsinnonresidentialﬁxedassetsandthusbeneﬁtonly marginallyfromfullexpensingprovisions.

Theexcessfiscaldepreciationofpartnershipshassharplyincreasedovertime.Asshown byFigure1,itwasnegligiblein1980andthenrosetoreachabout2.5%ofnationalincomein recentyears.Thisrisereflectsboththeriseofpartnershipsasaformofbusinessorganization andtheincreasinggenerosityoftherulesgoverningfiscaldepreciation.BeforetheTaxReform

5 Unlessotherwisenoted,inthiscommentbynationalincomewemeanfactor-pricenationalincome,i.e., nationalincomeexcludingsalesandexcisetaxesnetofsubsidies.In2019,market-pricenationalincomewas $18.3trillionandfactor-pricenationalincomewas $17.4trillion.

6 In2019,soleproprietorsdeductedonly $1.2billionindepreciationforthebusinessuseoftheirhome(Form 8829ﬁledbyindividuals,line42),whenBEAestimatesthatthenetstockofresidentialrealestateusedbysole proprietorshipswas $1,920billion.

Actof1986mostlargeprivatebusinesseswereorganizedasC-corporations;partnershipsand S-corporationsthengrewinimportance.Thiscausedariseintheamountofassetsownedby partnerships,includingassetsforwhichdepreciationisfasterinthetaxcodethaninthenational accounts.Inaddition,fiscaldepreciationbecamemoregenerouswiththegradualtransitionof theUStaxsystemtofullexpensingandchangestoamortizationrules.7 Incontrast,excess fiscaldepreciationforsoleproprietorshipshasremainedslightlynegativethroughouttheperiod. Before1980,excessfiscaldepreciationwasnegligibleforbothtypesofbusinesses.

2.2TheASTreatmentofExcessFiscalDepreciation

Theownershipofpartnershipsishighlyconcentrated.Anaccurateallocationofthelarge amountofpartnerships’excessﬁscaldepreciationisthuscriticaltoobtainanaccurateestimate ofthelevelandriseofthetop1%incomeshare.

AnanalysisofAS’spubliclyavailablecoderevealsthatASallocatethisexcesspartnership depreciationnottopartnershipowners,buttoownersofsoleproprietorships,whoaremuch lessrich.TherelevantlinesofcodeinASarethefollowing: if(&yr>1980)and(tPropDepr>0)thendo;

UNDER=UNDER+0.85*PropExpn

+(1000000*\&\&nfcc\&yr-0.85*totexp)*(PropDepr/tPropDepr) +1000000*\&\&nfres\&yr*(pPARTSCP+pBUSN)/(ppartscptot+ptotbusn);

TheselinesaddtoAS’sestimatesofunderreportedincome(UNDER,moreonthisinsection3.1 below)theexcessﬁscaldepreciationofpartnershipsandsoleproprietorships(nfcc)andthe residualamountofuntaxedincomeearnedbythesebusinesses(nfres).

Theexcessfiscaldepreciationofpartnershipsandsoleproprietorships($381billionintotal in2019inAS’scode)isallocatedintwosteps.ASfirstconsideraspecificformoffiscal depreciation,knownasSection179expensing(PropExpn, $45billionin2019),whichcanbe directlyobservedintaxreturns.8 Theyallocate85%ofthisexpensingdirectlytotheindividuals

7 Bonusdepreciationrulesinforcein2001–2004and2008–2017allowedbusinessestodeductfromtaxable incomealargepercentageofthecostofinvestmentstheyeartheymadetheseinvestments.In2018,theTax CutandJobsActdoubledthebonusdepreciationdeductionfrom50%in2017to100%.In2004,theAmerican JobsCreationActallowedsportsteamstoamortizetheirintangibleassets.

8 Section179expensingrepresentsonlyasmallfractionofexcessdepreciationmadebypassthroughbusinesses becauseitiscappedat $1million(pertaxreturnandperbusinessin2018withinﬂationadjustmentsin subsequentyears)andappliesonlytobusinessesthatinvestlessthan $3.5millioninequipmentintheyear (againin2018),sothatlargepartnershipsandS-corporations,wheremostinvestmentisconcentrated,donot qualify.Outofthe $45billioninSection179expensingclaimedin2019,lessthan $7billionwasfrompartnerships.

claimingtheseexpenses,whichisavalidapproach.About90%ofexcessdepreciation($381 0 85 × $45= $343billion)isthenallocatedproportionallytodepreciationdeductionsreported bysoleproprietorshipsonly(PropDepr),suchasUberorLyftdrivers.Thisapproachisinvalid, sincethisexcessdepreciationcomesfrompartnerships,notsoleproprietorships(Figure1).

AnalyzinganearlierversionofAS(AutenandSplinter,2019),SaezandZucman(2020) highlightedthetreatmentofexcessdepreciationasakeysourceofdiscrepancywithPSZand pointedamethodologicalissue.“InAutenandSplinter(2019),businessprofitsearnedbythetop 1%butnottaxable(dueinparticulartogenerousdepreciationrules)areclassifiedastaxevasion; taxevasionisthenallocatedtothebottom99%basedonanerroneousreadingofrandomaudit data”(abstract).Inresponse,ASrevisedtheirmethodologytoallocateexcessdepreciation separatelyfromtaxevasion.However,asshownabovetheyallocateexcessdepreciationtosole proprietors,nottopartnershipowners.InbothASandAutenandSplinter(2019),onlyabout 10%–15%ofexcessfiscaldepreciationthusendsupbeingallocatedtothetop1%,explaining whythebottomlinefindingsaresimilarinthetwoversions.Inbothcases,toolittleexcess depreciationisallocatedtothetop1%,albeitfordifferentreasons.

2.3WhoEarnsExcessFiscalDepreciation?

Partnershipsare“pass-through”entities,whoseprofitsandlossesflowtopartnersandare subjecttotaxationatthepartnerlevel.Theownershipofpartnershipsisdramaticallymore concentratedthanthatofsoleproprietorships.Thetop1%ofthefiscalincomedistribution earnsabout60%–70%ofpartnershipincomeasopposedtoabout15%ofsoleproprietorship incomeinrecentyears.

Ideally,partnershipexcessdepreciationshouldbeallocatedtotheultimateindividualowners ofthecorrespondingpartnerships.Inpractice,itisnotpossibletofullytracetheultimateownershipofpartnerships,whichcanbeownednotonlybyindividualsbutalsobycorporations(the shareholdersofwhichmightnotbeknown),trusts,non-proﬁts,andnon-residents,sometimes throughcomplexholdingchains(Cooperetal.,2016).Becauseabout70%oftotalpartnership incomeisdirectlyobservableinindividualincometaxreturns,andthisincomeﬂagspartnershipownership,anaturalstartingpointinvolvesallocatingexcessdepreciationproportionally topartnershipincomeobservedinindividualtaxreturns.PSZfollowthisapproach.

Apotentialconcernwiththisapproachisthatthepartnershipsthathaveexcessdepreciation maybediﬀerentfromthepartnershipsthatgenerateincomeobservableinindividualtaxreturns. Forexample,lawpartnershipsmayhavelittleexcessdepreciationbutmayconstitutemostof

thepartnershipincomeearnedbyindividuals,whilebycontrastheavy-industrypartnerships mayhavethelion’sshareofexcessdepreciationandmaybejointventuresamongpublicly listedcorporations,whicharemoreequallyheldthanlawpartnerships.

TounderstandwhetherthisconcernislikelytobiasthePSZmethodology,oneneedsto examineitmoreclosely.PSZallocateexcessfiscaldepreciation(likeotherformsofuntaxed partnershipincome)firsttoindividualsreportingpartnershiplossessoastofullyoffsetthese losses,andthen,ifanyuntaxedincomeremainstobeallocated,proportionallytopartnership profits.9 AsshownbyAppendixFigureA1,servicesectorpartnership(likelawfirms)make littlelosses.Partnershipsincapital-intensivesectors,bycontrast,accountforthebulkoflosses andalsoforthebulkofdepreciation—whichislogicalsincedepreciationrequiresassetsand reducesincome.Theallocationofuntaxedincometopeoplereportinglossestargetsowners ofcapital-intensivefirmsthatarelikelytohaveexcessdepreciation.Moreover,becauselosses observableinindividualtaxreturnsaccountforabout70%oftotalpartnershiplosses(asdetailed inAppendixC.2),thedistributionoflossesreportedbyindividualsislikelytobeinformative ofthedistributionofallpartnershiplosses.

Toquantifythepotentialmarginoferrorinvolved,wecanrelaxtheassumptionsmadeby PSZ.First,wecanchangetheweightputonlosses.InPSZ, $1ofreportedlossisassumedto reﬂect $1ofuntaxedincomesuchasexcessdepreciation.Thisleadstoallocatingabouthalfof untaxedpartnershipincometoindividualsreportinglosses(aslossesrepresenttheequivalent ofabouthalfoftheamountofuntaxedincome)attheendoftheperiod.

Assumenowthat $1ofreportedlossreflects $a oftrueeconomiclossand$1 a ofuntaxed income.Figure2considersvaluesrangingfrom a =1(reportedlossesareallreallossesand havenoassociateduntaxedincome)to a = 1(a $1millionreportedlossinfactcorrespondsto $1millioninrealprofitand $2millioninuntaxedincome).Inthe a = 1scenario,alluntaxed incomeisdefactoallocatedtoindividualsreportinglossesinrecentyears.Anegligibleamount goestopartnersinskill-intensiveindustrieslikelawfirmsthathavehighprofitsbutlittlelosses. Itturnsoutthatbecausebothpartnershipprofitsandlossesarehighlyconcentratedatthetop oftheincomedistribution,theeffectismodestrelativetothe a =0assumption(a $1million losscorrespondsto $1millioninuntaxedincome)usedbyPSZ.

