Women and Taxes
Thursday, February 28, 2002
by Edward J. McCaffery
Table of Contents
The Curious Tale of the EITC
Things are even worse for the low-income Sallys of the world, as noted throughout the above discussion. This is because the phaseouts of benefits such as the earned income tax credit, or EITC, work just like taxes on their situation. This takes a bit of explaining.
The EITC is now the largest federal program of assistance to the poor, far bigger than what remains of now old-fashioned "welfare" programs. Begun in the 1970s largely to offset the burden of payroll taxes on the working poor, the EITC grew, especially in the 1990s, as a "workfare" program, largely replacing welfare as we had come to know it.20
"EITC phaseouts operate as a tax system, often with extremely high marginal rates."
The EITC operates as a negative income tax. Over an initial range of earnings - again giving exact numbers is complicated - the federal government pays low-wage workers extra cash through the tax credit. This is now even available in a form of negative withholding, built into payroll checks. The payments can be significant: up to 40 percent of earned income for a taxpayer with two or more dependents, over a range of income as high as $10,000.21 In other words, the federal government kicks in up to $4,000, above wages, to help out the working poor.
The EITC has been a highly successful program for helping the transition of the non-working into the paid workforce, and in helping the working poor to make ends meet. Problems begin when the government weans folks away from the EITC under a so-called phaseout. Workers begin to lose their EITC benefits once they start to earn "too much;" the phaseout occurs at 21 percent of marginal earned income for a person with two or more dependents. This continues until the positive payback brings the total EITC amount - the amount paid under the tax credit minus the amount paid back under the phaseout - down to zero. In other words, whereas the very poor get a full EITC benefit, the near-poor systematically lose that benefit at the significant rate of 21 percent.
Although it may not seem like it at first, phasing out a benefit is the same thing as taxing someone. Consider that if Sally earns $10,000 and has two children, the government gives her $4,000. But as she earns more money, reaching into the phaseout range, the government takes that $4,000 away from her. The missing dollars will surely feel like a tax to Sally, and any economist or accountant would agree.
Viewed in this way, the EITC is no more and no less than its own tax system, running alongside the regular income tax. It simply has a negative marginal rate as its initial range. The EITC boils down to the tax rate structure shown in Table III.
An unmarried Sally must face the tax rates in Table I combined with those in Table III. For her first $7,500 or so, this comes out well enough - no positive income tax and a negative EITC of 40 percent that more than offsets the 7.65 percent payroll tax burden.
But look what happens to the poor Sally if she makes more than $13,000 - barely more than a minimum wage job. Her marginal tax rate - and recall the importance of the margin - quickly becomes almost 44 percent, the same facing the solidly upper middle-income class Sally in our first extended example. This comes from adding together the income tax rate of 15 percent from Table I, the ever-present 7.65 percent payroll tax rate and the 21.06 percent EITC phaseout rate.
It gets worse. Recall the contrast between Tables I and II. The rate brackets under the regular income tax go up by 1.6 times for married couples - not as good as double the amount, but better than nothing. Had they not gone up at all, then couples could only have received a marriage penalty, tax-wise, for going to the altar.
"The steepest marriage penalties in America, percentage-wise, apply to lower-income households."
Guess what? The rate brackets under the EITC do not go up at all for marriage! Table III applies in full force to single persons or to married couples, unadjusted. The steepest marriage penalties in America, percentage-wise, apply to lower-income households. It's all but impossible to have two married working parents qualify for the full EITC.
To take a particularly gruesome example, imagine that Sally and Bill each made $13,000, and were each supporting two kids. Unmarried, they would get a combined $8,000 under the EITC. Married, this falls to $1,270. That's a marriage penalty of $6,730 under the EITC, a staggering 26 percent of Sally and Bill's combined earned incomes! To set this in context, as a percentage matter, it would be as if a Sally earning $30,000 and a Bill earning $60,000 would have to pay an additional $23,000 a year to their distant Uncle Sam for the privilege of being married.
No wonder so many lower-income households feature single parents, or unmarried parents living together.22
Not Just the EITC. It gets worse. The EITC is not the only government program that works through a high marginal tax rate on the near poor. Phaseouts abound, under housing subsidy programs, state welfare laws and so forth. In a wonderfully lucid piece of scholarship, law professor Daniel Shaviro explains how marginal tax rates facing the working poor often exceed 50 percent, and sometimes go over 100 percent!23 That means that one literally loses money by earning an extra dollar - an absurd state of affairs.
Shaviro shows that a one-parent, two child household in certain high benefit states, and receiving federal housing subsidies, faces marginal tax rates of 89.6 percent on earned income from $9,800 to $12,850, 109.2 percent from $12,850 to $14,350 and 78 percent for most of the range from $14,350 to $25,000. It can be even worse if one is married.
Given these biases against two-earner families among the poor and near-poor, it is not surprising that single-parent families predominate among the lowest income classes. Not surprising, just sad.
What We Don't Know. It is important to note that none of the tax effects we've been discussing depends on citizens' consciously being aware of any of the details of the tax law. Often when I've explained the effects of tax and transfer policies on lower-income households, especially women, people will scoff. "It's all so complicated," skeptics assert. "How could it affect anyone in real life?"
There's an easy answer: What we don't know can most definitely hurt us. It's a fact that, on the average, middle-class working mothers lose two-thirds of their salary to work-related expenses and taxes. Whether Sally in our extended example did the math or not, understood tax or not, her $30,000 job was only adding some $9,000 to the family's bottom line.
"What we don't know about complicated tax policy can most definitely hurt us."
In the lower-income classes, by marrying, women can sometimes just flat out lose money, in the form of benefits as well as cash, by having their wages taxed and their credits phased out. Whether or not they ever read the tax laws, their bottom lines will suffer. Two-parent, two-worker families will not form, or will not be economically stable if they do form. Looking around, young women growing up in lower-income households will not have many role models for becoming married working mothers. They might well blame the men in their lives for this sorry state of affairs - although there is evidence that many low-income men are supporting families outside of marriage, which they may not be able to afford24 - but it's a fictional guy, Uncle Sam, who deserves part of the blame, too.