The Dead Zone: The Implicit Marginal Tax Rate

Off Topic Politics and World Issues
1

To say that antipoverty programs in the United States are perverted may be an understatement. When you take into account the loss of means-tested benefits (e.g., cash assistance, food stamps, housing subsidies, and health insurance), and the taxes that people pay on earned income, the return to working is essentially zero for those in the lower two quintiles of the income distribution.

For many of the working poor, the implicit marginal tax rate is greater than 100 percent. The long-run consequence of undermining the positive incentive to work is, of course, the creation of an underclass acclimated to not working; the supplement of cash and noncash benefits with income from crime and the underground economy; and the government resorting to negative incentives such as mandatory work programs.

Below, I show the relationship between earned income and after-tax income plus subsidies for a hypothetical Virginia family of three, consisting of one adult and two minor children. As you can see, the relationship is essentially flat from $0 to about $40,000 in earned income.

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To see exactly what is happening, I developed the following chart. It shows the implicit tax paid on the last $10,000 of earned income (initially by comparison to the welfare grant and then by comparison to income less taxes plus subsidies).

At A, the marginal tax rate is quite high, essentially because of the generosity of the package of cash and noncash benefits provided to those on welfare. At B, the marginal tax rate is relatively low (!) because of the Earned Income Tax Credit (EITC). From B to D, we (or, rather, the working poor) are in the Dead Zone, with implicit marginal tax rates mostly exceeding 100 percent.

How stupid and evil must our elected representatives be to do this to the working poor! Actually, this being a democracy, there is nobody to blame but the electorate. Especially the left-liberal do-gooders. Since Milton Friedman developed the negative income tax, waaay back in the 1950s, there can be no excuse for any educated person to not be aware of the fact that taxes and means-tested benefits destroy the lower classes’ positive incentive to work.

At C, the implicit marginal tax rate is momentarily “only” 75 percent. This is because, in the face of losing other means-tested benefits while the federal income tax kicks in, the children of the household still qualify for the State Children’s Health Insurance Program (SCHIP). The lull in the onslaught is momentary, however, ending as soon as that prop is removed from the household.

At D, the family is finally done with jumping through the hoops to qualify and remain qualified for the give-away programs. Now all it has to concern itself with is paying taxes. But there is no rest for the weary because, at E, the child tax credit phases out.

In the above scenario, I describe the effects of the tax and subsidy programs of the government with respect to a hypothetical family of three, consisting of one adult and two minors, with a focus on the working poor. I could just as well have talked of a middle-class family with one or more children of college age, and how means-tested financial aid programs such as the Pell Grant and federally subsidized loans make fools of those who save for college; or how Medicaid’s rules for nursing-home eligibility make those who save for retirement into fools; or how bringing back the pre-Reagan tax rates will make utter fools of families in which the wife and husband both work.

Everywhere, the government’s desire (meaning the left-liberal do-gooders’ desire) to be generous to the poor is destroying the positive incentives to work and to save that are so necessary for a well-functioning economy. What they have done to Detroit, and are doing to New Jersey, they will do to the entire country.

Chief Justice Marshall said, in McCulloch versus Maryland, “The power to tax is the power to destroy.” At the time, he was talking about state taxation of the federally chartered Bank of the United States. He didn’t want the states to destroy the instrumentalities of the federal government or even the federal government itself through the power to tax. When will we have a Supreme Court that forbids the federal government from using the power of taxation to destroy our entire country?

3

It will vary according to the state: for example, in Florida the giveaways are nowhere near so great, but that data for Virginia is shocking.

Absolute insanity.

4

[quote]Bill Roberts wrote:
It will vary according to the state: for example, in Florida the giveaways are nowhere near so great, but that data for Virginia is shocking.

Absolute insanity.[/quote]

Really?

They are literally destroying the incentive to work and to learn and teach the skills necessary to hold and keep a job.

In essence they destroy the social capital capitalism has created and depends upon and create a class of people that is not capable of providing for itself.