Second,Figure2considersscenariosaboutwhoearnsthe30%ofpartnershipproﬁtand lossesnotdirectlyobservableinindividualtaxreturns.ThePSZmethodologyassumesthat theunderlyinguntaxedincomeisdistributedliketheuntaxedincomeofpartnershipsdirectly 9 AppendixC.1providesadditionaldiscussionofthetreatmentoflossesinPSZ.

heldbyindividuals.Cooperetal.(2016)documentthatin2011,68%ofnetordinarybusiness incomedistributedbypartnershipsdirectlywenttoindividuals,9%toS-corporations,5%to C-corporations,4%toestatesandtrusts,2%toforeignpartners,1%totax-exemptinvestors, and11%tounidentifiedpartners.10 Love(2021)showsthattheseunidentifiedpartnersare mostlyforeigncorporationsintaxhavens,whichinturnmaybeownedbyUSpensionfunds andothernonprofits(e.g.,investinginhedgefundsthroughoffshoreblockers),USindividuals, andforeigners.Informedbythisevidence,weconsideralow-endscenariowhere30%ofall untaxedpartnershipincomegoestobroadfinancialwealth(includingpensionwealthandthe wealthofnonprofits),andanintermediatescenariowhere15%goestobroadfinancialwealth and15%ultimatelytoindividualpartners.11 Inallcases,55%to72%ofpartnershipexcess depreciationgoestothetop1%in2019—asopposedto65%inPSZandonly11%inAS.

3UntaxedIncomeanditsDistribution

Supposethat y isfiscalincomeand z = y + s isabroadernotionofincome,with s being incomenotincludedinfiscalincome,suchasunderreportedincome(taxevasion)orexcess fiscaldepreciation.Howdoesadding s affectthetop1%incomeshare?

Let Z,Y,S bethemacroeconomicaggregatesof z,y,s with Z = Y + S>Y .Let sh(y)be theshareof y goingtothetop1% y-incomeearnersand sh(z)betheshareof z goingtothetop 1% z-incomeearners.Let sy betheshareof s incomegoingtothetop1% y-incomeearners,and sz betheshareof s incomegoingtothetop1% z-incomeearners.Naturally, sz >sy ,andthere isoftenadebateonwhether sz or sy isthemostmeaningfulstatisticforunderstandinghow s aﬀectsincomeconcentration.AsdetailedinAppendixD.1,neitheris.Therelevantstatistics istheshare ss oftheextraincome S thatgoestothetop1%deﬁnedas:

10 E.g.,3.4%ofallincomedistributedbypartnershipswaspaidtoS-corporations(Cooperetal.,2016,Figure 3B);73%oftheincomepaidtoS-corporationswasordinarybusinessincome(Cooperetal.,2016,Figure8B); hence2.5%ofthe $895billioninincomedistributedbypartnerships(atotalwhichincludesinterest,dividends, etc.)wasordinarybusinessincomepaidtoS-corporations.Thisrepresents $22billion,or9%ofthetotalamount ofordinarybusinessincomedistributedbypartnershipsthatyear.

11 ThisintermediatescenarioismotivatedbythefactthatinCooperetal.(2016),13%ofpartnershipbusiness incomegoestoS-corporationsandtrusts,andthusultimatelytoindividualpartners.Ahigh-endscenariowould allocate15%ofuntaxedpartnershipincometoindividualownersoftaxhavenassets(insteadofbroadﬁnancial wealth),inlightoftheanalysisofFATCAreportsinJohannesenetal.(2024)showingthatalargeamount oftaxhavenwealthisownedbyUSindividuals,andthatthiswealthisextremelyconcentrated.Notethat becausetheshareofpartnershipbusinessincomeultimatelygoingtoforeignersislikelytobesmall,andbecause allocatingaportiontoforeignerswouldrequireoﬀsettingadjustmentstokeepmatchingUSnationalincome,all scenariosassumethatexcessdepreciationultimatelygoingtoforeignerscanbeneglected.

Thatis,whenmovingfrom y-incometo z-income,top1%incomes—afterre-ranking— increaseby ss S.Inparticular, s incomeincreasesconcentration—i.e. sh(z) >sh(y)—if andonlyif ss >sh(y).WeshowinappendixD.1that sy <ss <sz .

ThissectionusesthepubliclyavailableASExcelﬁlestocompute ss forthemaincategoriesof untaxedincome,confronttheresultstoexistingevidence,comparethemtothecorresponding ss inthePSZmethodology,andclarifythemethodologicalchoicesthatliebehindthediﬀerence. Thediscussionisorganizedaroundthethreemainsourcesofuntaxedincome:(i)untaxed businessincome;(ii)untaxedcapitalincome;and(iii)non-cash,notionalincome.12

3.1UntaxedBusinessIncome

Natureandsize. Considerﬁrstbusinessincome,deﬁnedastheincomeofpass-throughbusinesses:partnerships,soleproprietorships,andS-corporations.Thereisalargegapbetweenthe amountofbusinessincomereportedintaxreturnsandtheeconomicincomeofthesebusinesses asrecordedinthenationalaccounts.AsshownbyFigure3,untaxedbusinessincomeamounts tocloseto7%ofnationalincomein2019.Abouthalfofthisuntaxedincomecorrespondsto legally-exemptincome,whichinturnisalmostentirelyduetoexcessdepreciation.Theother halfcorrespondstotaxevasion.

Taxedbusinessincomeishighlyconcentrated,anditsconcentrationhassharplyincreased sincethe1960s.Incontrast,ASassumethatuntaxedbusinessincomeisveryequallydistributed, withlittletrend(Figure4).Theobservableincomeofcardealerships,plumbersandpainters, doctorsanddentists,retailchains,realestatefirms,oilandgaspartnerships,lawfirms,etc.,is highlyandincreasinglyconcentrated—buttheiruntaxedincomeisassumedbyAStobemuch moreequallydistributedwithalmostnotrend.Thisflatconcentrationcomesprimarilyfrom AS’streatmentoflegally-exemptincome.

Distributionoflegally-exemptincome.

Aswehaveseen,ASallocatetheexcessdepreciationofpartnershipsnottoownersofpartnershipsbuttoownersofsoleproprietorships.Asimilar issuearisesintheirallocationofthelegally-exemptincomeofS-corporations.ThisuntaxedincomeisallocatedbyASnottoownersofS-corporations,buttoownersofC-corporations,who

12 ThisﬂeshesouttheargumentmadeinPiketty,Saez,andZucman(2019)thatthe(earlier)ASresults (AutenandSplinter,2019)canonlybeexplainedbyunrealisticassumptionsonuntaxedincome.Relativeto thisearlierwork,themaincontributionofthissectionistoconductarigorouscomparisonofthedistribution ofuntaxedincomecomponentbycomponent,totraceouttheunrealisticnatureofAS’sassumptionstospeciﬁc methodologicalchoices,andtotakestockoftheupdatesmadebyASrelativetoAutenandSplinter(2019).Our comparisonwithPSZalsousestheupdatedPSZmethodology,revisedinSaezandZucman(2020).

arelessrichduetotheownershipofC-corporationsbypensionfunds.13

Ideally,onewouldmatchallS-corporationstotheirowners,identifyuntaxedbusinessincome inS-corporationtaxreturns,andapportionittothecorrespondingshareholders.Inpractice thistaskismadedifficultbythefactthatkeyformsofuntaxedincomecannotbeidentifiedin S-corporationtaxreturns,suchascertaindifferencesbetweenfiscalandeconomicdepreciation. PSZuseasimplifiedmethodologythatallocatesuntaxedS-corporationincomefirsttoerase reportedS-corporationlosses,thenproportionallytoS-corporationprofits.Thisisthesame approachastheoneusedforpartnerships,withtheaddedadvantagethatS-corporationsare allownedbyindividuals.

Overall,afraction ss =62%ofuntaxedpartnershipandS-corporationincomegoestothetop 1%inthePSZmethodologyin2019,asopposedto ss =16%inAS.Becausethelegally-exempt incomeofpartnershipsandS-corporationsaddsupto3.5%ofnationalincomein2019,theAS approachunderestimatesthetop1%incomeshareby1.6pointrelativetothatbenchmark.14

ThebiasinASisnotonlyinlevelbutalsointrend:itismaximalin2019andnegligible beforethe1980s,duetothecombinationoftwofactors.First,exemptpartnershipandScorporationincomewassmallbeforethe1980sandhasgrownregularlysincethen.Second,in contrasttopassthroughs,theuntaxedincomeofC-corporationsis—likeinPSZ—allocatedby AStotheownersofC-corporations,proxiedinvariousways.Thisillustratesamethodological problemattheheartofthecontroversyontheevolutionofUSinequality.Toobtainconsistent measuresofinequality,privatebusinessesincome(amajorsourceofincomefortherichas shownbySmithetal.,2019)shouldbetreatedconsistentlyovertime.Inequalityshouldnot changesimplybecauseabusinesschoosestofileadifferenttaxform.Yetthisiswhathappens intheASmethodology.WhenaprivatebusinessfilesasaC-corporation(aswasthenormuntil themid-1980s),untaxedincome—unreportedorlegallyexempt—isallocatedprimarilytothe topofthedistribution,proportionallytoreportedpositiveincome(proxiedbydividendsand capitalgains).Whenthesamebusinessfilesasapass-throughentity(whichisincreasinglythe casesincethe1980s),untaxedincomeisallocatedbyASprimarilytothebottom.Inequality falls,eventhoughnothingrealhaschangedintheeconomy.15

13 AS(OnlineAppendix,footnote39p.21)acknowledgethisissueforS-corporations,donottakeitinto accountintheirmethodology,andclaimthatitislikelysmall.

14 ThePSZmethodology,ifanything,maybetooconservative.AccordingtopubliclyavailableSOItabulations ofS-corporationstaxreturns,depreciationclaimedbyS-corporationsismoreconcentratedthanS-corporation income:in2019,50%ofdepreciationdeductionswereclaimedbyS-corporationswithmorethan $10millionin assets,whichearned32%ofordinarybusinessincomes.

15 InPSZ,bycontrast,thetreatmentofprivatebusinessesisconsistent.Nomatterthetaxformﬁledbythese business,lossesareﬁrstsettozeroandtheremaininguntaxedincome(whetheritislegally-exemptincomeor

Distributionoftaxevasion. Tomeasurenationalincome,BEAmakesanallowancefor underreportedbusinessincome,basedonIRSrandomauditstudies.Amethodologicaladvance claimedbyASinvolvestheuseoftheseIRSstudiestoallocateunderreportedincome.

ASdonotpublishtheirdistributionofunderreportedincome,butthroughcommunications withthemwewereabletoobtainit.Only16%ofunderreportedincomeisallocatedbyAS tothetop1%taxunits(rankedbycorrectedadjustedgrossincome)in2019.Usingthesame IRSauditstudies,thecanonicalstudyofthedistributionoftaxevasionintheUnitedStates ﬁndsthatthetop1%taxunits(alsorankedbycorrectedAGI)earned27%ofunderreported incomein2001(JohnsandSlemrod,2010,Table5),vs.19%inASthatsameyear.This diﬀerenceisobscuredinAS,whowrite(p.2199)thattheir“...methodproducesresultssimilar toNRP-basedestimatesofthedistributionofunderreportinginJohnsandSlemrod(2010)...”.

