“Continued dependence upon relief induces a spiritual and moral disintegration fundamentally destructive to the national fibre. To dole out relief in this way is to administer a narcotic, a subtle destroyer of the human spirit… We must preserve not only the bodies of the unemployed from destitution but also their self-respect, their self-reliance and courage and determination.”
-President Franklin D. Roosevelt, 1935 State of the Union Address.
Background: In 1996, a Republican Congress passed, and Bill Clinton signed, the Personal Responsibility and Work Opportunity Reconciliation Act. This law turned the Aid to Families with Dependent Children (AFDC) program into a reformed Temporary Assistance for Needy Families (TANF) program. However, sixteen years later, there are still approximately 70 means-tested welfare spending programs. Since President Lyndon Johnson declared a “War on Poverty” in 1964, Americans have spent $16 trillion on means-tested welfare. All levels of government may spend another $10 trillion over the next decade based on recent projections.
A means-tested welfare program provides benefits to individuals based on income. This is in contrast to Social Security, Medicare, and other such entitlement programs that provide benefits linked to contributions made by the individual. In order to confine benefits to intended beneficiaries, means-tested programs phase-out as income increases. These phase-outs, along with the tax code, result in extremely high implicit marginal tax rates for many individuals. These rates can exceed 100%. In other words, someone is made financially worse off for earning more money.
However, it is actually very difficult for an individual to determine whether working more, or getting a job that pays more, will result in a smaller personal budget. This is for two reasons:
Ø First, there are about 70 different means-tested welfare programs, each with its own eligibility criteria.
Ø Second, no federal agency is responsible for figuring out how all of these programs (and the tax code) interact with each other in terms of the incentive to work. There is not a federal report that provides a comprehensive analysis of this issue. Here is former Chairman of the Council of Economic Advisors, Greg Mankiw, calling for such an analysis to be conducted by CBO.
What Is the Implicit Marginal Tax Rate?: The marginal tax rate illustrates how much money someone can keep, after accounting for taxes, from an extra dollar earned. Counting the income tax, the payroll tax, and state and local taxes, the top marginal tax rate comes close to 50% in many states (see here for an analysis from the Tax Foundation on this point).
But the welfare state adds another dimension to this. Many individuals, especially lower-income and working-class families, face not just higher taxes but also less government benefits for each dollar earned.
When both: 1) higher taxes and 2) foregone government benefits are accounted for from an extra dollar earned, you get the implicit marginal tax rate.
Selected Examples of the Problem:
Ø Jeff Liebman, an economic advisor to President Obama, tells the story of a lady who went from earning $25,000 a year to $35,000 a year, and could not make ends meet anymore as a result. See here for the details. He estimated that the government imposed a 130% implicit marginal tax rate on her.
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