The Dead Zone: Implicit Marginal Tax Rates and the New Democrat Majority

[roo_ster]

Folks, it is worse than you think, if you look at the numbers. 

We already have an underclass that, by means of government action, acts "rationally" by never getting a job.

Note: these numbers are based on current programs.  The "Dead Zone" of 100+% implicit marginal tax rates will go MUCH farther to the right (including much higher incomes) if the Obama health care reform goes through.

The key distinction is between marginal tax rate and implicit marginal tax rate. The marginal tax rate is the rate we all talk about - what absolute percentage of your last dollar earned will be taken by the government.

The implicit marginal tax rate is the absolute percentage of your last dollar taken by the government plus the loss of government benefits resulting from that last dollar. This implicit marginal tax rate can, and does, exceed 100% for the lower-middle and middle classes., and will expand under Democratic health care proposals.

To say that antipoverty programs in the United States are perverted may be an understatement. When you take into account the loss of means-tested benefits (e.g., cash assistance, food stamps, housing subsidies, and health insurance), and the taxes that people pay on earned income, the return to working is essentially zero for those in the lower two quintiles of the income distribution.

For many of the working poor, the implicit marginal tax rate is greater than 100 percent. The long-run consequence of undermining the positive incentive to work is, of course, the creation of an underclass acclimated to not working; the supplement of cash and noncash benefits with income from crime and the underground economy; and the government resorting to negative incentives such as mandatory work programs.

Below, I show the relationship between earned income and after-tax income plus subsidies for a hypothetical Virginia family of three, consisting of one adult and two minor children. As you can see, the relationship is essentially flat from $0 to about $40,000 in earned income.

To see exactly what is happening, I developed the following chart. It shows the implicit tax paid on the last $10,000 of earned income (initially by comparison to the welfare grant and then by comparison to income less taxes plus subsidies).

At A, the marginal tax rate is quite high, essentially because of the generosity of the package of cash and noncash benefits provided to those on welfare. At B, the marginal tax rate is relatively low (!) because of the Earned Income Tax Credit (EITC). From B to D, we (or, rather, the working poor) are in the Dead Zone, with implicit marginal tax rates mostly exceeding 100 percent.

...

At D, the family is finally done with jumping through the hoops to qualify and remain qualified for the give-away programs. Now all it has to concern itself with is paying taxes. But there is no rest for the weary because, at E, the child tax credit phases out.

...

Everywhere, the government's desire (meaning the left-liberal do-gooders' desire) to be generous to the poor is destroying the positive incentives to work and to save that are so necessary for a well-functioning economy. What they have done to Detroit, and are doing to New Jersey, they will do to the entire country.

In addition to all the other problems with highly subsidized, income-tested health care benefits, will come an even more permanent underclass which, being economically rational, will choose not to earn another dollar rather than lose more than a dollar of benefits.

Conservatives often speak of the Obama-Pelosi-Reid axis as seeking to create a permanent Democratic majority through big government handouts. This implicit marginal tax analysis shows that it is much worse than it seems; the permanent big-government majority will not be there by choice, but by government-created economic necessity.

Lower income voters, who pay no federal taxes and who are very voters facing this government-benefits trap, voted for Obama overwhelmingly, as this chart from the Tax Prof shows:

[Jocassee]

We're humped.

[AZRedhawk44]

What affect might inflation have on the entitlement curve?

I would imagine that in such a curve, inflation might be a good thing.

It reduces the actual cost of the stated benefits, and the eligibility level remains static while the adjusted-for-inflation value of earned income increases.

Between that and rabid fury of voters against entitlement-oriented Congressional incumbents, perhaps we can fight our way out of this quicksand?

[Balog]

The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money.

[MicroBalrog]

Mmm. Remember that Mises.org is run by the same Lew Rockwell that runs LewRockwell.com

[zahc]

Confirms what many have "known" for some time.

[brimic]

Meh, when Obamacare gets finalized, there will be no reason for anyone to work anymore.

Should be fun times for all.

[Nightfall]

Sometimes I struggle with the concept that perhaps I'm not totally sane if I'm not trying to milk the government for all I can, as so many make a decent life doing. For instance, I sit in a college class with a man who has never worked, but 1) has his school paid for with our tax dollars and 2) still has money to waste on such pursuits as sports betting. For crap sake, he walks to the cashier's window and they write HIM a check, while I plop down 4 more digits every quarter to continue. My wife and I save and skimp, and pay for school out of pocket. But how is that rational, when the guy sitting next to me can have everything I have without working a day in his life? Is pride the only thing left to motivate people to support themselves? 

[longeyes]

Don't worry, it's all only play money.  Should be a great boon for the Second Amendment.

[roo_ster]

Sometimes I struggle with the concept that perhaps I'm not totally sane if I'm not trying to milk the government for all I can, as so many make a decent life doing. For instance, I sit in a college class with a man who has never worked, but 1) has his school paid for with our tax dollars and 2) still has money to waste on such pursuits as sports betting. For crap sake, he walks to the cashier's window and they write HIM a check, while I plop down 4 more digits every quarter to continue. My wife and I save and skimp, and pay for school out of pocket. But how is that rational, when the guy sitting next to me can have everything I have without working a day in his life? Is pride the only thing left to motivate people to support themselves? 

A buddy of mine has a sister who games the system.  She learned how to by majoring in bulls** -studies (black, womens, etc.) where she learned how to be a professional and perpetual victim.

She has worked a grand total of two weeks in her life.  The litany of her spongecraft is nauseating to hear.

[ilbob]

A relative of my wife has three kids, no husband, father of children pays nothing.

She can afford a nice rental house in a not cheap to live in suburb of Chicago, along with all the amenities including cable TV and a big screen TV. Has not worked in a number of years on any regular basis.

Two of her three children are below school age and are going to some kind of day care at our expense. Not sure what the rationale is since she is not working or going to school. As best I can tell she has no intention of working at all.

Her sister has two different kids by two different fathers. Neither pays a nickle. Has a just above minimum wage job and car. Government pays for her to put her youngest in day care. WIC and section 8. At least she works.

[sanglant]

section 8 a fitting name? we report you decide 

[Monkeyleg]

I'm sure many of you have read about my old range buddy. He hasn't worked since 1985, but gets along just fine (just bought a nice late model car). He's been going shooting several times a week for 24 years and I haven't because, as he put it, "you have to work."

My neighbor has a much nicer house than mine. When he was laid off, they got food stamps and all the other goodies. He got new windows, siding and a new garage with an assist from a county program that pays for removing parts of houses that have lead paint. His wife has never worked.

In January of 2008, an old friend of my wife decided he was sick of working. He spent all of last year getting drunk and sitting around his apartment. When he ran out of money this year, and things were looking bad, another friend of my wife who knows how to scam the system told friend #1 about all the freebies available from the government. He even got a new cell phone.

The advisor (friend #2) has been operating antique stores under the government radar for decades. Didn't pay taxes of any type. Meanwhile he's been getting all sorts of freebies, from health care to rent assistance.

This is just a few of the bloodsuckers I know are bleeding the rest of us. I'm sick of it.