Whydothetwostudies,usingtheexactsamedata,diﬀer?TheIRSestimatesunderreported incomeintwosteps.Someevasionisﬁrstdetectedinrandomaudits,which,afterbeingscaled topopulation,isthenmultipliedbyafactorofabout3toaccountforundetectedevasion.Johns andSlemrod(2010)usetheIRS’sownmethodologytodistributeundetectedevasion.Auten andSplinterdiscardtheIRSmethodology,towhichtheypreferamethodologydesignedby AutenandSplinter(2021).Inthatapproach,alargershareofundetectedevasionisallocated tothebottomofthedistribution.16

Therearetwomainreasonswhysomeevasionfailstobedetectedinrandomaudits.First, someunreportedincomeisgenuinelydiﬃculttodetect,suchasincomeearnedincash,income earnedoﬀshore,orincomeconcealedthroughsophisticatedschemes.Second,somecategories ofincomearenotcomprehensivelyexaminedinthecontextofIRSrandomaudits.Crucially, incomefrommid-orlarge-sizeS-corporationsandpartnershipsisessentiallynotexamined, becauseexaminingthesebusinesses(whichcanoperateinmultiplestatesorcountries)would requiremuchmoreresourcesthanavailabletotheIRSinthecontextofitsrandomaudit program.Incomeearnedbyrelativelylow-incomeindividualsiscomprehensivelyexamined,but alargeandgrowingfractionofthetaxableincomeoftopearnersisnot(Guytonetal.,2023).

Ideally,onewouldusedirectinformationonundetectedevasiontoallocateittoindividuals.Guytonetal.(2023)marshaltheavailableevidenceonthisissue,includinginformation generatedbyIRSenforcementactivitiesandapilotrandomauditprogramofS-corporations. IselinandReck(2024)discusstheimplicationsofthisevidencefortheASvs.PSZcontroversy. taxevasion)isallocatedproportionallytoreportedpositiveincome.

16 AutenandSplinter(2019)usedtorelyonJohnsandSlemrod(2010)toallocateunreportedincomebut switchedtotheirnewmethodinAS.

Arguably,thedistributionofundetectedtaxevasionisinherentlyuncertainandmoreresearch isneededonthisissue.Inthemeantime,theliteraturesuggestsallocatingunreportedincome inaneutralmanner,i.e.,proportionallytoreportedincomecomponentbycomponent.This isthepatternobtainedbyJohnsandSlemrod(2010)usingthestandardIRSmethodology,by Galeetal.(2023)usingtheSurveyofConsumerFinances,andtheapproachfavoredbyIselin andReck(2024).17 ItisalsotheoneusedbyPSZ.18 Relativetothisneutralallocation,AS’s methodologydepressestheriseofthetop1%incomesharebyabout0.4percentagepointsover the1979–2019period.

3.2UntaxedCapitalIncome

Thesecondmainsourceofuntaxedincomeiscapitalincome.Wedeﬁnecapitalincometoinclude allincomederivingfromtheownershipofassets,excludingpassthroughbusinessincome(already discussedabove).Taxedcapitalincomeincludestaxableinterest,dividends,rents,andtrust andestateincomereportedinindividualincometaxreturns.Untaxedcapitalincomeincludes corporateretainedearnings,investmentincomeearnedintax-exemptpensionaccounts,untaxed rents,tax-exemptinterest,andincomeretainedintrusts.Thebulkofcapitalincomeisuntaxed: about70%-75%inthe1960s-1970s,risingto85%inthe2010s.

Taxedcapitalincomeishighlyconcentrated,anditsconcentrationhasincreaseddramatically sincethe1980s.The1%adultindividualsatthetopoftheﬁscalincomedistributionearn45% oftaxedcapitalincomein2019vs.22%in1979.AccordingtoAS,however,therehasbeen anequalizationofuntaxedcapitalincome:thetop1%earnsonly ss =16%ofuntaxedcapital incomein2019vs.21%in1979(AppendixFigureA2).Becausethebulkofcapitalincomeis untaxed,andbecauseASassumethatuntaxedcapitalincomeisincreasinglyequallydistributed, therehasbeen,accordingtoAS,asigniﬁcantequalizationofcapitalincomesincethe1960s. Thetop1%earnsonlyabout20%oftotalcapitalincomein2019vs.closeto30%inthe1960s (AppendixFigureA3).TheUnitedStateshasachievedaremarkabledegreeofcapitalequality inaninternationalandhistoricalperspective.19

17 JohnsandSlemrod(2010,Table4,col.4and5)showthattheratioofunreportedtotruebusinessincomeis constantacrosstheincomedistribution,componentbycomponent.Gale,SabelhausandThorpe(2023)notethat aproportionaladjustmentbringsSCFbusinessincomesintobetteralignmentwithIRSdata.IselinandReck (2024)favoramacroapproachwithunreportedincomeallocatedproportionallytoreportedpositiveincome, componentbycomponent.

18 InPSZ,unreportedincomeisallocatedatthemicrolevelproportionallytoreportedincome,firsttooffset lossesandthenproportionallytoreportedpositiveincome(seeAppendixC.1).Relativetothemacroapproach favoredbyIselinandReck(2024)thismicroapproachhasaleveleffectbutonlyaverysmalleffectontrends (IselinandReck,2024,Figure2).

19 AsshownbyAppendixFigureA3,thispatternisatoddswiththesharpincreaseintheconcentrationof

ThissurprisingresultcanbetracedtospeciﬁcassumptionsmadebyASaboutinvestment incomeearnedinretirementaccountsandcorporateretainedearnings,detailedinAppendixE.

First,ASarelikelytounder-estimatetheshareofpensionincomeearnedbythetop1% in2019anditsrise,becauseinvestmentincomeearnedinretirementaccountsisallocatedby ASproportionallytofundedand unfunded pensionwealth.Unfundedpensions,however,by definitionhavenoassets—theyaresimplypromisesoffuturepensionbenefits.Thebeneficiaries oftheseunfundedpromisesarealmostentirelystateandlocalgovernmentworkers,whoarein thebottom99%oftheincomedistribution.Bycontrast,PSZallocateinvestmentincomeearned inretirementaccountstoownersoffundedpensionwealthonly.

Second,forequitiesdirectlyheld,ASallocatethree-quartersofretainedearningsproportionallytodividendsandonlyone-quarterproportionallytorealizedcapitalgains.Thisassumption islogicallyinconsistent,sinceownersofﬁrmswithrelativelyhighretainedearningsreceive relativelylittledividends.Italsoappearstohavenoparticularempiricalbasis.

Ideally,onewouldallocateretainedearningsbylinkingC-corporationstotheirshareholders. ThisisgenerallynotpossibleintheUnitedStates,however,evenwithinternaladministrative data.Thenext-bestapproachinvolvesusingtheavailableevidenceonthedistributionofequity wealth.Abodyofworkdocumentstheevolutionandcompositionoftopwealthshares,using multiplesources(householdsurveys,estatetaxreturns,namedlistsofwealthyindividuals).

PSZbasetheirallocationofretainedearningsonequitywealthseriesreconciledwiththese sources,whileASimputeretainedearningswithoutreferencetowealth.20

3.3Non-CashNotionalIncome

Nationalincomeconventionallyincludesanumberofnon-cash,notionalcomponents,whichAS allocateinawaythatreducesinequalityanditsrise,mostlyduetoconceptualissues.

Consumptiontaxes:Factor-pricevs.market-pricenationalincome. Market-price nationalincome(ornationalincomeinbrief)isthesumoffactor-pricenationalincome(income wealthseeninallavailabledatasources.

20 InPSZ,equitywealthisfirstestimatedusingincometaxdata(50%basedondividendsand50%basedona smoothedmeasureofrealizedcapitalgains),andthencross-checkedagainstandreconciledwithexternalsources. Specifically,theequitywealthofthetop400richestindividuals,whichcannotbecapturedaccuratelyusingtax dataonly(duetorelativelylowdividendyieldsattheverytopandlimitedcapitalgainsrealization,seeSaezand Zucman,2022)isupgradedtomatchdatafromtheForbes400ranking(based,e.g.,onmandatorydisclosures totheSecurityandExchangeCommission).Retainedearningsarethenallocatedproportionallytoreconciled equitywealth.Thismakesitpossibletoallocateameaningfulamountofretainedearningstolargeownersof non-dividendpayingfirms(suchasAmazon’sJeffBezos,Facebook’sMarkZuckerberg,BerkshireHathaway’s WarrenBuffett,Alphabet’sSergeyBrinandLarryPagein2019)whoareotherwiseassignedtoolittleincome.

paidtoworkersandcapitalowners)andtaxesonproducts(mostlysalesandexcisetaxes). Factor-pricenationalincomemeasuresincomeatpre-taxprices(i.e.,pricesbeforeconsumption taxes),whilenationalincomemeasuresincomeatpost-taxprices(inclusiveofconsumption taxes).PSZdistributefactor-pricenationalincomeandscaleincomesupuniformlytogetto pre-taxnationalincome:consumptiontaxesareneutralonapre-taxbasis.ASinsteadadd consumptiontaxestothecorrespondingconsumerswhencalculatingpre-taxnationalincome. Asconsumptiontaxesareregressive,theASallocationofproducttaxesreducesthelevelofthe top1%pre-taxincomeshare(by0.8percentagepointin2019)anditsrise(by0.5percentage pointoverthe1979–2019period).21

Tounderstandtheconceptualissuehere,consideranecessitysuchasbreadthatabsorbsa highershareofincomeforthepoorthanfortherich.Factor-pricenationalincomedoesnot changewhenataxonbreadisintroduced.Butbecausethebreadpriceincreasecausedby thetaxpushesuptheoverallpriceindex,market-pricenationalincomeincreases.InAS,the pre-taxincomeofthepoorisinﬂatedbytheamountofthebreadtaxtheypay.Thebreadtax “enriches”thepoor,eveniftheydonothaveanypre-taxincometostartwith.InPSZ,the breadtaxdoesnotaﬀectthedistributionofpre-taxincome,consistentwiththeliterature.22

Whencomputingpost-taxinequality,ASsubtracttheimputedbreadtax.Sincewhatis subtractediswhattheyaddedtocomputepre-taxincome,whetherthetaxonbreadishigh orlowmakesnodiﬀerencetothepost-taxincomeofthepoor.Bycontrast,PSZstartfrom factor-pricenationalincome,addtransfers,andsubtractalltaxespaid—includingconsumption taxes—sothataregressivebreadtaxworsenspost-taxinequality.23

Governmentdeficit. Post-taxnationalincomealsoincludesthegovernmentdeficitasnegativeincome,eventhoughnobodypaysforthisdeficitoutoftheircurrentincome.InASthe governmentdeficitisallocatedwitharelativelyhighweightontherich,proportionallytofederalincometaxandpayrolltaxpayments.Thisshavesoff0.6percentagepointsintheriseof thetop1%post-taxincomesharesince1960(ASTable2),becausethegovernmentdeficitis muchhigherin2019thanin1960or1979.

