Why Tax and Transfer Programs Often Discourage Work and Savings

By :: February 14th, 2013

Economists and many policymakers generally agree that our tax and transfer systems should promote opportunity, work, saving, and education rather than consumption. The problem is these programs often penalize people for earning that extra dollar of income. Rather than promoting work and savings, these implicit taxes punish such otherwise positive behavior.

These penalties occur in TANF (formerly welfare), SNAP (formerly Food Stamps), Medicaid, the new health exchange subsidy, Pell grants, student loans, and unemployment compensation. The tax code also is loaded with disincentives to work, save, and study. They include PEP and Pease (reductions in tax allowances for personal exemptions and itemized deductions), child tax credits, and the earned income tax credit. These implicit taxes combine with explicit taxes to create incentives for many households that are often inefficient and inequitable, to say nothing of strange and anomalous.

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

One way couples avoid some of these penalties or taxes is to not get married. Indeed, this strategy is the major tax shelter for low- and moderate-income households with children. Our tax and welfare system thus favors those who consider marriage optional—to be avoided if it raises taxes or reduces benefits but embraced if it comes with a financial bonus.  The losers tend to be those who consider marriage a social or religious necessity.

These high rates and marriage penalties occur partly because of the piecemeal fashion in which they are developed.  Designing 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.

8Comments

  1. Tax Roundup, 2/14/2013: Happy Valentine’s Day! Oh, and tell me more about your illegal tax shelter, honey! « Roth & Company, P.C  ::  10:01 am on February 14th, 2013:

    […] Gene Steurle, Why Tax and Transfer Programs Often Discourage Work and Savings (TaxVox): […]

  2. Secondary Sources: Discouraging Work, Potential Output, Economics of Love | Hillbilly News  ::  11:03 am on February 14th, 2013:

    […] –Discurgin Wurk, Savin: Gene Steuerle looks at hoe sum tax and transf'r programs discourage wurk and savin. ” Ekunomists and minny a policymakers generly agree at air tax and transf'r systems should promote oppertuntee, wurk, savin, and skoolin rath'r thun consumpshun. T' problem is these programs ofte penalize folk fer earnyun' at xtrey doller o'income. Rath'r thun promotyun' wurk and savins, these implicit taxes punish such otherwise positif' behavier. These penaltees occur n' TANF (fermerlee welfare), SNAP (fermerlee Food Stamps), Medicaid, t'new heelth exchange subsidy, Pell grants, student loans, and unemployment compensashun. T' tax code also is loded wit disinsantives to wurk, save, and study. Thay include PEP and Peese (reductyuns n' tax allowances fer personal exemptyuns and itemizd duckshuns), youngn tax credits, and t'earnt income tax credit. These implicit taxes combine wit explicit taxes to creete insantives fer minny a households at air ofte inefficient and inekwitabull, to say nuthin o'strange and anomaleeus.” […]

  3. Michael Bindner  ::  6:22 pm on February 14th, 2013:

    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.

  4. Secondary Sources: Discouraging Work, Potential Output, Economics of Love – Real Time Economics – WSJ  ::  5:07 am on February 15th, 2013:

    […] –Discouraging Work, Saving: Gene Steuerle looks at how some tax and transfer programs discourage work and saving. ” Economists and many policymakers generally agree that our tax and transfer systems should promote opportunity, work, saving, and education rather than consumption. The problem is these programs often penalize people for earning that extra dollar of income. Rather than promoting work and savings, these implicit taxes punish such otherwise positive behavior. These penalties occur in TANF (formerly welfare), SNAP (formerly Food Stamps), Medicaid, the new health exchange subsidy, Pell grants, student loans, and unemployment compensation. The tax code also is loaded with disincentives to work, save, and study. They include PEP and Pease (reductions in tax allowances for personal exemptions and itemized deductions), child tax credits, and the earned income tax credit. These implicit taxes combine with explicit taxes to create incentives for many households that are often inefficient and inequitable, to say nothing of strange and anomalous.” […]

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