They stay in power by keeping the poor poor.

That is sinister but not insane.

5

Yes, you are correct. For those that have set this up, it is not insane but rather an intelligent furtherance of their goals.

But for most of society, it is insane.

I really did not realize it was as severe anywhere in the country as the data you posted shows, though I was aware of the general problem.

Even though I’m personally well aware of the effect, as my ex-fiancee is, unfortunately, in this situation. She has become genuinely disabled for the most part, though she would be able to handle a small amount of part-time work. However, as measly as her SSI disability is – and it is truly measly – she is better off not working at all than she would be working and losing her Medicare (or is it Medicaid, I can never remember) coverage, as her medical costs are high.

So she also is in the category of being anti-incentived to work, even though she would gladly work productively part-time to whatever extent she could, even if she got only pennies on the dollar benefit or quite likely she would do it even for no net benefit. But for a loss, she can’t.

Which is insane.

No matter a person’s income level, earning further income ought to result in having more net money. Any other situation is harmful to society and to the individual.

6

Thanks for bringing this article to my attention.

I do wonder why this kind of thing isn’t being addressed at a national level? The only thing I’ve ever heard was the odd grumbling about how it doesn’t make sense for people at the bottom to work.

I’m kind of suprised that so few people in PWI have commented on it though.

7

[quote]fraggle wrote:
I’m kind of suprised that so few people in PWI have commented on it though.[/quote]

I think you overestimate many of the forum posters.

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[quote]LIFTICVSMAXIMVS wrote:
fraggle wrote:
I’m kind of suprised that so few people in PWI have commented on it though.

I think you overestimate many of the forum posters.[/quote]

Haha, I’m just saying that given the subject, I would have expected at least a few more posts, even if they were just simple insulting or ass kissing comments.

9

It’s possible that people are confounded as to what would be a workable improvement on this, as at first glance solutions such as having no means testing or having partial benefits extended up to greater incomes than currently the place might seem to increase cost.

However I’ll tackle it anyway, stipulating (for sake of argument) that the benefit level at zero income should be the same as present for our Virginia example.

First, on food. There was an article in Scientific American back in the 70s that went into this subject with considerable thoroughness. I would have no hope of finding the article now. The authors’ conclusion was that the most economical approach, which further would be the most assured approach of ending hunger, would be for certain staple foods to be free to the consumer. Markets selling them would of course be compensated by the government.

I forget what those foods were, but for example rice, beans, some kind of oil, there were a couple of vegetables, and a few other things. It was determined to be a sustainable and healthy diet, though not of course what most would prefer.

Yes, you’d have millionaires getting their rice “for free” (actually, paying for it on their 1040 instead of at the cash register.)

But the authors’ research indicated it would be much cheaper than the food stamps program.

We had someone on here arguing that people would get so much rice as to fill their furniture with it or find other odd uses, which I think does not make too much sense – for example, sand is free in many places but is there a problem with people packing their houses with hundreds or thousands of pounds of sand?

However with today’s magnetic-stripe technology, it would be easy to have a per-person limit per month on these items.

So, this would end the disincentive to work based on losing food stamps.

On other benefits paid by cash, while at first glance it might seem to increase the cost of the program to provide partial benefits at higher incomes than current cutoffs, that might well not be the case, as many people would move towards the partial benefits (with higher income now being worth earning) instead of taking the full benefits. Certainly it ought to be looked at.

It’s a horrible system that earning further income results in having no more money to show for it. If the actual intent were to improve the country and people’s lives, this would be changed to where at any income level, earning more meant you had more.