Inreality,onlythefuturewilltellwhethergovernmentdebtcreatedbythedeﬁcitwillbe paidthroughinﬂation,reducedgovernmentspending,orincreasedtaxesonthepoorvs.the

21 ThisissuewaspointedinSaezandZucman(2020,pp.30-31)butisignoredbyAS.Itbiasesthedistribution ofbothpre-taxandpost-taxnationalincome.

22 Forinstance,inofficialCongressionalBudgetOffice(2024)estimates,indirecttaxes(i.e.,federalexcisetaxes inthecontextofCBO’sanalysiswhichfocusesonfederaltaxes)donotaffectthedistributionofpre-taxincome, butincreasetheconcentrationofpost-taxincome(asinPSZ).

23 Foraformal,detaileddiscussionofhowtotreatproducttaxes,seeSaezandZucman(2023,AppendixA.4).

rich—affectingthedistributionofpost-taxincomeatthatfuturetime.Inthemeantimethe deficititselfdoesnotaffectthedistributionofcurrentconsumptionandcurrentsaving,which iswhyPSZtreatitneutrally.

Governmentconsumption. TheUSgovernmentspendsaround18%oftotalnationalincomeincollectiveconsumptionofpublicgoods—defense,policeandprison,infrastructure,and education—withnotrend.InPSZ,publicgoodsconsumptionisleftoutofdistributionalconsiderations,i.e.,itisassignedproportionallytopost-taxincome.InAS,halfofthisspending, about9%ofnationalincome,isallocatedasalumpsumpercapita,likeabig“universalbasic income.”ThisUBIisequivalentto $4,500perpersonin2019—$9,000foramarriedcoupleand $18,000forafamilyoffour.TheotherhalfisallocatedproportionallytoAS’safter-taxincome. AS’sbigUBIessentiallyerasespovertyanddramaticallychangesthepictureofinequalityat thebottomofthedistributionrelativetothelargebodyofexistingworkwhich,asPSZ,leaves publicgoodsoutofthepicture.Italsoreducesthelevelofthetop1%post-taxincomeshare, moreso(inpercentagepoints)wheninequalityisrelativelyhigh(in2019)thanwhenitislow (in1979).

Outofgovernmentconsumption,onlyspendingoneducation(30%ofthetotal,withno trendsince1979)couldinprinciplebeallocatedacrossindividualsandlegitimatelybeviewed asreducingpost-taxinequality.24

3.4PuttingItallTogether

InAS,thetop1%pre-taxincomesharerisesby4.4pointsbetween1979and2019.Adjustingfor eachofthepointsraisedinthiscomment,andassummarizedinTable2,itrisesby4 4+3 1=7 4 points,closetotheriseof8.3pointsobservedinthePiketty,SaezandZucman(2018,updated) series.TheASseriesbecomessimilarinlevelandtrendtoPSZovertheentireperiod1979–2019(toppanelofFigure5).25 ThebulkoftheadjustmenttoAScomesfromaddressingthe empiricalissueswiththeallocationoflegally-exemptbusinessincomeandallocatingproduct taxesneutrally.

24 PSZprovidesensitivityanalysisinwhicheducationspendingisdistributedasalumpsumperchild.AS similarlyconsiderallocating25%ofgovernmentconsumption(i.e.,roughlythesharecorrespondingtoeducation) asalumpsumperindividualandtherestproportionallytoafter-taxincome.ButbecauseAS’safter-taxincome concentrationhardlyincreases(duetoissueswithpretaxincome,seeTable2below),reducingthelump-sum portionincreasesthelevelofinequalitywithoutaﬀectingtheﬂatAStrend.

25 Asmallleveldifferenceremains,whichcanbeexplainedbydifferencesintheunitofobservationandin thetreatmentofthecorporatetax(partlyallocatedtoworkersinAS,thusreducingtoppre-taxincomeshares throughoutbutwithminimaleffectson1979–2019trendsandnoeffectonpost-taxshares).Theseissuesare discussedinSaezandZucman(2019,pp.22-23)andSaezandZucman(2023),respectively.

Similarly,inASthetop1%post-taxincomesharerisesby1.4pointbetween1979and2019. Afterourreconciliation,itrisesby1 4+4 0=5 4points,closetothe6.4pointsinthePSZseries (bottompanelofFigure5).Theadjustmentmostlycomesfromchangestopretaxincome.

AS(Table4)alsoprovideacomparisonoftheirtop1%incomesharewithPSZ.AS’sTable4, however,lumpstogetherthetreatmentoflegallyexemptbusinessincomeandtaxevasion—an artifactoftheiroldermethodologythatconﬂatedboth(AutenandSplinter,2019).Overthe 1979–2019period,asshownhere,itislegallyexemptbusinessincomethatisthekeysourceof divergencebetweenASandPSZ.26

InAppendixFigureA4weprovideasimilarcomparisonforthetop0.1%andtop0.01% incomeshares.PikettyandSaez(2003)showedthatthegrowthintopﬁscalincomeshareswas largerandlargerasonemovesupthedistribution.This“fractal”resultremainstrueinboth PSZandAS—eventhoughinAStheverytopincomesharesexhibitalesssigniﬁcantrise.After implementingthesameadjustmentsasthoseweappliedtothetop1%,AS’stop0.1%andtop 0.01%incomesharesbecomeveryclosetoPSZonapre-taxbasis,andnearlyidenticalona post-taxbasis.

4Conclusion

Accordingtoallavailablesources—incomereportedinindividualtaxreturns,wagesandsalaries fromSocialSecurityearnings,CEOpay,householdwealthsurveys,andrichlistssuchasthe Forbes 400—observableincomeandwealthhavebecomemassivelymoreconcentratedinthe UnitedStatessincethe1980s.

Tooffsettheriseinthetop1%incomeshare,itmustbethatunobservableincomehas becomemuchmoreequallydistributed.Mostlaborincomeintheeconomyistaxed,butmost capitalandbusinessincomeisuntaxed.Thus,bycarefullychoosingassumptionsaboutthe distributionofuntaxedbusinessandcapitalincome,onecanobtainmanydifferentpossible distributionsoftheseformsofincome,whichplayakeyroleatthetopofthedistribution. ASmakeassumptions,clarifiedinthiscomment,whichleadtoerasingtheriseofbusinessand capitalincomeinequality.

Theseassumptions,oncecarefullyexamined,arefoundtobeempiricallybiasedorconceptuallyunsound.Oncetheseissuesareaddressed,theASestimatesturnouttobesimilarinlevel andtrendtothoseofPiketty,SaezandZucman(2018).Inthefuture,additionalreﬁnements

26 AS’sTable4alsousestheoriginalPSZserieswhichendedin2014,whileTable2usesthecurrentPSZseries (October2022vintage),allowingforacomparisonofthetwomethodologiesascurrentlyimplementedoverthe full1979–2019period.

shouldbepossible,e.g.,shouldimprovedadministrativedatabecomeavailable—particularly datalinkingUSbusinesses,corporationsandpassthroughs,totheirultimateowners(National AcademiesofSciences,Engineering,andMedicine,2024).

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Figure1:GapBetweenFiscalDepreciationandEconomicDepreciation

Partnerships

Sole proprietorships

Notes:Thisfigurereportstheexcessoffiscaldepreciation(asreportedbybusinessesintheirtaxreturns)overeconomicdepreciation(asestimatedbythe BureauofEconomicAnalysisforthecomputationofnationalincome)fornon-farmsoleproprietorshipsandpartnershipsseparately,expressedasafraction offactor-pricenationalincomefrom1980to2020.Thegapispositiveandgrowingforpartnershipsbecauseoftheriseofpartnershipsasatypeofbusiness entityandtheintroductionofaccelerateddepreciationrulesforinvestment.Thegapisslightlynegativeforsoleproprietorshipsbecauseoflimitationsto thetaxdeductibilityofdepreciationonresidentialrealestateusedbysoleproprietorships(e.g.,homeoffices).Sources:seeAppendixA.

(a) ShareofExcessDepreciationGoingtoTop1%(2019)

Losses are real losses Losses are paper losses (PSZ) Losses are real gains

Auten-Splinter

(b) ExcessDepreciationGoingtoTop1%(%ofNationalIncome)

Losses are real losses

are

losses (PSZ)

Auten-Splinter

Notes:Thetoppanelshowsthefractionofexcesspartnershipdepreciationgoingtothetop1%inAS–who allocateittosoleproprietorshipowners–vs.differentscenariosthatallocateittopartnershipowners.Partnership scenariosdifferregardingthetreatmentoffiscallosses(fiscallossesarereallosses;fiscallossesareonlypaper lossesasinPSZbenchmark;fiscallossesareactuallyrealprofits)andfractionofexcessdepreciationgoingto non-individualpartners(usingthePSZbenchmarkforlosses).Seetextforcompletedetails.Thebottompanel showstheexcessdepreciationgoingtothetop1%expressedasafractionoffactor-pricenationalincomeovertime forthesamescenarios.Source:AS(seeAppendixD.2)andauthors’computations(seetext).

