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John C. Goodman / Apr. 20, 2014

Why Are the Poor, Poor?

Have you ever wondered why poor people are poor? It's not as though there aren't plenty of role models around. Millions of people live highly successful, productive lives in this country. So why don't people at the bottom of the income ladder copy the behavior of those several rungs above them and better their lot in life? As I wrote previously, the federal government's own pilot programs established conclusively from the very early days of the War on Poverty that the welfare state encourages people not to be married, not to work and not to invest in human capital.

Have you ever wondered why poor people are poor? It’s not as though there aren’t plenty of role models around. Millions of people live highly successful, productive lives in this country. So why don’t people at the bottom of the income ladder copy the behavior of those several rungs above them and better their lot in life?

As I wrote previously, the federal government’s own pilot programs established conclusively from the very early days of the War on Poverty that the welfare state encourages people not to be married, not to work and not to invest in human capital.

This is Gene Steuerle before a House Ways and Means subcommittee:

The chart below shows a hypothetical example whereby a family (single parent and two children) can receive nearly $30,000 in government benefits with no household earnings, but only about $10,000 in government benefits with $35,000 in household earnings.

So if the mother earns, say, $35,000 she loses about two-thirds of that amount in lost welfare benefits, and that’s not even counting what the government will take in income and payroll taxes.

Steuerle’s chart shows what incentives look like at a point in time. But activities today affect benefits tomorrow. For example, working and earning wages produces Social Security benefits and perhaps a private pension at the time of retirement. What do the incentives look like when we look at the lifetime effects of earning wages today?

That question was addressed in a study for the National Center for Policy Analysis by Jagadeesh Gokhale, Laurence J. Kotlikoff and Alexi Sluchynsky (NBER version here.) The authors explicitly incorporate future Social Security benefits as well as current payroll taxes to calculate lifetime marginal tax rates. They conclude that:

• Americans at every income level face a lifetime marginal net tax rate greater than 50 percent.

• That is, for every dollar they earn, they will lose more than 50 cents in higher taxes and reduced transfer benefits.

Furthermore, the highest marginal net tax rates are not imposed on the highest-income families. They are imposed on those with the lowest earnings. For example:

• At two times the minimum wage ($42,800), working couples get to keep less than 30 cents out of each dollar they earn.

• At 1.5 times the minimum wage ($32,100), they get to keep less than 20 cents out of each dollar they earn.

• By contrast, a couple earning $200,000 a year gets to keep 44 cents.

In a follow up study, Kotlikoff and coauthor David S. Rapson calculate the effects of working more hours for people at different income levels. They conclude that effective marginal tax rates are generally and substantially higher for lower-income households than for high-income households.

• For 30-year-old couples earning $20,000 the marginal tax rate on an additional dollar earned is 42.5 percent; yet those earning $50,000 a year face a marginal tax rate of only 24.4 percent.

• At age 45, couples earning $30,000 a year face a higher marginal tax rate (41.9 percent) than do those earning $200,000 a year (35.9 percent).

• At age 60, couples earning $10,000 a year face a marginal tax rate of 50.9 percent, compared to a 43.2 percent marginal tax rate for those earning $200,000!

Moreover, single-parent households who qualify for more benefit programs than do couples face astonishingly high marginal tax rates beginning at lower incomes. For example:

• At age 30, a single parent earning $10,000 a year faces a 72.3 percent marginal tax rate on an additional dollar earned due to their loss of welfare benefits; this rate is substantially higher than the 36.9 percent tax rate on the single parent earning $200,000.

• At 45 years of age, a single parent earning $20,000 faces a marginal tax rate of 42.9 percent; higher than a single parent earning $200,000.

• A 60-year-old single parent earning $10,000 a year faces a 50.9 percent marginal tax rate, while those earning $200,000 face a rate of 43.2 percent.

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