How Tax and Transfer Policies Affect Work Incentives

When the design of safety net programs is considered alongside that of our tax code, it is easy to see that our tax and transfer systems need to focus less on increasing consumption and more on promoting opportunity, work, saving, and education.

The government doesn’t affect work incentives just through direct taxes. Implicit taxes—that is, penalties for earning additional income—are everywhere, whether in TANF or SNAP, Medicaid or the new health exchange subsidy, PEP or Pease (reductions in tax allowances for personal exemptions and itemized deductions), Pell grants or student loans, child tax credits or earned income tax credits, unemployment compensation or workers compensation, or dozens of other programs. These implicit taxes combine with explicit taxes to create inefficient and often inequitable, certainly strange and anomalous, incentives for many households.

At some income levels, families face prohibitively high penalties for moving off assistance. Accepting a higher paying job could mean a steep cut in child care assistance for a single worker with children, for instance. For some, the rapid phaseout of benefits can offset or even more than offset additional take-home pay. Asset tests in means-tested programs create similar barriers to saving.

Not getting married is one way that people avoid some of these penalties or taxes and is the major tax shelter for low- and moderate-income households with children. Our tax and welfare system thus favors those who consider marriage an option—to be avoided when there are penalties and engaged when there are bonuses. The losers tend to be those who consider marriage a social or religious necessity.

The high rates and marriage penalties arising in these systems occur partly because of the piecemeal fashion in which they are considered. Efforts to design benefit packages more comprehensively could greatly improve both the incentives families face and the quality and choice of benefits they receive.

For more details, see my congressional testimony for today’s hearing on “Unintended Consequences: Is Government Effectively Addressing the Unemployment Crisis?” before the Committee on Oversight and Government Reform.


One Comment on “How Tax and Transfer Policies Affect Work Incentives”

  1. The problem is, there are too many tax benefits and subsidies. They need to be integrated. First, for those adults who are less than functionally literate, paid remedial education should be offered at a higher minimum wage ($12 per hour, with indexing). Additionally, if these students have children (including under-age parents), they should also receive a $500 per month per child tax credit from both the federal and state governments, as well as health coverage equivalent to what is offered to the employees of the training providers. To do anything less is to provide unequal treatment to those serving and those who serve (although training providers would get more than the minimum wage and pension savings whiled clients would not). I suspect that the desire not to do this has more to do with cultural and racial enmity and a desire to create a permanent lower working class than most are wiling to admit. I will admit it.


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