Figure3:BusinessIncome:Taxedvs.Untaxed(2019)

Notes:Thebarsonthefiguredecomposesthemacro-economicincomeofsoleproprietorships,partnerships,andS-corporationsin2019.Taxedincomeis thenetamountreportedinindividualincometaxreturns.ExcessfiscaldepreciationiscomputedinAppendixAforsoleproprietorshipsandpartnerships, andinBEA(2024)forS-corporations.MisreportedincomeandotheruntaxedincomearecomputedfollowingNIPAmethodology(BEA2023).TotalNIPA misreportednonfarmproprietors’incomeisbrokendownintosoleproprietorshipsandpartnershipstomatchthemisreportingrateof57%fornonfarm soleproprietorshipsin2014–16reportedintheIRStaxgapstudyfortheseyears(IRS,2022).Otheruntaxedincomeincludes,forsoleproprietorships: non-deductiblemealsandentertainmentandasmallamountofmisclassifiedwages;forpartnerships:theresidualamountofotheruntaxedincomeincluded inNIPAnonfarmproprietors’income;forS-corporations:otheruntaxedincomeinBEA(2024).Thefigurealsoreportsonthesideofthebarstheshare ofeachincomecomponentgoingtothetop1%.Fortaxedincome,itiscomputedusingpublicly-availableindividualincometaxdata,rankingindividuals (withincomeequallysplitbetweenmarriedspouses)byfiscalincomeexcludingcapitalgains.Theshareofuntaxedincomegoingtothetop1%iscomputed usingtheASpubliclyavailableExcelfiles,asdetailedinAppendixSectionD.2.

Figure4:Top1%ShareofTaxedvs.UntaxedBusinessIncome

Taxed income (observed)

Untaxed income: Auten-Splinter assumptions

Notes:Theblacklineshowstheshareoftaxablesoleproprietorships,partnership,andS-corporationnetincomeearnedbythetop1%individualswith thehighestfiscalincome,wherefiscalincomeistaxablemarketincomeexcludingcapitalgains,andtheunitofobservationistheadultindividualwith incomeequallysplitbetweenmarriedspouses.Thecomputationisdoneusingpublicly-availableindividualincometaxdata.Theredlineshowstheshare ofuntaxedsoleproprietorships,partnership,andS-corporationincomeearnedbythetop1%inAS,computedusingtheASpubliclyavailableExcelfiles, asdetailedinAppendixSectionD.2.

Figure5:Top1%IncomeShare:ASvs.CorrectedAS

(a)Pre-TaxIncome

Top 1% pre-tax income share: PSZ

Top 1% pre-tax income share: Auten-Splinter corrected

Top 1% pre-tax income share: Auten-Splinter

(b)Post-TaxIncome

Top 1% post-tax income share: Auten-Splinter Top 1% post-tax income share: PSZ

Top 1% post-tax income share: Auten-Splinter corrected

Notes:Theredlineshowsthetop1%incomeshareinAS.Theblacklineshowsthetop1%shareinPiketty, SaezandZucman(2018,updated).Thebluelineshowsthetop1%incomeshareinASafterimplementingthe correctionslistedinTable2eachyearfrom1979to2019.SeenotestoTable2.

Panel B: Partnerships

Panel C:

Notes:Thistabledecomposesthefiscalandeconomicdepreciationofnon-farmnon-corporatebusinessesintonon-farmsoleproprietorshipsvs.partnerships. PanelAreportsestimatesfornon-farmsoleproprietorshipsandpartnershipscombined,aspublishedbytheBureauofEconomicAnalysisinNIPATable 7.13.PanelsBandCusespubliclyavailableSOItotalsforspecificlineitemsinpartnershipandindividualtaxreturnstocomputefiscaldepreciation separatelyfornon-farmsoleproprietorshipsvs.partnerships.PanelDreportstheresidualbetweenPanelAandPanelsB+C,whichisduetothesmall amountofdepreciationattributabletofarmpartnerships(whichcannotbeseparatelyidentifiedwithpublicdata).Sourcesandadditionaldiscussions:see AppendixA.

Table2:SourcesofBiasinAS’sMethodology:Summary

Notes:Thedifferenceinthetop1%incomeshareriseoverthe1979–2019periodiscomputedinpercentagepointsasfollows.Foreachcategoryofuntaxed income S listedinthefirstcolumn,wecomputetheshare sAS s goingtothetop1%usingtheASpubliclyavailableExcelfile,followingthetheorydescribed inAppendixSectionD.1.Thatis,whenadding S,top1%incomes(afterre-ranking)increaseby ss ·|S| where |S| isthemacroeconomicaggregateof S Wethencompute sPSZ s usingthePSZmethodologydescribedincol.4,andapplythe sPSZ s sAS s differencetotheamountofuntaxedincome S;cf.online Excelfilesforcompletedetails.ThedifferenceslistedinthistableexplainmostofthediscrepanciesbetweenASandPiketty,SaezandZucman(2018, updated),andhencethemanyotherdifferencesinmethodologywhicharenotcoveredinthistablenetouttoasmallresidualoverthe1979-2019period (aswellaseachyear,seeFigure5).

Appendix(forOnlinePublication)

AEconomicDepreciationforPartnershipsvs.SoleProprietorships

A.1BEAMethodology

Toconverttheﬁscaldepreciationreportedbyproprietorshipsandpartnershipsintoeconomic depreciation,BEAusesaholisticapproach,whereallﬁscaldepreciationisdiscardedandreplacedbyeconomicdepreciation.Thisisdoneinthreesteps.

Step1.IRSdepreciationtotal. AsindicatedinNIPATable7.13,BEAstartswithtotal depreciationandamortizationintaxdata(NIPATable7.13line14),whichcanbereconstructed usingpubliclyavailableSOIlineitemtotals27 asthesumof:

• Depreciationofpartnerships:Line22ofform4562ﬁledbypartnerships($505billionin 2019)

• Amortizationofpartnerships:Line44ofform4562ﬁledbypartnerships($84billionin 2019)

• Depreciationofnon-farmsoleproprietorships:Line13ofScheduleCﬁledbyindividuals ($52billionin2019)

• Depreciationforbusinessuseofhome:Line42ofform8829ﬁledbyindividuals($1.2 billionin2019)

• Amortizationofsoleproprietorships:Line44ofform4562ﬁledbyindividuals($3.4billion in2019)

ThetotalfiscaldepreciationreportedinNIPATable7.13line14($642billionin2020)differsveryslightlyfromthesumofthefiveitemslistedabove($646billion),withanabsolute valueofthedifferenceoflessthan1%,becauseBEAremovesanestimateofpartnershipfarm depreciationwhichcannotbecomputedwithpubliclyavailabledata.

Step2.AdjustmentstoIRSdepreciation. BEAthenappliesanumberofadjustments toreportedfiscaldepreciationtocaptureacomprehensivetax-basedmeasureofdepreciation, whichiscalled“capitalconsumptionallowances,NIPAs”(reportedinNIPATable7.13line23, $654billionin2019).Theneteffectoftheseadjustments(i.e.,thedifferencebetweenNIPA 7.13line23andline14)issmall, $12billionin2019.

27 Availableat https://www.irs.gov/pub/irs-prior/p5035--2021.pdf forpartnershipsand https://www. irs.gov/pub/irs-prior/p4801--2021.pdf forindividuals

Step3.Capitalconsumptionadjustment. Lasttheall-important“Capitalconsumption adjustment”isimplemented,whichreplacesthecomprehensivetax-basedmeasureofdepreciationbytheeconomicmeasure.

Tocomputetheeconomicmeasureofdepreciation,called“consumptionoffixedcapital” inthenationalaccounts,BEAstartsfromitsestimatesofbusinesses’capitalstockbytypeof businessandtypeofasset(equipment,structure,etc.),asreportedinitsfixedassetsstatistics. Itthenapplieseconomicdepreciationschedulesbyassettype.Thismethodologyresultsinan estimatedconsumptionoffixedcapitalof $278billionfornon-farmsoleproprietorshipsand partnershipscombinedin2019(asreportedinNIPATable7.5line10).

TheCapitalconsumptionadjustment(reportedinNIPATable7.13line24)iscomputedas thediﬀerencebetweenthecomprehensivetax-basedmeasureofdepreciation($642billionfrom step1+ $12billionfromstep2)andtheconsumptionofﬁxedcapital($278billion).Itisequal to $376billionin2019.

ExcessfiscaldepreciationisthesumoftheadjustmentstoIRSdepreciation(step2)and theCapitalconsumptionadjustment(step3).Itisalsoequaltothedifferencebetweenfiscal depreciationandconsumptionoffixedcapital.Excessfiscaldepreciationisequalto $364billion fornonfarmsoleproprietorshipsandpartnershipscombinedin2019,versus $0billionin1980.

A.2BreakingDowntheBEAAggregate

TodecomposethisBEAaggregateintopartnershipsvs.soleproprietorshipsseparately,wefollowtheBEAmethodologyusingpubliclyavailableSOItabulateddataforeachtypeofbusiness separately.

Partnerships. Theexcessﬁscaldepreciationofpartnershipsiscomputedas:

Fiscaldepreciationofpartnerships(SOItotalofline22ofform4562ﬁledbypartnerships)

Plus Fiscalamortizationofpartnerships(SOItotalofline44ofform4562ﬁledbypartnerships)

Minus Consumptionofﬁxedcapitalofpartnerships(BEAFixedAssetsTable6.4line7).

Nonfarmsoleproprietorships. Theexcessﬁscaldepreciationofnonfarmsoleproprietorshipsiscomputedas:

Fiscaldepreciationofnon-farmsoleproprietorships(SOItotalofline13ofScheduleCﬁledby individuals)

Plus Fiscaldepreciationforbusinessuseofhome(SOItotalofline42ofform8829ﬁledby individuals)

Plus Fiscalamortizationofsoleproprietorships(SOItotalofline44ofform4562ﬁledbyindividuals)

Minus Consumptionofﬁxedcapitalofnonfarmsoleproprietorships(BEAFixedAssetsTable 6.4line6,minusNIPATable7.5line9).28

28 FixedAssetsTable6.5line6istheCFCofsoleproprietorships,andNIPATable7.5line9istheCFCof noncorporatefarms.Thusthiscomputationtreatsallnoncorporatefarmsassoleproprietorships(whilesomecan fileaspartnerships).Alternatively,onecouldestimatetheexcessfiscaldepreciationofall(farmplusnonfarm) soleproprietorshipsbyaddingtheFiscaldepreciationoffarmsoleproprietorships(Line14ofScheduleFfiled

ReconciliationwithBEAaggregate. Theexcessfiscaldepreciationofpartnerships($411 billionin2019)andnonfarmsoleproprietorships(-$44billionin2019)addsupeachyearto theofficialBEAexcessfiscaldepreciationofnonfarmsoleproprietorshipsandpartnerships combined($364billionin2019),moduloaresidualofabout1%.29

BSourcesofPartnershipDepreciation

B.1PartnershipDepreciationinTaxData

In2019,accordingtoSOItabulationsofpartnershiptaxreturns,partnershipsdeducted $589.2 billionindepreciationandamortization,whichcanbedecomposedasfollows:

• Expensedinvestment: $254.8billion(Form4562line14).Thisprimarilyincludestangible propertywitharecoveryperiodoflessthan20years(e.g.,equipment,airplanes,land improvement,pipelines,machines,etc.),whichcouldbefullyexpensedin2019.

