Following up on my preceding post, I asked my colleague here at Harvard, Jeff Liebman, about the evidence on the effective marginal tax rate facing low-income workers. (Professor Liebman is an expert in this area, which I am not. Incidentally he is also an economic advisor to Barack Obama.) Here is his response:
“Despite the EITC and child credit, the poverty trap is still very much a reality in the U.S. A woman called me out of the blue last week and told me her self-sufficiency counselor had suggested she get in touch with me. She had moved from a $25,000 a year job to a $35,000 a year job, and suddenly she couldn’t make ends meet any more. I told her I didn’t know what I could do for her, but agreed to meet with her. She showed me all her pay stubs etc. She really did come out behind by several hundred dollars a month. She lost free health insurance and instead had to pay $230 a month for her employer-provided health insurance. Her rent associated with her section 8 voucher went up by 30% of the income gain (which is the rule). She lost the ($280 a month) subsidized child care voucher she had for after-school care for her child. She lost around $1600 a year of the EITC. She paid payroll tax on the additional income. Finally, the new job was in Boston, and she lived in a suburb. So now she has $300 a month of additional gas and parking charges. She asked me if she should go back to earning $25,000. I told her that she should first try to find a $35k job closer to home. Also, she apparently can’t fully reverse her decision to take the higher paying job because she can’t get the child care voucher back (the waiting list is several years long she thinks). She is really stuck. She tried taking an additional weekend job, but the combination of losing 30 percent in increased rent and paying for someone to take care of her child meant it didn’t help much either.
The question is what is the policy solution here. Means-tested transfers have to be phased out at some point, so there is no easy answer. I think there are three things we might be able to do — all of which would, as you say, be a better use of revenue than tax cuts for the rich. First, make child-related tax benefits equal for all families (now they are high at the bottom because of the EITC and high at the top because the dependent exemption is more valuable the higher the tax bracket you are in, and the dip in the middle raises marginal tax rates by 21 percent for a family with two kids — so eliminating the dip would get rid of this 21 percent portion of the effective marginal tax rate). David Ellwood and I analyze this first idea. Also Sawicky and Cherry have put forth a similar idea. Second, in designing universal health insurance, we need to be very careful not to phase out income-related premium subsidies over the same income range where all of these other benefits are being phased out. Third, implement a delay between income increases and rent increases in section 8 — allow people to save up a bit before they are hit with the rent increase (I believe I read that some states have been trying out something like this recently, but I am not up to date on these policies). There are some excellent papers that carefully model how the cumulative effects of the welfare system create a poverty trap. But I don’t think either of these papers includes all of the factors facing the woman above — so they would probably indicate that she faced a 60 percent marginal tax rate rather than the 130% (or whatever it really is) rate that she actually faces.”
Low Income, High Marginal Tax Rate…
Jeff Frankel quotes Jeff Liebman: “There are some excellent papers that carefully model how the cumulative effects of the welfare……
Nancy Cauthen, at Columbia’s National Center for Children in Poverty, has done some good recent and very policy relevant work on this issue, see, for example, this paper: http://www.nccp.org/publications/pub_666.html.
This is a very interesting aspect of the EITC-reforms. Louis Kaplows article in International tax and public finance “Optimal income transfers” also deals with the high marginal effects on low income households generated by means tested social support.
Another aspect about this is that different groups in society perhaps should be taxed differently. Low marginal tax at low incomes for people with low earnings capacity and low marginal tax at high incomes for people with high earnings capacity.
In Sweden we are currently implementing such a scheme for people with disability pensions. They will be able to keep a lot of their original benefits as they try to come back into the labour market. It will be interesting to see the effects of having a “targeted negative income tax” to help reduce the marginal effects for people outside the workforce.
Personally I think the EITC is an ingenious system, but it should be seen in the light of US-style means-tested social benefits. In Sweden we have a tradition of not having a large proportion of means-tested benefits in the welfare system.
[...] Poverty Trap Kennedy School economist Jeff Liebman (via Jeff Frankel’s new blog) tells a sad story about the incentive effects of government programs aimed at helping the [...]
[...] Jeff Frankel (via Greg Mankiw): [...]
I suppose we’ll be really screwed as a country when information like this reaches the people not already gaming these means-tested programs, who then realize how little they are rewarded by society for their extra efforts.
Maybe that’s why elsewhere such notions tend to be dismissed as “talk radio” annecdotalism, and euphemised as marginal “tax” rates.
