Timothy Taylor reviews some of the CBO’s findings in its Effective Marginal Tax Rates for Low- and Moderate-Income Workers report. He concludes (referencing the graph below in part):
These high marginal tax rates on those with low and moderate levels of income raise some questions for those on all sides of the tax debates. For those who don’t believe that high marginal tax rates have much affect on incentives to work at higher income levels, like households earning $250,000 or more per year, consistency would seem to suggest that they shouldn’t worry too much about incentives to work at lower income levels, either. For those who express a lot of concern about how high marginal tax rates would injure incentives to work for those at the top income levels, consistency would seem to suggest that they express similar concern over lower marginal tax rates for those at the lower and moderate income levels, too–which means making programs like the Earned Income Tax Credit, food stamps, welfare, and others more generous, so that they can be phased down more slowly as people earn income.
From the report itself, I particularly enjoyed this section on marginal tax rates and the decision to enter the workforce.
A person’s marginal tax rate influences many different decisions about working: whether to increase or decrease the number of hours worked, bargain for wages or nontaxable fringe benefits, get or quit a second job, or enter or leave the labor force. For people who are already working, an increase in marginal tax rates on additional earnings lowers the financial gain from working additional hours, which in turn has two effects:
- Hours worked tend to fall from their initial level because other uses of time become relatively more attractive; and
- Hours worked tend to increase from their initial level because the amount of additional disposable income (income after accounting for taxes and transfers) available to reach consumption and saving goals is lower.
Because those two effects work in opposite directions, the net effect depends on which one dominates.On balance, in CBO’s judgment, increases in marginal tax rates on earnings tend to decrease the supply of labor by inducing people already in the workforce to put in fewer hours or to be less productive. The responsiveness of labor supply to tax changes varies across groups. On average, working-age men are not very responsive to changes in marginal tax rates. Married women, who tended in the past to be the lower earner in the household, typically decreased their hours of work—on average—when marginal tax rates rose. In recent decades, their decisions about decreasing or increasing the number of hours worked have become more similar to those made by men.
Marginal tax rates that result from a relatively large increase in income are relevant to the decision to enter the workforce. For instance, because the earned income tax credit increases disposable income for all eligible workers, the ability to qualify for the credit makes work more appealing. Studies have found that expansions of the EITC between 1986 and 1996 significantly increased the movement of single mothers into the workforce but had little effect on the number of hours they worked.
This, I think, adds some granularity to the debate of the disincentives of things like the EITC; though I would add one very important caveat. The work incentive is only a component of the overall picture related to tax policy benefits for the unemployed and working poor. As the fiscal debate continues in Washington, I suspect the quantification of specific tax and spending policies will become very popular (rightfully so). What I will be interested in seeing is if there is any quantification of secondary and tertiary effects of policy changes. For instance, I have been reading quite a bit lately about the idea of progressive consumption taxes (something I’ve written about in the past) as an alternative to income taxes. Beyond the practical and political challenges of implementation; there are two problems I see with such a system (not to imply that these issues are without remedy).
- A PCT does not easily allow for fiscal policy shocks through the tax code. While tax preferences for certain behavior are generally distortionary and not beneficial, things like education and HSAs ought to be encouraged. Obviously tax relief for such spending could be implemented, but I think it amplifies some of the practicality concerns.
- I have seen no writing as of yet on the transition costs of such a system. Businesses, individuals, investors, savers, spenders, charities, etc. have all developed systems based on an income tax structure. Not to say the status quo is best by virtue of being the status quo, but there are certainly costs for any change that must be analyzed.
Point 2 above really goes to my concern in the current and upcoming debate over taxes and spending. Will we properly access the impacts of our various tax and spending proposals? Will we consider the fact that by incentivizing increased transitions from the unemployed poor to the working poor without increasing HHS benefits, we are potentially disincentivizing focusing on children’s behavior.
The numbers mandate action on the fiscal front and I am very much in favor of creating work incentives, but that probably also means maintaining strong familiar support for certain segments of society.