• Rentalrealestatedepreciation: $173.8billion(Form8825line14).Outofthisroughly 40%wasforresidentialrealestateandhalffornon-residentialrealestate.30

• Depreciationofotherassets: $76.2billion(Form4562line22minusForm4562line14 minusForm8825line14)

• Amortization: $84.4billion(Form4562line44).

AccordingtotheBEAFixedAccountsstatistics,partnershipshad $178.1billionineconomic depreciationandamortization,sotherewas $411.1billioninexcessﬁscaldepreciation.Themain sourcesofexcessdepreciationwereexpensedinvestment(accountingforabout50%–55%oftotal excessdepreciation),residentialrealestate(about10%-15%),31 intangibles(about10%),and othergapsbetweeneconomicandﬁscaldepreciation,suchasfasterdepreciationpatternsinthe taxcode(about20%–30%).32

byindividuals)andsubtractingtheCFCofallsoleproprietorships(FixedAssetsTable6.5Line6)insteadof onlytheestimatedCFCofnonfarmsoleproprietorships.Theresultsarenearlyidentical(e.g.,-$42billionin excessﬁscaldepreciationforallsoleproprietorshipsin2019vs.-$44fornonfarmsoleproprietorships).

29 Thisresidual(of $3.7billionin2019)isduetotheexcessﬁscaldepreciationoffarmpartnerships(andother potentialresidualdiscrepanciesthatcannotbereadilyaddressedwithpublicdata).

30 35%ofrealestateplacedinservicebypartnershipsin2019wasresidential($93.3billion,Form4562line 19h)and65%wasnon-residential($173.6billion,Form4562line19i).Inearlieryearsaslightlyhigherfraction (around40%)wasresidential.

31 Oﬃcebuildingsaredepreciatedover39yearsinthetaxcodeand34to40yearsinthenationalaccounts (BEA,2003)andthusdonotappeartobeamajorsourceofexcessdepreciation,incontrasttorentalresidential realestatewhicharedepreciatedfasterinthetaxcode,27.5yearsvs.65to80yearsinthenationalaccounts (seecasestudybelow).

32 Specifically,assumingthat85%ofexpensedinvestmentisinexcessofnormaleconomicdepreciation,then expensingaccountsfor0.85 × $255B/ $411B=53%oftotalexcessdepreciation.Assumingthat40%offiscal real-estatedepreciationisforresidentialrealestateand65%ofthatisinexcessofeconomicdepreciation,then residentialrealestateaccountsfor$174B × 0 4 × 0 65/$411B =11%oftotalexcessdepreciation.Economic amortizationbypartnershipisestimatedbyBEAtobe $57.1B(BEAFixedAssets4.4line64),henceexcess fiscalamortizationis $27.3billion,i.e.,7%oftotalexcessfiscaldepreciation.

B.2CaseStudies

Pipelinetransportation. AccordingtoSOItabulationsofpartnershiptaxreturns,pipeline transportationistheindustrywiththehighestamountof(non-real-estaterelated)depreciation.33 Pipelinescanbedepreciatedover15yearsinthetaxcode,whiletheyhaveaservice lifeof40yearsinthenationalaccounts(BEA,2003),thusgeneratingexcessﬁscaldepreciation. Fullexpensingprovisionsmagnifythisgapbetweeneconomicincomeandtaxableincome,as newpipelinescanbefullydepreciatedinjustoneyear.

Anumberofpipelinepartnershipsarepubliclytraded,andknowntogeneratehigh-cash flowswhilesimultaneouslyallowingtheirpartnerstoclaimordinarybusinesslosses.34 Our methodologythatallocatesexcessdepreciationproportionallyfirsttoordinarybusinesslosses (andthentoordinarybusinessprofitsifsomeuntaxedincomeremainstobeallocated)naturally capturesthedistributionofsuchexcessfiscaldepreciation.

Sportsclubowners. In2014,SteveBallmerboughttheLosAngelesClippersfor $2billion. SincetheAmericanJobsCreationActof2004,sportsteamsareallowedtoamortizenearlyall theirintangibleassetsover15years,includingTVandradiocontracts,playercontracts,goodwill (theClippersbrand),etc.Thisamortizationisnotrecognizedinthenationalaccounts,thus contributingtoexcessfiscaldepreciation.Accordingtopublicinformation,Ballmerreported atotalof $700millioninlossesfromhisamortizationoftheClippersoverthe2014–2018 period,allowinghimtooffsettaxesondividendincomeandcapitalgains.35 Ourmethodology thatallocatesexcessdepreciationproportionallyfirsttoordinarybusinesslossescapturesthe distributionofsuchexcessfiscaldepreciation.

Realestatepartnerships. DonaldBrenistheownerofIrvineCompany,afirmthatowns 65,000housingunitsspreadinOrangeCounty,SanDiego,LosAngeles,andSiliconValley.36 In2019 Forbes estimatedhisnetworthat $16.4billion.WedonotknowwhetherIrvine Companyfilesasapartnership,butpartnershipsareknowntobethepreferredformofbusiness organizationintherealestatesector,becausetheyallowtheirownerstotakefulldepreciation deductionsevenifthepropertiesaredebt-financed,incontrasttocorporations.37

33 In2019,“transportationandwarehousing”accountedfor16.6%ofall(non-rental-realestate)depreciation, cf.AppendixFigureA1.In2014,SOItabulationsarebrokendownatamoregranularlevelandshowthatmore than80%of“transportationandwarehousing”depreciationcomesfrompipelinetransportation.

34 See,e.g., https://www.investopedia.com/articles/personal-finance/062515/ mlps-how-they-are-taxed.asp forapractitioners’view.Whenunitsaresoldthedepreciationis“recaptured”andsubjecttotaxation,butthistaxitselfcanbeavoided,e.g.,bybequeathingassets,generatinga stepupinbasis.

35 See https://www.propublica.org/article/the-billionaire-playbook-how-sports-owners-use-their-teams-to-avoid-millions-in-taxes Inprinciplepassivelossescanonlybeoﬀsetagainstpassivegains,butlossescanbeclassiﬁedasnon-passiveif theownerisinvolvedinthemanagementofthebusiness.

36 https://www.irvinecompany.com/portfolio/.

37 ConsidertwopartnersAandB,whocontribute $10each.Thepartnershipborrows $80.Thedebt isallocated $40eachtoAandB,thusAandBeachhave $50ofoutsidebasisinthepartnership.If thepartnershipbuysdepreciablepropertyfor $100,anddepreciatesitall,eachpartnercantake $50of depreciationdeductions.InanS-corporation,eachownerwouldbeallowedtotakeonly $10ofdepreciationdeduction,correspondingtotheiractualcapitalcontribution.Theremaining $40inlosswouldbesus-

Residentialrentalpropertiescanbedepreciatedover27.5yearsinthetaxcode,whilethey haveaservicelifeof65years(for5-or-moreunitsstructures)to80years(for1-4unitsstructures) inthenationalaccounts(BEA,2003).Whenapropertyisfullydepreciatedafter27.5years andchangeshand,itsbasisissteppedup,allowingitsnewownertodepreciateitagainfortax purposesandthusgeneratingexcessﬁscaldepreciationeconomy-wide.38

Ideallythisexcessdepreciationwouldbeallocatedbymatchingreal-estatepartnershipsto theirowners,ataskdiﬃcultinpracticeduetothewidespreaduseofholdingchainsinthereal estatesector.Asdetailedabove,availableevidencesuggeststhatexcessreal-estatedepreciation accountsforonlyabout10%–15%oftotalexcesspartnershipdepreciation.

CTreatmentofBusinessLosses

C.1RelaxingthePSZAssumptions:SensitivityAnalysis

PSZassumethata $1netlossinpassthroughbusinessprofitreportedinindividualtaxreturns correspondsto $0realincome.Inotherwords,fiscalbusinesslossesarenotrealbusinesslosses butratherpaperlossesduetogeneroustaxdeductions(e.g.,fordepreciation)ortaxevasion. Evendiscardingfiscallosses,positivefiscalprofitsaretypicallysubstantiallysmallerthantotal (net)profitsfromtheNIPAs.PSZassignthisdiscrepancyproportionallytopositivefiscal profits.

Itiseasy,however,tomodifythePSZtreatmentoflossesandtoexploretheimpactof differentassumptionsonincomeconcentration.Letusassumethat $1ofnetlossreflects $a of reallosses(and$1 a ofpaperlosses).InPSZ, a isassumedtobe0,i.e.,allfiscallossesare paperlosses,notreallosses.

If a =1,allfiscallossesareactuallyreallosses,inwhichcasethediscrepancybetweenfiscal incomeandNIPAincomeislargerandrequiresmultiplyingpositiveprofitsbyalargernumber tomatchNIPAprofits.39 Inthiscase,incomeconcentrationwouldbeevenhigherthaninPSZ (seebelow).

Onecanalsoassumethatafiscallosscorrespondstoarealpositiveprofit.Forexample with a = 1,a $1lossrepresents $1intrueprofit(thatis,alossisnotonlyapaperlossbut alsoreflectsactualrealprofits).Inthiscase,incomeconcentrationwoulddecreaseveryslightly relativetoPSZ.Theeffectismuted,becausetreatinglossesasdisguisedprofitsreducesthe multiplierthatneedstobeappliedtomatchNIPAprofits(whichlowersconcentration),butit alsomakeslargelossesbecomelargepositives(whichaddstoconcentration).40

ThebottomlineisthatthePSZtreatmentofignoringlossescanbeseenasamiddle-ground pendeduntilAandBhavemorebasistotakethedeductions(e.g.,bycontributingmorecapital),cf.loss suspensionrulesforS-corporations: https://www.irs.gov/businesses/small-businesses-self-employed/ s-corporation-stock-and-debt-basis.WethankMichaelLovefortheseexplanations.