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In Maine, a single mother with two children earning minimum wage qualifies for many government programs (TANF, food stamps, day care, etc) to the tune of about $56,000 after taxes, including min. annual wage of about $13,500 (2006 numbers)-- all these things have gone up due to legislated “indexing”:

These are the numbers for the benefits available for a
Single Mom with 2 children making minimum wage

Benefit Hourly Weekly Annually
Min Wage $6.50 $260 $13,520
ASPIRE $6.25 $250 $13,000
Food Stamps$2.50 $100 $5,200
TANF $2.88 $115 $5,980
MaineCare $6.25 $250 $13,000
Misc Reimb. $1.00 $40 $2,080 Transportation, Clothes, Auto Repair�¢â?¬�¦
Federal Taxes $2.27 $91 $4,716 Earned Income Credit
State Taxes $0.00 $0 $0
Social Security Taxes ($0.50) ($20) ($1,034) Pay 7.65% SS

hourly weekly annually
NET INCOME AFTER TAXES $27.15 $1,086 $56,462
Including State Paid Benefits

Compare to:

Single Mom with 2 kids making $13/hr

hourly weekly annually
Wages $13.00 $520 $27,040
Social Security Taxes ($0.99) ($40) ($2,068)
State Taxes $0.02 $1 $39
Federal Taxes $1.71 $69 $3,565 Earned Income Credit
NET INCOME $13.74 $550 $28,576

11

[quote]orion wrote:
Actually, this being a democracy, [/quote]

Plutocracy, who’s economy metastasized into full blown corporate protectionism…you mean. :wink:

12

Probably one of the better threads I have read on this site. Though I am suprised as to your motivation for caring so much about the US economy if you are from Austria, being the great birthplace of Austrian Economics.

The data you posted confirmed suspicions and case studies I have dealt with. I have seen friends of mine, divorced families and deadbeat dads with mothers literally slaving away to provide for their children and they seem worse off for it. My one friend particularly paid his way through college and everything else for that matter while his mother made about 10-12 an hour with 3 kids. They didnt take a dime in entitlement programs. Similarly I see welfare parents driving escalades. I also particularly liked the mention of the underground economy, which is huge in urban america. Drug dealing, barber shops, salons, other person to person services can account for thousands of dollars off the books while someone is recieving mass amounts of government aid. I wonder, if you stop the aid, maybe the dealing of drugs will also subside as a result of lost clientel (drug dealers woudlnt be hurt but their consumers would). Though the drug war is a whole seperate issue.

SteelyD’s data is also frightening and yes one wonders why THIS is not on CNN or capitol hill. Though it is a longshot, there are flickers of hope if one saw the "Audit the Fed’ bill hearing on CSPAN a few weeks back. There was a few representatives along with Dr Paul who were quoting Mises suprisingly. The data you showed also leads to the incorrect causation correlation argument of “the rich get richer and the poor get poorer because of capitalism”… which as we see …is not the case.

13

[quote]spurlock wrote:
orion wrote:
Actually, this being a democracy,

Plutocracy, who’s economy metastasized into full blown corporate protectionism…you mean. ;)[/quote]

The democratic element is important, because without the narrative of “democratic legitimacy” people would not stand for this shit.

14

[quote]666Rich wrote:
Probably one of the better threads I have read on this site. Though I am suprised as to your motivation for caring so much about the US economy if you are from Austria, being the great birthplace of Austrian Economics.
[/quote]

I care about incentive systems.

The underlying problem is the same in Europe but if I post about welfare in Austria who cares?

15

[quote]666Rich wrote:

The data you posted confirmed suspicions and case studies I have dealt with. I have seen friends of mine, divorced families and deadbeat dads with mothers literally slaving away to provide for their children and they seem worse off for it. My one friend particularly paid his way through college and everything else for that matter while his mother made about 10-12 an hour with 3 kids. They didnt take a dime in entitlement programs. Similarly I see welfare parents driving escalades. I also particularly liked the mention of the underground economy, which is huge in urban america. Drug dealing, barber shops, salons, other person to person services can account for thousands of dollars off the books while someone is recieving mass amounts of government aid. I wonder, if you stop the aid, maybe the dealing of drugs will also subside as a result of lost clientel (drug dealers woudlnt be hurt but their consumers would). Though the drug war is a whole seperate issue.
[/quote]

The drug war actually belongs in this thread.

