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.”

What do Milton Friedman, Ronald Reagan, and the current US Congress have in common with Joseph Stalin?

No, it’s not that they are dead.

Recently I appeared on one of those TV shows where a right-wing host interrupts the guest frequently. (Not that I had realized what it was. I had not heard of the guy, Glen Beck, and the producer had only told me they wanted me to talk about Washington’s reaction to new recession fears.) On the show I said I thought it would be a good idea if the recipients of tax rebates this time around included lower-income Americans, at least those workers who did not make enough to pay income taxes, but who did pay payroll (social security) taxes. This would be in contrast to the last 7 years of tax cuts which have left these people out. The TV host’s reaction was “Welcome to the show Mr. Stalin.” A media watch site called Media Matters for America picked this up, as an egregious comment even by the standards of talk show hosts. Of course the Democratic and Republican leadership of Congress, with the encouragement of the White House, have decided to include precisely these lower-income workers in the tax cuts this time. So I guess they are Stalinists. And Milton Friedman originally proposed the negative income tax, which was enacted as the Earned Income Tax Credit, and became highly successful when expanded by Ronald Reagan (1986) and Bill Clinton (1993). Quite a few Stalinists around!

I think the serious point is that conservatives like to think that they are keenly aware of the adverse effect of marginal tax rates on work incentives. Effective marginal tax rates on lower-income Americans trying to lift themselves out of poverty can be higher than on ultra-wealthy Americans. Yet the fixation of the Republican party from 2001 to 2007 was to make sure that the tax cuts went largely to the upper end and that they excluded workers at the bottom. Incentives are a third argument for tax rebates at the lower end, in addition to the two more familiar arguments we have been hearing: (1) income distribution, and (2) lower-income Americans will spend the money, which is supposed to be the point of the new fiscal stimulus.