38 Incertaintransactions,thisbasisshiftingcantakeplacewithinrelatedparties,thusallowingthesameowner todepreciatethesamepropertymultipletimesover.See https://home.treasury.gov/news/press-releases/ jy2408

39 Onlypositiveprofitsmustbeadjusted,sincebydefinitionwith a =1allfiscallossesarereal(theyarenot duetotaxevasionorexcessdepreciation).

40 Intermediatecasessuchas a = 5or a = 5canalsobeconsideredandleadtosmalleradjustments.

scenario,ifanythingconservative.Takinglossesatfacevaluewouldproducemoreconcentration. Takinglossesasdisguisedgainswouldproduceonlyslightlylessconcentration.Thecommon intuitionthatdisregardingﬁscallossesmustbiastopincomesharesupwardsisgenerallynot correct.

Thiscanbeillustratedsimplyusing2019individualincometaxdata.InAdjustedGross Income(fiscalincomereportedinindividualincometaxreturns),S-corporationprofitsare $530.4B(positiveprofits)minus $69.5B(losses)andpartnershipprofitsare $348.8B(positive profits)minus $132.5B(losses).41 Inthenationalaccounts,S-corporationnetprofitsare $716B andpartnershipnetprofitsare $852B.42

Thetop1%oftaxfilershave20.43%oftotalAGI.Wecanrecomputethetop1%income sharebymakingvariousassumptionson a,andallocatingtheremaininggapbetweencorrected fiscalprofitsandnationalaccountprofitsproportionallytocorrectedfiscalprofitsasinPSZ.

• If a =1(ﬁscallossesarereallosses),thetop1%incomesharegrowsto24.10%.

• If a = .5(ﬁscallossesare50%real):thetop1%incomesharegrowsto23.80%

• If a =0(ﬁscallossesareallpaperlosses,PSZbenchmark):thetop1%incomeshare growsto23.58%.

• If a = .5(ﬁscallossesare50%proﬁt):thetop1%incomesharegrowsto23.45%

• If a = 1(ﬁscallossesareinrealitydisguisedproﬁt):thetop1%incomesharegrowsto 23.38%.

Thebottomlineisthatthetreatmentoflosseshasonlyasecond-ordereffectrelativeto thefirst-ordereffectofblowingupfiscalprofitstomatchNIPAprofits,whichisnecessaryto accountforthelargeamountofexcessfiscaldepreciation,otherlegallyexemptincome,andtax evasion.

C.2WhatFractionofPartnershipProﬁtsandLossesCanbeSeen inIndividualIncomeTaxReturns?

Asnotedinthemaintext,about70%ofbothtotalpartnershipproﬁtandtotalpartnership lossesaredirectlyobservableinindividualincometaxreturns.Wedetailthiscomputationhere fortheyear2019.

AccordingtopubliclyavailableSOItabulationsofpartnershiptaxreturns(form1065), partnershipsoverallmade $557billioninordinarybusinessprofit.Totalprofits(andtotallosses) madebypartnershipscanbecomputedusingpublicSOItabulateddatabecausepartnerships mustseparatelyreportprofitsandlossesflowingfromotherpartnerships,makingitpossibleto avoiddoublecounting.Specifically,

41 Thesenumbersareobtainedwhenaggregatingproﬁtsandlosseswithineachtaxreturnforthepartnerships categoryandtheS-corporationcategoryrespectively.

42 ThesenumbersaretakenfromthePSZbreakdownsofNIPAproﬁtsintoSvs.Ccorporationproﬁtsand NIPAproprietors’incomeintopartnershipvs.soleproprietorshipincomeusedforthe2022updateofPSZ.

• Partnershipsintotalreported $732.7billioninpositiveordinaryincome

• Partnershipsintotalreceived $175.6billionin“Ordinaryincomefromotherpartnerships andﬁduciaries”

• Hencetheymade $732.7 $175.6= $557.1billioninpositiveproﬁt,netofdoublecounting.43

AccordingtoSOIlineitemstotalsforForm1040,individualsreported $407billioninpositive partnershipproﬁt,i.e.,73%ofthe $557Bintotalpositivepartnershipproﬁt.

Asimilarlyhighfractionoftotalpartnershiplosseswenttoindividualsafteraccountingfor losslimitationrules.Speciﬁcally,partnershipsintotalmade $306billioninlosses(netofdouble counting).Individualshad $185billioninallowedpartnershiplossesandmorethan $25billion indisallowedlossesduetopassivelosslimitationrules,henceatleast69%ofpartnershiplosses ﬂewtoindividuals.44

DAllocatingUntaxedIncome

D.1Theory

Supposethat y isfiscalincomeand z = y + s isabroaderdefinitionofincome,with s being incomenotincludedinfiscalincome(s couldforinstancebeunreportedincome,oruntaxed incomesuchasexcessdepreciationinfiscalprofits).Howdoesadding s affectthetop1%income share?

Let Z,Y,S bethemacroeconomicaggregatesof z,y,s withofcourse Z = Y + S>Y .Let sh(y)betheshareof y goingtothetop1% y-incomeearnersand sh(z)betheshareof z going tothetop1% z-incomeearners.Let sy betheshareof s incomegoingtothetop1% y-income earners,and sz betheshareof s incomegoingtothetop1% z-incomeearners.Wehavethe followinginequalities:

Theﬁrstinequalityisbecausethetop1%in z musthaveatleasttheincomeofthetop1% in y plusthe s incomegoingtothetop1%in y,sothat sh(z) Z isatleast sh(y) Y + sy S Thesecondinequalityisbecausethetop1%in z hasless y incomethanthetop1%in y and hencetheirtotalincome sh(z) Z cannotexceed sh(y) Y plustheir s income sz S.Inboth cases,thereisequalityifandonlyifthetop1%in y andthetop1%in z arethesamegroup

43 Proﬁtreceivedfromﬁduciariesisneglected.

44 Lossesanddeductionsmadebyapartnershipthatcanbeclaimedbyindividualpartnersarelimitedby basisrules(lossescannotbedeductedifapartnerhasnobasis),at-riskrules(partnerscannotdeductlossesin excessoftheamountsofmoneytheyhave“atrisk”inthebusiness),andpassivelossrules(passivelossescan onlybeoﬀsetagainstpassivegains).Disallowedpassivelossescanbeestimatedasfollows: $70billioninpassive lossesfromnon-rentalactivitieswerereportedonline3bofForm8582,butonly $45billioninpassivelosses wereallowedonScheduleE,henceabout $25billioninlossesweredisallowed.Disallowedlossesfrombasisand at-riskrulescannotbeidentiﬁedwithpublicdata.

ofpeople(alsoequivalentto sz = sy ).Italsofollowsfromtheinequalitiesthat sz ≥ sy :top z-earnersmusthavemore s-incomethantop y-earners.

Thereisoftenadebateonwhether sz or sy isthemostmeaningfulstatisticforunderstanding how s aﬀectstheconcentrationofincome.Itturnsoutthatneitheris.Therelevantstatistics is ss whichwecandeﬁneas: sh(z)= sh(y) (1 S/Z)+ ss S/Z

Inwords,whenmovingfrom y-incometothebroader z-incomemeasure,top1%incomes increaseby ss · S,so ss iseﬀectivelytheshareoftheextraincome S thatgoestothetop1%. Importantly,itisnotthesametop1%people(ifthereisre-rankingwhenmovingfrom y to z) butitistherelevantconceptforourpurposes.Notethat s incomeincreasesconcentration—i.e. sh(z) >sh(y)—ifandonlyif ss >sh(y).45 Theparameter ss istheoreticallyinbetween sy and sz ,andempiricallyisoftenaboutmidwaysothat(sy + sz )/2isoftenagoodapproximationto ss eﬀectivelyadjudicatinghalf-waythedebateonthemeritsof sy vs. sz

D.2RecoveringtheDistributionofUntaxedIncomeinAS

Usingthisconceptualframework,wecanusetheASonlineExcelﬁlestoclarifytheassumptions madebyASaboutthedistributionofuntaxedincome.46 UsingtheirTableC1,onecancompute thefractionofuntaxedincomeassignedtothetop1%(theshare ss discussedabove)forthe variouscomponentsofuntaxedincome S. 47

Distributionofuntaxedbusinessincome. Untaxedbusinessincomeisthesumofuntaxednoncorporatebusinessincome(soleproprietorshipspluspartnerships)anduntaxedScorporationincome.

ThedistributionofuntaxednoncorporatebusinessincomeisinferredfromAS’sTableC1, cols.EBtoET.InaﬁrststeponecancomputethetotalofwhatAScall“underreported income,”ascol.ELminuscol.EB($1,084billionin2019).Thistotalincludesbothlegallyexemptincome(e.g.,excessﬁscaldepreciation)andtaxevasion(unreportedtaxableincome). Thistotalalsoincludesunreportedtaxablewageincome,whichislumpedwithunreported businessincomeanddistributedidenticallybyAS.Thetop1%gets $124billionofAS’stotal “underreportedincome”in2019(col.EQminuscol.EG),i.e.,ashare snc s =11%ofthis additionalincomegoestothetop1%,thenumberreportedinFigure3forsoleproprietorships andpartnerships.Byapplyingthissharetothetotalamountofuntaxednoncorporatebusiness income($1,084billionin2019minus $159billioninunreportedwageincome),weobtainthat thetop1%isassigned $106billion(in2019)ofuntaxednoncorporatebusinessincomebyAS. ThedistributionofuntaxedS-corporationincomeisalsoinferredfromAS’sTableC1.First, taxevasiononS-corporationincomeisincludedinAS’s“underreportedincome”aggregate.

45 The ss concepthasbeenusedtodistributegrowthofincometopercentileswhere y isincomeinsomeyear and z = y + s isincomeinalateryear(where s denotesincomegrowth).

46 https://davidsplinter.com/AutenSplinter-IncomeIneq.xlsx downloadedonDecember1st,2023.

47 Whentherearevariousincomecomponents,theordercouldinprinciplematter.TableC1fromASisthe onlysourcewecanuseforsuchcomputationssowehavetofollowtheirspeciﬁcordering.Computationsbased onpublicmicro-datasuggeststhatre-orderingeﬀectsaresmall.