Without keeping the price of drugs artificially high, those young gentleman of the entrepreneurial persuasion would actually have to find another way of trying to move up the social ladder.

Also a misguided incentive system.

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But, everyone FEELS better.

Hard to argue with feelings.

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Alot of people dont seem to realize that everything in life is incentive based. Change the incentives you change the game so to speak. A pretty popular read that illustrated that was Freakanomics. I really liked Levitt’s research into the incentive system.

I see the drug war as almost a misguided form of corporatism. Keep the drug price high you support dictatorships who profit off of it in South America, thus they give kickbacks in resources and contracts to the American government. Then it gives an excuse to meddle in foreign affairs similar to how bills in congress are an excuse to write in earmarks. It also uses the tool of fear as an expansion of federal power.

This might sound perverse but the major players in drug dealing did not get there by accident, they have pretty astute business skills and keep accurate accounting records. Like you said, imagine if the incentives changed to facilitate these men pursuing honest business instead.

18

[quote]666Rich wrote:
Alot of people dont seem to realize that everything in life is incentive based. Change the incentives you change the game so to speak. A pretty popular read that illustrated that was Freakanomics. I really liked Levitt’s research into the incentive system.

I see the drug war as almost a misguided form of corporatism. Keep the drug price high you support dictatorships who profit off of it in South America, thus they give kickbacks in resources and contracts to the American government.

Then it gives an excuse to meddle in foreign affairs similar to how bills in congress are an excuse to write in earmarks. It also uses the tool of fear as an expansion of federal power.

This might sound perverse but the major players in drug dealing did not get there by accident, they have pretty astute business skills and keep accurate accounting records. Like you said, imagine if the incentives changed to facilitate these men pursuing honest business instead.[/quote]

Look at the post above yours.

Dont you know that people do not react to incentives but to feelings?

“Animal spirits” if you will.

That is real “voodoo economics”.

Aha, they are under the wrong spirit, let us replace it with the right one!

Now you also know why the Asian economies were so successful “tiger economies”.

They simply had the right animal spirit.

edited

19

There was a pretty decent article about this in a recent issue of Forbes.

A couple major talking points:

[i]While the first $60,000 of her income would be lightly taxed, the next $60,000 would be hit with what is in effect a 79% tax rate. Given a choice between a part-time or easy job paying $60,000 and a demanding, stress-ridden job paying $120,000, Lederman would be wise to take the former. In the tougher job she would be contributing twice as much to the economy. But she wouldn’t be doing herself much good.[i]

[i]With their older son in his freshman year at Colgate and their middle son a high school senior eyeing similarly pricey schools, Denver residents Randy S. and Valerie Lewis decided she’d have to go back to work after 17 years as a stay-at-home mom. Valerie, 46, is applying for local teaching jobs paying $35,000. If she lands one, taxes will eat up $15,000 and the need-based aid they’d be eligible for will decline by $10,000, figures college finance consultant Troy Onink, who runs Stratagee.com.

That leaves the Lewises $10,000 ahead if she works.
[/i]

“Don’t think the American public is stupid,” says Cheryl Morse, a tax practitioner in eastern Massachusetts with both middle- income and affluent clients. “People call me and say, ‘What’s the most I can earn before I lose the earned income tax credit?’ [They] may not understand marginal rates, but they’re shocked when they lose the college or child credits. You hear all the time, ‘The harder I work, the more they take away from me.’”

20

One other interesting thing to remember when discussing this topic is to remember that those that are not looking for jobs do not count against the unemployment rate. That means creating an incentive to not work simultaneously lowers the unemployment rate, in addition to all of the other effects of such incentives.

So these government handout policies not only get votes from the feel good crowd, they are also able to claim a drop in unemployment. Of course, we know here that the drop has nothing to do with added jobs or an expanding economy.