Finding an Opportune Way to Expand the Earned Income Tax Credit

President Obama announced only one major new proposal during last night’s State of the Union address. Here’s what he said:

I agree with Republicans like Senator Rubio that it [the EITC] doesn’t do enough for single workers who don’t have kids. So let’s work together to strengthen the credit, reward work, and help more Americans get ahead.

Having worked on the EITC and other wage subsidies for a long time (and having introduced them at a crucial stage of tax reform efforts in the 1980s), I say it’s about time they were back on the table. Particularly since the onset of the Great Recession, policy discussions around helping those with lower incomes have focused on unemployment insurance, food stamps, and government-subsidized health insurance. Employment needs to move toward the front of our public policy agenda.

As necessary as these other social safety net programs might be—and am not trying to assess their merit here—they generally do not encourage people to stay in the workforce. Like the welfare of old, before the onset of reform of what then was Aid to Families with Dependent Children (AFDC), they provide the greatest benefit to those who do not work at all.  While it’s debatable whether a simple EITC expansion increases total labor supply, there is almost no doubt that per dollar of cost it increases employment more than many other social welfare provisions.

Employment has been a vexing and growing challenge for the American economy. The share of all adults who work—also called the employment rate— was declining even before the Great Recession, particularly among the young and the near-elderly. Indeed, a declining employment rate represents a far bigger and longer-term issue than unemployment, since the NON-employment rate includes both those who are unemployed and those who drop out of or never join the labor force.

Concern over employment makes wage subsidies fertile ground for bipartisan consensus, if—and this is a big “if” in these partisan times—both sides can claim victory from the deal.

Consider the history the EITC. Almost every president since Richard Nixon has signed legislation establishing the EITC, expanding it, or making some provisions permanent. And it’s been bipartisan. The  initial enactment and the largest increases all occurred under Republicans—Ford, Reagan, and George H.W. Bush, while the expansion during the Democratic Clinton administration was also quite significant.

Many who backed these legislative changes did not view the credit in isolation. They often favored it over some alternative—welfare for Senator Russell Long (the EITC’s first champion) and a minimum wage increase for President George H.W. Bush. Or they accepted the EITC as part of a broader tax or budget package. The EITC was never the subject of stand-alone legislative action.

That leads us to today, and what compromises might be supported by both political parties. I suggest two possibilities.

One, following our historical pattern, is to expand the EITC as an alternative to other efforts. At some point, recession-led unemployment insurance expansions will end. A bill to increase the minimum wage might go nowhere. Might an expanded wage subsidy be a compromise?  A broader tax or budget bill always presents possibilities. The EITC offers one way to mitigate the net impact on lower-income populations, whether offsetting  losses from new deficit reduction efforts, or ongoing cutbacks due to sequestration or dwindling appropriations.

The other is to tweak the EITC so it interacts better with other policy goals, such as reductions in marriage penalties—a cause often advocated by Republicans. The childless single workers identified by the president are not the only ones left out of any significant wage support. So also are many low-income married workers. Despite recent changes, the EITC still creates marriage penalties, particularly if a low-wage worker marries into a household already receiving the maximum credit. Such a low-wage worker often fares worse than a single person who gets nothing or almost nothing: once added to the household, the additional worker’s income can phase out his partner’s’ EITC benefits and reduce or eliminate any previous eligibility for other public benefits. Current government policy announces that it is more advantageous to stay unmarried.

Simply expand the current, very small, credit for childless single people, and marriage penalties would multiply in spades. I suggest including in any expansion low-wage workers who decide to marry or stay married, not only those single persons left out. Such an expansion would proceed largely along the same lines as the president’s, but also reduce marriage penalties .

In sum, the president’s best path to bipartisan support for the EITC is to stress more policies that favor employment, offer the expansion as a compromise from other efforts less favored by his opposition, and reduce marriage penalties.

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.

Allocating Monies Where Unemployment Is Highest

As Congress debates how to unwind from all the debt it is accumulating, it continues to face high unemployment around the nation. One possible deficit-reducing approach is to provide greater assistance or revenue sharing to those regions, or people in the regions, most suffering from high unemployment, while reducing some across-the-board supports.