Thusafraction snc s (11%in2019)ofunreportedS-corporationincome($54billionintotalin ASin2019)isassignedtothetop1%;thisamountisalreadyincludedinuntaxednoncorporatebusinessincomeabove.Second,legally-exemptS-corporationincome($205billionin2019 accordingtoBEAdata48 )isdistributedbyASasC-corporationretainedearnings.ThedistributionofC-corporationretainedearningsiscomputedusingAS’sTableC1cols.CNtoCX, e.g.,thetop1%getsashare sret s =28%oftotalretainedearnings(andhenceofS-corporation legally-exemptincome)in2019.Overall,thetop1%isassigned25%ofuntaxedS-corporation incomein2019(asreportedinFigure3)and14%ofalluntaxedbusinessincome($163billion outof $1,130billion)in2019,asreportedinFigure4.

Distributionofuntaxedcapitalincome. Untaxedcapitalincomeisthesumofcorporate retainedearnings,investmentincomeearnedontax-exemptpensionaccounts,untaxedrents, tax-exemptinterest,andincomeretainedintrusts.Wecomputethedistributionofuntaxed capitalincomeusingAS’sTableC1usingthesamemethodasdoneaboveforbusinessincome. Foreachcomponentofuntaxedcapitalwecancomputetheshare ss ofuntaxedincomeassigned bytheAStothetop1%.Thisshareforalluntaxedcapitalincomecomponentstakentogether isreportedinAppendixFigureA2.49

EDistributionofUntaxedCapitalIncome

AssumptionsmadebyASabouttheallocationofinvestmentincomeearnedinretirementaccountsandcorporateretainedearningsleadtoalikelybiasintheriseofthetop1%income share.

E.1Pensions

First,ASunder-estimatetheshareofpensionincomeearnedbythetop1%in2019anditsrise sincethe1980sbyabout0.3points,becauseinvestmentincomeearnedinretirementaccounts isallocatedbyASproportionallytofundedand unfunded pensionwealth.

Unfundedpensionsarepromises(mostlytostateandlocalgovernmentemployees)offuture retirementbenefitsthatarenotbackedbyactualwealth.AS’smethodologyallocatesdividends,interest,aportionofcorporateretainedearnings,businesspropertytaxes,etc.,tothe beneficiariesoftheseunfundedpensions—eventhoughthesepensionshavenoassetsattached tothem.ConcretelythepublicschoolteachersofIllinoisgetallocatedafractionofAlphabet’s, Amazon’setc.profiteveniftheIllinoisstatepensionsystemdoesnotownanyequitywealth.

ASnotethattheirallocationofpensionwealthallowsthemtomatchtheDFAdistribution of“pensionentitlements.”BecausetheDFA(andtheunderlyingSurveyofConsumerFinances) istheonlycomprehensivesourceonthedistributionofpensionwealthintheUnitedStates,

48 In2019,S-corporationshad $720billioninpre-taxincome(BEA,2024).Outofthis, $461billionwastaxed inindividualincometaxreturns;ASmakeanallowancefor $54billioninevasion,hence720 461 54=$205 billionremaintobeallocated.

49 ASlumpuntaxedrents(otherthanimputedrentsforowner-occupiedhousing)alongwithtaxevasionand legally-exemptincome,soweallocatetheseuntaxedrentsfollowingthedistributionofthisaggregate.

matchingthissourceiskey.However,because“pensionentitlements”intheDFAincludes unfundeddeﬁnedbeneﬁtpensions,itisnotthecorrectaggregatetotarget.50 Aftersubtracting unfundedpensions,thetop1%byincomeowns7.0%offundedpensionwealthintheDFAin 1989and8.3%in2019.InAS,thetop1%isassigned7.0%ofretirementaccountincomein 1989butonly6.3%in2019.ThereisatrendbiasinAS’sallocationoftax-exemptretirement income.

SaezandZucman(2020)notedthatAutenandSplinter(2019)’stax-exemptretirement incomedistributionwerenotconsistentwithexistingevidence.Inresponse,ASimprovedtheir allocationbyusingadministrativedataonthedistributionofindividualretirementaccounts. This,however,didnotaddresstheproblem,asmostpensionandinsuranceassetsarenotin IRAs.Theissuepointedhere—thatinvestmentincomeisallocatedtobeneﬁciariesofunfunded pensions—hadnotbeennotedbefore.

E.2RetainedEarnings

ASalsounderestimatetheriseintheconcentrationofretainedearnings,duetotwoissues.

First,forequitiesdirectlyheld,ASallocatethree-quartersofretainedearningsproportionally todividendsandonlyonequarterproportionallytorealizedcapitalgains.Thisassumptionis logicallyinconsistent:ownersoffirmswithrelativelyhighretainedearningsreceiverelatively littledividends—theoppositeofwhatASassume.Becausetheconcentrationofdividendshas increasedlessthanthatofcapitalgains,theASassumptionsislikelytoleadtobiasedtrends.51 ASdonotjustifytheirapproach,whichisatoddswiththeliteratureanddoesnotappear tohaveaparticularempiricalbasis.Theysimplynote(p.2197):“Wefavorusingdividends receivedastheprimaryindicatorofcorporateownership(Smithetal.,2023).”This,however, reflectsaconfusionbetweenthedistributionofcorporateprofitsandthedistributionofretained earnings.52 Thisissuehadnotbeennotedbefore:inAutenandSplinter(2019),halfofretained earningswereallocatedproportionallytodividends.

Second,forequitiesheldthroughpensionfunds,ASallocateaportionofretainedearnings tobeneﬁciariesofunfundedpensionplans,whichbydeﬁnitionhavenoassets(seeabove). Altogether,thesetwoissuesreducetheASriseinthetop1%pre-taxincomeby0.4points overthe1979–2019period.

50 Moreover,“pensionentitlements”excludesindividualretirementaccounts,whichareslightlymoreconcentratedthanfundedDBplusDCpensions.

51 Theshareofdividendsearnedbythetop1%taxunits(rankedbyﬁscalincomeexcludingcapitalgains)is aboutthesamein2019and1962(45%–46%)buttheshareofcapitalgainsismuchhigherin2019(46%)than in1962(33%),eventhoughtherichhadincentivesinthe1960storeportincomeascapitalgainstoavoidthe highdividendtaxrates.Therelativelylowconcentrationofcapitalgainsinthe1960sisconsistentwithother evidencepointingtoarelativelylowconcentrationofwealthatthetime,suchasthe1957 Fortune magazine richlist(see,e.g.,Pikettyetal.,2021,Figure3)orthelowlevelsofwealthinequalityinthe1960sestimated usingestatetaxreturns.

52 Smithetal.(2023)allocateabout3/4ofdirectly-heldequitywealthinrecentyearsproportionallyto dividends,whichwouldcallforallocating3/4ofthecorrespondingcorporateprofitsproportionallytodividends. ButASallocatemuchmorethan3/4ofdirectly-heldcorporateprofitstodividends(specifically,3/4ofretained earningsplus100%ofdistributedprofits).

FigureA1:ShareofPartnershipProﬁt,Loss&Depreciation(%ofAllIndustries)

Notes:Foreachsector,partnershipbusinessprofitiscomputedas“Ordinarybusinessincome”minus“Ordinaryincomefromotherpartnershipsand fiduciaries”(thusremovinganydoublecountingofprofitduetoholdingchains),partnershipbusinesslossesarecomputedas“Ordinarybusinessloss”minus “Ordinarylossfromotherpartnershipsandfiduciaries”(thusremovinganydoublecountingoflosses),anddepreciationisasreportedonthefirstpageof IRSForm1065.Sources:SOIpartnershipstatistics.

FigureA2:Top1%ShareofTaxedvs.UntaxedCapitalIncome

Untaxed income: Auten-Splinter assumptions

Notes:Theblacklineshowstheshareoftaxedcapitalincome(thesumoftaxabledividends,interest,rents,andestateandtrustincome)earnedbythe top1%individualswiththehighestfiscalincome,wherefiscalincomeistaxablemarketincomeexcludingcapitalgains,andtheunitofobservationisthe adultindividualwithincomeequallysplitbetweenmarriedspouses.Thecomputationisdoneusingpublicly-availableindividualincometaxdata.The redlineshowstheshareofuntaxedcapitalincome(corporateretainedearnings,investmentincomeearnedontax-exemptpensionaccounts,untaxedrents, tax-exemptinterest,andincomeretainedintrusts)earnedbythetop1%size-adjustedtaxunitsinAS,computedusingtheASpubliclyavailableExcel files,seeAppendixSectionD.2.

FigureA3:Top1%ShareofWealthvs.CapitalIncome

Top 1% wealth share: Smith et al. - Fed - Saez-Zucman

Top 1% capital income share: Auten-Splinter

Notes:Theredlineshowstheshareofcapitalincome(taxedplusuntaxed)earnedbythetop1%accordingtoAS.Taxedcapitalincomeincludestaxable dividends,interest,rents,andestatesandtrustincome;itsdistributioniscomputedusingpublicly-availablesamplesofincometaxreturns,rankingadult individuals(withincomeequallysplitbetweenspouses)byﬁscalincomeexcludingcapitalgains.Untaxedcapitalincomeincludescorporateretained earnings,investmentincomeearnedontax-exemptpensionaccounts,untaxedrents,tax-exemptinterest,andincomeretainedintrusts;thesharegoing tothetop1%inASiscomputedusingtheASpubliclyavailableExcelﬁles,seeAppendixSectionD.2.Thedarklinesshowtheshareofwealthowned bythetop1%wealthiestinSaezandZucman(2016,updated),Smithetal.(2023)andtheFederalReserveDistributionalFinancialAccounts.Theunit ofobservationistheadultindividualwithwealthequallysplitbetweenspousesinSaez-ZucmanandSmithetal.,andthehouseholdintheDFA.For comparabilitywiththeotherseries,theDFAseriesexcludesconsumerdurablesandunfundedpensions(whichareexcludedinSmithetal.andSaezand Zucman,anddonotgenerateinvestmentincome).

Notes:Theredlinesshowsthetop0.1%andtop0.01%incomesharesinAS.TheblacklinesshowsthecorrespondingseriesinPiketty,SaezandZucman (2018,updated).Thebluelineshowsthetop0.1%andtop0.01%incomesharesinASafterimplementingthecorrectionslistedinTable2eachyearfrom 1979to2019.SeenotestoTable2.