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WASHINGTON - In a keynote address at an American Enterprise Institute conference on how the tax code affects low-income taxpayers Tuesday, Rep. Tom Petri outlined his work on the disincentives faced by low-income individuals and families as they try to make their way into the middle class. He further discussed the ways the nation's benefit programs and tax structure discourage marriage among those with modest and moderate incomes.
"Our stated policy is to encourage marriage, families and moving up the income ladder, but our actually policy is to discourage all that, and unfortunately, our actual policy is proving to be quite successful," he said.
Following Petri's address, AEI director of economic policy studies Kevin A. Hassett and former senior White House economist and Harvard professor Lawrence B. Lindsey presented a paper they coauthored with AEI research fellow Aparna Mathur on replacing the current system of tax credits to provide tax progressivity while reducing complexity and work disincentives. While considering only the tax code but not the other government benefits included in Petri's analysis, Hassett and Lindsey also found significant disincentives working against economic advancement.
Central to Petri's thesis is the steep loss of assistance faced by employees if they work longer hours and gain skills and experience. At various levels of a rising income, earning an extra dollar can mean losing 24 cents from the Supplemental Nutrition Assistance Program (food stamps), losing 21 cents from the Earned Income Tax Credit, losing four cents of the Federal Dependent Care Tax Credit, and paying 7.65 cents in Social Security Payroll Tax. Changes in various state benefits and taxes add to the negative effect.
From $17,000 to $40,000 in earnings, a single mother in Wisconsin typically experiences combined marginal effective tax rates in excess of 50 percent - averaging 59 percent between $24,000 and $41,000.
At lower income levels, she even approaches a rate of 100 percent at some points.
Putting this into perspective, Petri noted, the U.S. corporate tax rate is 35 percent (one of the highest in the industrialized world). The highest U.S. income tax rate for individuals is also 35 percent.
Economists have long contended that high tax rates affect the investment decisions made by affluent individuals. Rep. Petri stressed his belief that all people respond to economic incentives, and if we want people to work their way into the middle class, we need to change a system which says that if you are poor and you struggle to earn a higher income, you won't be able to keep enough of it to make it all seem really worthwhile.
Petri also discussed the "marriage penalty" - the benefits lost and the extra taxes paid by a couple if they decide to make their relationship official. "In my state of Wisconsin, the marriage penalty starts rising from about zero at $19,000 of combined income to about $7,000 in after-tax income at $28,000 of combined earnings, which is what you get if two people earn minimum wage. At $42,000, the cost of being married reaches $8,154. After that, it declines as better-off families are making too much to lose additional public benefits or tax credits," Petri said.
Petri said that the effect of these disincentives is illustrated by the fact that 84 percent of households of cohabiting unmarried couples living with children earn less than $50,000. This contrasts sharply with married couples with children, 71 percent of which have incomes over $50,000. "$7,000 is a lot of money to lose for two people earning minimum wage. That marriage certificate is expensive," he said.
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