To examine variation in unemployment, I would like to draw attention to some of the interesting interactive graphs available from Urban Institute’s MetroTrends web site. The graph below looks at unemployment in the top 100 metro areas in the United States. By clicking on a city, you can look at the unemployment rate going back to 2000 or compare unemployment between two cities.

Below is a screenshot; the interactive graph can be found at

Employment and That Magical Year, 2008

Everyone knows that 2008 promises to be a bellwether year, rife with dramatic changes already glimpsed. Some harbingers of change are obvious. A new president will be elected—though campaigns hide as much as reveal what that president will choose or be forced to do. The subprime mortgage market also portends dramatic changes in the financial markets in 2008 and beyond. But perhaps the biggest change of all is a sleeper so far—the first year of a scheduled drop-off in employment growth that will last for some 30 years running. If this decline is left unchecked, the net impact on employment will be far greater and longer lasting than the temporary employment dip during the Great Depression.

Suppose that the economy was about to suffer the equivalent of an increase in the unemployment rate of about 3/10 of 1 percent every year for the next 30 years. Further suppose that in many of those years, the number of workers declined rather than rose. Meanwhile, suppose that the rate of revenue growth declined along with employment growth—at the very same time that the rate of government spending starting rising rapidly because more and more people qualified for “elderly” benefits.

If you were an official in charge of economic policy, would you be worried? If you’re an investor in stocks and bonds, should you be concerned?

Well, you should be. These ominous trends and more are now at the starting gate. The unprecedented mega-transition scheduled for the U.S. economy stems from both demographics and public policy. The rise and coming fall in employment of the baby boom generation—those born between 1946 and 1965—provides much of the demographic impetus.

Tracing the impact of the baby boomers on the economy over the years has often been likened to following a pig swallowed by a python. First, the boomers affected their parents’ demand for post-World War II housing. Then their ranks swelled enrollment in primary and secondary schools. From the mid-1960s to the mid-1980s, college enrollment ballooned. Lately, the baby boomers have been stocking away retirement assets, adding to the national total, and, through increased demand, driving up the prices for second and vacation homes.

So how does the swallowed pig affect the national employment picture? When the Reaganites and the Clintonites brag about job growth during the 1980s or 1990s, they are mainly trying to claim personal credit for the number of human eggs fertilized from 1946 through 1965. Those embryos became babies who became workers and swelled the labor markets a few decades later.

Two other demographic factors added to labor market buoyancy and lack of fiscal pressure during the period that boomers stocked the workforce. First, these boomers came on the heels of a baby bust population born during the Depression and World War II, so growth in the ranks of the elderly was restrained. Also, women entered the labor market in droves, eventually reaching employment levels close to men’s.

One net result was that U.S. employment grew 12 percent in the 1950s, 20 percent in the 1960s, 26 percent in the 1970s, 20 percent in the 1980s, and 15 percent in the 1990s. From 2000 to 2007, the growth was roughly 7 percent.

Public policy adjusted to the pig in the belly of the snake partly by taking advantage of the additional revenues provided by the new workers. Occasionally, elected officials increased subsidies for housing, education, and retirement saving to accommodate this generation. They also offered more and more years of retirement support and higher annual benefits to each succeeding generation of retirees.

But that was then. If higher employment growth spurred economic demand and growth, as well as government revenues and spending, in the past, what is lower employment growth likely to mean for the future?

We often read statistics about when Social Security funds will become inadequate to pay promised benefits. But the current system’s obligations aren’t confined to giving bigger benefits to more people. Besides that tall order, policymakers will have to deal with the projected decline in revenue growth rates as close to one-third of the adult population moves onto Social Security.

We can hold off on the hand-wringing only if we believe that demand for older workers will swell and that many boomers will stay in the workforce. I, for one, think that can happen and that many of the doomsday scenarios for this new labor market are wrong. Yet, the supply of older workers will be crimped as long as public and private employment policies stay rooted in the 1970s—or even the 1990s. How fast and well employers and government officials adjust will determine whether demographic changes poised to unfold starting in 2008 bolster or drag down the economy. Among the tallest of orders is to move away from private and public policies that now encourage retirement in middle age—a subject for another time.