A Bipartisan Tax Idea: Let’s Quit Punishing Indiana’s Working Poor

February 4, 2013

For the use of the membership only (525 words)

by ERIC SCHANSBERG, Ph.D.

Talk of taxes and tax reform is in the air again. At the federal level, the “Fiscal Cliff” of Jan. 1 was more about political theater and procrastination than effective solutions. Less publicized, the most recent phase of ObamaCare brought some new taxes.

In addition, the 2 percent “holiday” on payroll/FICA taxes ended, resulting in much higher taxes for all workers. Politicians in Washington generally ignore this most burdensome aspect of income taxation — 15.3 percent of every dollar earned (up to a cap of $110,100). This is regrettable, especially since the FICA hammers the working poor and those in the middle class. For example, someone earning $20,000 loses about $3,000; someone earning $60,000 loses about $9,000.

At the state level, Indiana is talking about tax cuts, given its projected budget surpluses. Gov. Mike Pence has proposed a reduction in the marginal income-tax rate from 3.4 percent to 3.06 percent. If I were king, I’d reduce income taxes overall but specifically would eliminate state income taxes on the working poor and expand the state’s “Earned Income Tax Credit” (EITC).

The EITC is a “tax credit” for “earned income” — monies paid to those in lower-income families who earn wages. The idea is to subsidize those who are working but earning an income that is too low to support a family.

Often, people embrace the minimum wage as a policy to reach this goal, but a higher minimum wage also increases the cost of hiring low-skilled workers, making it more difficult to employ them. The EITC has the merit of keeping low-skilled workers attractive to firms, allowing them to build job market skills and pick up valuable job experiences, while subsidizing their earnings to help them support their family.

The federal government has a significant EITC that offsets some or all of the FICA tax on low-income households. About half of the states offer an EITC. States might embrace or expand an EITC to further offset the federal income-tax policy — or beyond that, to subsidize those who are working but struggling to make ends meet. Indiana’s EITC is set at 6 percent of federal credit (and refundable if one’s tax liability is reduced below zero), but it could be expanded.

Indiana imposes income taxes on parents and children living at or near the poverty line. For a two-parent household of four at the poverty line, Indiana has the 12th highest burden in the nation at $108. Looking at 125 percent of the poverty level, a one-parent household of three pays $206 (16th highest); a two-parent household of four pays $413 (11th highest). In this last category, our neighbor Kentucky takes $1,021 — tops in the nation. (I guess it’s good to see Kentucky #1 in something.)

The EITC and eliminating taxes on the working poor should make sense to liberals and conservatives. Those on the political left claim to care about the poor, although this is usually more about posing than policy. Those on the right want to encourage hard work, efficiency and so on. How can those on either side be fond of income taxes on those trying to survive on an income near the poverty line?

D. Eric Schansberg is professor of economics at Indiana University Southeast (in New Albany), the author of “Turn Neither to the Right nor to the Left” and an adjunct scholar for the Indiana Policy Review Foundation.

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