Does It Pay Both Spouses to Work?
Wednesday, May 14, 2003
by Jagadeesh Gokhale and Laurence J. Kotlikoff
Table of Contents
- Executive Summary
- Calculating the Effects of Social Security on Two-Earner Couples
- Lifetime Taxes and Lifetime Transfer Benefits
- Lifetime Marginal Net Tax Rates for Working Spouses
- Components of Marginal Net Tax Rates
- The Impact of Social Security on Lifetime Marginal Net Tax Rates
- Present Value of the Loss from Forced Participation in Social Security
- About the Authors
Our Social Security system is best designed for a married couple in which the husband works in the labor market and the wife stays at home. At the time of retirement, the wife is entitled to a monthly benefit equal to 50 percent of her husband's benefit (the spousal benefit). If the husband dies first, a wife is entitled during her retirement years to 100 percent of her husband's benefit (the survivor benefit). This is a generous outcome, considering that the woman in this example never pays a dime in payroll taxes.
Of course, the couple's arrangement could be reversed. That is, the wife could work and the husband could stay at home. Regardless of the arrangement, Social Security is much less generous to two-earner than to one-earner couples. For example, a woman can earn Social Security benefits in her own right. But she cannot claim benefits in her own right in addition to spousal benefits on her husband's contributions. It must be one or the other. Many women who have paid into Social Security over their work lives find that when they reach retirement their best option is to claim benefits on their husband's contributions. As a result, they get nothing in return for all the payroll taxes they paid. Others find that even if it is better to claim benefits on their own contributions, the net benefit is not much more than they would have received if they had never worked and never paid taxes.
Calculating the exact impact of Social Security on working couples is complicated. Going to work, earning a living, and spending one's earnings over time affects a variety of taxes and government benefits - not just in the current year, but in all future years.
If you save and invest some of your current earnings and spend the proceeds in the future, you'll raise your future capital income taxes as well as consumption taxes. You'll also limit your ability to qualify for government tax credits and welfare benefits. Earning more today also will affect your future Social Security benefits and the federal income tax assessed on those benefits.
In order to sort through all of the effects, we consider a hypothetical two-earner couple at various levels of income. The couple has two children and takes advantage of tax avoidance opportunities, including the mortgage interest deduction, the earned-income tax credit, and the child tax credit. When qualified, the couple receives transfer benefits, including Food Stamps and Medicaid.
By incorporating all of the fiscal policies that affect households through time, our model is able to calculate the lifetime consequences of employment. We conclude that because working couples are required to participate in Social Security, they are worse off than they otherwise would be. That is, their lifetime consumption of goods and services is lower than it would be in the absence of Social Security payroll taxes and Social Security benefits. Specifically:
- A couple in which each spouse earns $10,000 a year can expect to pay almost $60,000 in Social Security taxes over and above any benefits they can expect to receive.
- The penalty for participation in Social Security is almost six times the wife's annual wage income.
The penalty for Social Security participation rises with income. A couple in which each earns $80,000 will pay almost twice the lifetime penalty paid by a couple in which each earns $10,000 a year. As a fraction of income, however, the burden of Social Security falls as income rises - reflecting the fact that Social Security tends to be regressive when all lifetime effects are taken into account.
Social Security does not exist in isolation. It is one of a number of government programs that reduce the rewards from working and producing. Consider a one-earner couple in which the husband is in the labor market and the wife is in the home. What does the couple gain, on net, from the wife's decision to enter the labor market? To answer this question, we need to calculate marginal net tax rates. In doing so, we ignore benefits to which people are entitled whether they work or not and only identify changes in taxes paid and benefits received as a result of the decision to work. The additional taxes paid plus the net reduction in transfer benefits received divided by the income from working is called the marginal net tax rate.
These marginal tax rates are quite high:
- If the wife of a male earning $20,000 a year enters the labor market and earns $10,000 a year, her marginal net tax rate will be 122 percent!
- For every dollar she earns, the couple will forgo $1.22 in increased taxes and reduced benefits.
Although it is unusual for marginal net tax rates to exceed 100 percent, it is not unusual for rates to exceed 50 percent. Indeed, second-earner spouses in moderate-income families typically lose more that half of all they earn to higher taxes and lower transfer benefits.
The mere act of marrying another wage earner can create strong disincentives to work. For example:
- A woman earning the minimum wage faces a marginal net tax rate of 21 percent if her husband does not work; if he also earns the minimum wage, her marginal tax rate will be 96 percent.
- At roughly twice the minimum wage ($20,000), her tax rate is 56 percent as long as her husband does not work; if he works and earns $10,000 a year, her marginal tax rate will be 106 percent.
Why are the marginal net tax rates faced by second-earner spouses so high? They are high at the low end of the income ladder because of the loss of means-tested benefits. Our system is very generous to those who do not work but withdraws those benefits quickly as people work and produce. For example:
- If a husband and wife both earn $10,000 a year, the wife's marginal tax rate will be 96 percent.
- About 65 percent of this marginal tax rate consists of the loss of Medicaid and other welfare benefits as a result of the wife's decision to work.
If the husband earns a higher income, the marginal tax rate is significantly lower (but still quite high) and the components of the tax rate change:
- If the husband earns $30,000 and the wife earns $10,000, her marginal tax rate will be 48 percent.
- Less than one-fourth of this marginal tax rate consists of loss of benefits, while more than three-fourths consists of taxes - mainly income and payroll taxes.
What is the contribution of Social Security to these marginal net tax rates? Consider that:
- If both spouses earn $10,000, 27 percentage points of the wife's marginal tax rate is due to Social Security alone.
- This means she loses more than one out of every four dollars she earns because of the existence of Social Security.
- At a wage of $20,000 a year, she loses more than one out of every seven dollars.
In general, Social Security penalizes moderate-income families by claiming one of every six or seven dollars the second-earner spouse receives. Thus virtually all of the Social Security payroll tax is a loss for the working spouse.