Arnold Kling  

Low Income, High Marginal Tax Rate

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Jeff Frankel quotes Jeff Liebman:


"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.”

The problem is that when a poor person starts earning income, he or she loses eligibility to a variety of in-kind benefits, especially Medicaid.

In my view, the key to changing this is to change the default measurement of income from "only count cash income" to "include in-kind benefits as income." A cynic could say that those who prefer to ignore in-kind benefits do so in order to overstate poverty.

But the consequences are real. Because so many subsidies and benefits are phased out or cut off on the basis of cash income, the effective marginal tax rates on poor people are enormous.

The sensible approach is to include in-kind benefits as income. Then, in order to avoid an across-the-board cut in benefits, you would raise the cut-off and phase-out points be several thousand dollars, to allow for the effect of including in-kind benefits in income.

Jeff Frankel is my oldest friend in the economics profession, and it looks like he has a great new blog.


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CATEGORIES: Income Distribution



COMMENTS (8 to date)
manuelg writes:

> A cynic could say that those who prefer to ignore in-kind benefits do so in order to overstate poverty.

Nothing cynical about it. Overstating poverty is just one or two steps away from aiding the eternal perpetuation of massive bureaucracies.

> In my view, the key to changing this is to change the default measurement of income from "only count cash income" to "include in-kind benefits as income."

Very sensible recommendation, for anyone who _actually_ cares about raising the fortunes of the lowest margins.

Psychohistorian writes:

Wouldn't it just make more sense to use a sliding scale for cash income?

Relevant in-kind income comes from the government; for any other kind of in-kind income, the recipient would rather it not be counted anyhow. Simply reducing payments as income went up without ever cutting off a large payment would fix, or at least significantly improve the system. For Medicaid one could require co-payments or a deductible after a certain income level, and then cutting off eligibility when prices became comparable to private insurance.

Obviously, this might not be feasible and it might be too complex, but it doesn't seem that counting the in-kind benefit is the issue - it's taking it all away at once.

ed writes:

Another factor to consider is that the high effective tax rates create a huge incentive to earn under-the-table income, or to otherwise cheat the tax/benefit system. I believe such cheating is very widespread.

Josh writes:

Your ideas are so sensible. I wish you had better hair so you were eligible to be president.

8 writes:

Overstating poverty is just one or two steps away from aiding the eternal perpetuation of massive bureaucracies.

In Massachusetts, the state has advertisements telling people to sign up for welfare.

Is including in-kind benefits as income the same as cutting the benefits, because of taxes? Also, what happens when people making $40,000 a year see that people on welfare are getting $35,000 in benefits? It seems that the solution is to cut benefits so they won't miss what they never had, or increase benefits and the number people who are on welfare.

Michael Sullivan writes:

I don't understand how including in-kind benefits helps this problem enough to matter much.

The problem is that certain benefits and subsidies have relatively hard cut-off points. Earn 10k you get a subsidy worth 3k, earn 10,500 you get nothing. Counting in kind benefits gives a cushion that eliminates marginal rates above 100%, but that's it. 100% marginal tax rate is still a pretty poor incentive to earn more.

Ideally you want the marginal rate to be in the 40% range or less, so that the incentive structure is no worse than what typical upper middle class workers face.

Floccina writes:

...or replace it all with an hourly wage susidy.

Garrett Kester writes:

We cannot depend upon the Federal Reserve to continue lowering the interest rates without any inflationary consequences. A new Home Owners’ Loan Corporation would be a very good idea with the current house market state being one of the large contributors to our near recession. Increased global regulations will also help stimulate our economy considering within the past couple of decades our balance of trade has switched to a trade deficit mainly from China. Income inequality definitely needs to be fought in order to encourage more spending than saving. Having an estimated $50 trillion debt to social welfare programs like welfare needs to be paid attention to before future generations are denied supposedly guaranteed financial support. FICA which helps to pay for social security and Medicare; and other payroll taxes which act as tax incidences, or the manner in which the burden of a tax is shared among participants in a market. Congress decided that FICA’s tax incidence should be shared between the firm and employees half and half, but research shows that lawmakers cannot so easily determine the distribution of tax burdens. In all, our economy will bounce back as long as precautions are followed correctly and future decisions considered with economic consequences in mind.
- This shows the need for a president which believes in a free market, which has been proven to lead to more economic growth

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