Bohanon: Obamacare Is a Penalty on Bootstraps

September 30, 2013

by Cecil Bohanon, Ph.D.

Government programs designed to help the poor are usually means-tested. This implies that recipients only get the benefits if their income earnings are sufficiently low. Most see this as a good thing because it ensures that persons who do not need the benefits don’t get them. It seems daft to tax middle-class and wealthy citizens to provide benefits to middle-class and wealthy citizens; programs for poor folks should benefit poor folks.

Applying a means test to benefits, however, opens up a can of worms: It is a huge incentive problem for the very people we are trying to help.

When supply-side economists talk about tax disincentives, they are usually referring to the high marginal tax rates that well-off entrepreneurs face when contemplating new ventures. And yes, there is a lot of evidence that high marginal tax rates on the wealthy do discourage business investment, but the very rich do not face the highest marginal tax rates. That honor goes to the working poor.

Consider a single mom with two children who earns between $10,000 and 20,000 a year. Her household is eligible for a number of government benefits, including earned income-tax credits, child-tax credits, food stamps, free or reduced school lunch fees and other benefits. The problem is, if she earns additional income, almost all of those benefits get reduced.

A recent study by the Congressional Budget Office indicates that, for every additional dollar earned by a single mom in this income range, she takes home only 5 to 33 cents in additional disposable income. In other words, her additional taxes, coupled with benefit losses, implies that she faces a marginal tax rate of 66 to 95 percent. Why take on those extra hours of work or enter into that training program if the rewards are that small?

My progressive friends have a pat answer: Extend the benefits farther up the income ladder. But then we have the same situation on the next rung of working taxpayers.

Of the many objections to Obamacare, the one I find most compelling is it increases marginal tax rates for both lower- and middle-income earners. A traditional family of four with earnings of $50,000 per year gets a generous health-insurance subsidy under Obamacare. They will lose 15 cents of that subsidy, however, for every additional dollar earned. Add on a federal marginal tax rate of 15 percent, payroll taxes of 7.5 percent, and state and local taxes, the middle-income family will face a marginal tax rate of 40 percent or more for every dollar earned.

A few years back, I was on the board of a local charitable organization. Several of us on the board worked hard to secure the resources necessary to open a transitional housing facility for homeless female-headed families. As we were putting the final touches on the facility, we showcased it to a black female minister on our board who had been involved in other projects. She heartily approved of our work but made a remark I’ll never forget: “Don’t make it too nice, or you’ll never get them to leave.”

There are two competing philosophies of government-provided benefits for the poor: Conservatives and classical liberals (libertarians) believe they should be temporary, limited and frugal; progressives seem to believe they should be permanent, expansive and comfortable.

Those of us in the first camp are routinely accused of being harsh, cruel and heartless. Yet, incentive traps are an inevitable part of government programs when the benefits are permanent and generous. They knock out the bottom rungs of the economic ladder — and that is both debilitating and cruel to the poor.

Cecil Bohanon, Ph.D., an adjunct scholar with the Indiana Policy Review Foundation, is a professor of economics at Ball State University.

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Sources:

Kaiser Family Foundation. http://kff.org/interactive/subsidy-calculator/

Salim Furth. “Effective Marginal Tax Rates for Low-Income Workers Are High.”

Heritage Foundation. http://www.heritage.org/research/reports/2013/01/effective-marginal-tax-rates-for-low-income-workers-are-high



Comments...

  • Tim Zank says:

    Very well said Cecil.

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