Which Americans pay the highest effective marginal income tax rates? Most folks would probably say, “With a progressive income tax, it’s obviously the highest-income earners.” Perfectly logical response, and also wrong. Actually, with our hodgepodge of welfare/income support programs, it’s the lowest earners who see the highest effective marginal income tax rates.
Look at all the public benefits available to those with low or no earned incomes. A list of major programs includes subsidized health care/health insurance (Medicaid, Obamacare, Indiana’s Hip 2.0), subsidized housing, the Earned Income Tax Credit, food stamps (now called SNAP), and Social Security Disability. That’s just for starters.
All these programs have one thing in common: As your work income increases, your benefits go down and are eventually eliminated. If someone’s earned income is so low as to qualify for several of these programs, the effective tax rate on additional income can run 50 percent to 90 percent. Each dollar of additional work income costs you an almost equal amount of lost cash or in-kind government assistance. Depending on the state and income range, it can actually exceed 100 percent.
Economists often call this the “poverty trap.” Why work or find a better-paying job if it makes you no better off? Pretty much everyone agrees this is lousy, but no one yet has come up with a good answer.
One way is to eliminate all these programs—which, by the way, will not happen. Another is to not phase out eligibility as incomes rise, but this would create even crazier, perverse incentives. Everyone would have an incentive to contrive a period of low or no income, qualify for subsidies, then collect those for life no matter how high income goes. Warren Buffett on food stamps?
One idea receiving serious attention in policy circles is a “Universal Basic Income.” UBI schemes come in various flavors, but all involve repealing existing means-tested welfare programs. Replace them with a small, government-provided income for every adult, something like $800 a month, which you don’t lose if your income rises. Questions abound: How much would this cost? Is the stipend enough or too much? What about health insurance? Should the UBI phase out at $40,000, $100,000, $500,000?
Both free-market economist Milton Friedman and left-of-center George McGovern embraced UBI in the 1970s. Today, Libertarian Charles Murray and various European socialist parties are making serious UBI proposals. Don’t worry: You will hear more.•
Bohanon is a professor of economics at Ball State University. Styring is an economist and independent researcher. Both also blog at INforefront.com. Send comments to firstname.lastname@example.org.