High Implicit Marginal Tax Rates Make Life Difficult for the Poor

November 15, 2013

This week, Slate published an interview with a food stamp recipient whose benefits were cut recently. The interviewee speaks well about the difficulty of providing her household with adequate nutrition. She also speaks well about the difficulty of improving her situation. She explains why she finds herself at a dead end:

Slate: Have you considered re-entering the workforce?

Debra: Yes, I’ve thought about it, and my daughter is also considering it. But my food stamps, rent [assistance], VA compensation, and social security would be affected. I’d have to make a lot of money to overcome all the reductions, something like $15 to $20 an hour.

SNAP is a program designed to help people pay for food – and in this, it succeeds. However, it is means-tested – that is to say, as you get relatively richer, your SNAP benefits get reduced, until eventually you don’t get it at all. Several welfare programs are designed this way, because for obvious reasons it seems silly to have financially sound people receiving benefits they don’t need.

However, as more and more of these programs have been added over the years, the effect Debra describes has been compounded; so many programs are means-tested based on income that some people aren’t helped much by additional income. The CBO did a great study on this a year ago. It found that the implicit marginal tax rates on some poor folk are frequently above 50%, and sometimes above 80%. That is to say, that when they figure out how to increase their income by a $100, they lose $50 or more in new taxes or lost benefits. The Urban Institute has done similar research. When this effect becomes extreme – and Debra perceives it to be extreme for her – people find themselves at dead ends where they can’t improve life for their families through work.

Over the longer range, of course, wage income does improve your life. For most people, earning more is really helpful. But for some people – particularly those between 100% and 150% of the poverty line – this effect doesn’t hold, because of the preponderance of means-tested programs. The ultimate result of this problem is that people make a rational, conscious decision to not work – and the rest of America loses out on their industry.

There is no fault with anyone here; nobody is a freeloader, nobody is greedy. It’s a purely technical problem with the way that welfare benefits are designed. The problem could be mitigated by coordinating between various programs and adjusting their phaseouts to protect the poor from this sort of trap.


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