Perhaps the public policy types have done “enough” for us already. Color me skeptical if I don’t believe that another round of government sponsored economic reasearch is somehow going to reconcile the fundamental inverse proportionality between benefits levels and income phase-out rates. I’m afraid a nebulous “Yes, we can” ain’t gonna cut it either.
I think that implementing Negative Income Tax as a replacement of all other financial aid would solve this problem
[...] the Jeff Frankels Weblog, The Havard Kennedy School Of Government “Despite the EITC and child credit, the poverty trap is still very much a reality in the U.S. A [...]
The poverty trap otherwise known as the welfare plantation is another example of unintended consequences, but those that implement these policies “care”. For many that is all that matters.
I was raised VERY, self-sufficient! Served in the Air Force, 72-76, and was Medically Discharged! In the 90’s I found myself starting life over. With my two children, and two of his. Living in a run-down 1 bedroom, efficeincy apartment. I sent out applications to over 300 housing authorities in the state. Begging for help. There was no ‘Veterans’ subsidized housing (anymore)! When I finaly got an interview with a manager of one development, I begged some more. Give us one year, to get on our feet!
Once we moved in, (very nice unit, that use to be for Veterans), there was a girl next door, 2 small babies, who was living in the unit her mother before her had, had. Her ‘boyfriend’ came in every night (father of one of the two)after 5 when no one from the Authority would come around! Another lady, bragged she’d been there 28 years, and acted like she owned it!
At the end of one year, we bought what we could afford, not what we wanted! As we were getting moved out, we learned the girl (20) next door would be getting our unit, so her sister could take over her’s!
That’s WRONG! Most county housing authorities had nothing to offer, someone who really needed help. There were 3 and 5 year waiting lists, or the lists were flat out closed! While others thought it was their right to stay forever.
The girl next door, also had her children picked up at her door, 5 days a week, and delivered home in the evening! No, she didn’t work, she went to GED classes three days a week for 3 hours a day. Her and her boyfriend, partied every night, and frequently didn’t have the kids ready in the morning, when the van arrived, beeping it’s horn! (We worked swing shifts, and really appreciated it)
Yes, I believe in helping the poor, the elderly and the disabled! I believe in helping people who are willing to help themselves! NOT freebies, and handouts! If you want Public assistence, you should be willing to do Public Service.
I completely disagree, (as do most Americans) with yourprofessor Mr. Jeff Liebman; on his views concerning Social Security. 1) Those of us, over 50 have paid in our entire lives, based on the Promise by OUR government, the SAME benifits would be there for us. (I started at 14, making 90 cents an hour)2) The Social Security Fund, was never intended to have a surplus, in the 80’s the % was doubled to (& we paid) to ensure there was sufficient funds to cover the ‘Boomers’. 3) The Post WWII baby-boomers actually started to slow down, after 1950. Another 57,000 of us died in Vietnam, and God only knows how many more from Agent Orange since. Once, the baby-boomers are gone, social Security should go back to a pay-as-you-go system, no surplus. The US Treasury Notes held by the trust, have to be paid back, as they were taken out, In Good Faith of our Government!
IF, people want to have Private Retirement Accounts, there are more then ample opportunities! NOW! There is no point in having Savings Accts. or Money Market Accts. becuse the interest earned on them doesn’t even keep up with inlation! After the S&L debacle, then the Tech-Bubble, not to mention Enron and the rest of the corruption in our financial Institutions, and Wall Street! House loans with nothing down, re-finance for 140% of value! How do you trust ANY of THEM?????? We’re moving to Gold,(coins) and Euro’s!
I was wondering would these problems be alleviated by instituting a super EITC and loosen income limits on section 8 and child care.
[...] losing health insurance or facing non-covered preexisting conditions when switching employers (see this, for [...]
Well i am no harvard student but i do work in the real estate business and i have to say poverty in Las Vegas where i work is on the up. It is a shame that todays economic climate is creating more poverty and misery for young families who are loosing their homes. I think the government needs to take a very close look at this and try to reduce the amount of people who will be driven over the poverty line after loosing their homes.
Jeff, I worked in the Human services field up until recently and your post is right on. This is a HUGE problem and I worked with many single mothers who worked hard and were punished by the system (no more free health care, no more food stamps, no more housing vouchers) because they made too much (barely) for assistance. It almost made sense for them to under achieve and stay unemployed because they would have more benefits and income from the state for their families!! I saw this happen every day and the families who worked hard were the one’s who got punished. There needs to be major reform made because there are so many poverty stricken families being negatively affected and I saw it first hand.