Schansberg: Overlooking the Working Poor

July 3, 2014

By Eric Schansberg, Ph.D.

The Pence administration is calling for a review of the Indiana tax code. The top goals are to simplify the code and to promote economic development. But another worthy goal, one that would boost the Indiana economy, is missing.

First, if the government is going to take our money, then it should do so as gently as possible. The U.S. income tax code is notoriously burdensome in terms of the billions of hours and dollars required to complete the paperwork. Governments will tax our money, but they shouldn’t unnecessarily tax our time, too.

Second, all things equal, fiscal and regulatory policies should minimize the damage to the economy and increase the possibilities of economic development. It is important for policymakers to strive for this goal.

But while Indiana’s leaders are looking at tax reform, they should achieve one other goal: eliminating the income-tax burden on working-poor households.

These days, it is common to make loud but vague complaints about the “gap between the rich and the poor.” Related to that, it is popular to advocate a higher minimum wage.

But a higher minimum is a mixed bag, just to name two reasons among many:

First, the minimum wage has both benefits and costs. By artificially increasing the price of less-skilled work, it will be less attractive to firms. Depending on the context, firms may respond by increasing prices to consumers or reducing other forms of compensation (e.g., free uniforms, discounts on products). But if these are not sufficient, firms will eliminate jobs.

It’s a shame to help some vulnerable people by harming other vulnerable people. This hurts those who lose jobs — short-term and then long-term, by taking away their opportunities to build skills, cutting off the first few rungs of the economic ladder that would allow them to move to the middle class.

Second, the minimum wage is poorly-targeted — it impacts middle-class teens and the elderly, as well as heads of households in poverty. Policy prescriptions should be as precisely targeted as possible, limiting the costs of the policy and concentrating the benefits of the policy appropriately.

Fortunately, there is a better policy alternative: eliminating taxation on working-poor households. By far the most onerous burden comes from FICA payroll taxes on income that are used to support the Social Security and Medicare of current retirees. These take 15.3 percent of every dollar earned by the working poor — more than $3,000 annually from a head of household at the poverty line. It always amazes me that so-called champions of the working poor rarely talk about this devastating policy issue.

Of course, the governor can’t do much about a nasty federal policy, but he shouldn’t add to those burdens by continuing to impose state income taxes on the same vulnerable people. At present, Indiana is one of a handful of states that imposes taxes on hard-working, lower-skilled, heads-of-households at the poverty line.

A decade ago, Indiana added an earned income tax credit (EITC) to offset much of this burden, but Indiana legislators should take the next step. They should remove all working-poor households from the tax rolls, freeing up the EITC to do what it was designed to do: subsidize working-poor households.

Poor households would have more money in their pocket — without the risk of being priced out of the labor market by a higher minimum wage. This would be a win-win for the working poor and the Hoosier economy.

D. Eric Schansberg, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is a professor of economics at Indiana University Southeast.



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