Does It Pay Both Spouses to Work?
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
Calculating the Effects of Social Security on Two-Earner Couples
4In an earlier study, Kotlikoff found that virtually all young workers are worse off as a result of their forced participation in Social Security. That is, at virtually every income level, young workers can expect to pay more in Social Security taxes than they will get back in Social Security benefits. For example:5
- Young workers earning the average income can expect to pay $723,591 in taxes over the course of their lifetimes (in present value terms) and receive only $140,190 in benefits.
- For higher-income workers the picture is much worse: expected taxes are $1,274,136, while expected benefits are only $163,861.
This study builds on the earlier study by focusing on two-earner couples in which each spouse is entitled to benefits as a result of the other's contributions and by taking into account all other tax and transfer programs that are affected by Social Security. For example, absent the Social Security payroll tax, wage income would be higher - leading to higher income taxes and, in some cases, fewer welfare benefits. Social Security income during retirement will typically trigger additional income taxes (at least for people who are young today) and make qualifying for means-tested benefits more difficult. Our goal in this study is to sort through all of these effects.
"Going to work raises taxes and reduces government benefits."
Taxes and Government Benefits Affected by the Decision to Work.The decision to enter the labor market and earn a wage has a number of economic consequences. In general, more work means a higher income and, therefore, higher taxes. A higher income usually also leads to fewer welfare benefits (such as Food Stamps). Moreover, the effects of working today are not limited to today's higher taxes and today's loss of entitlement benefits. Income earned today also affects future taxes and future benefits. In particular, there are five important links between today's decisions and their future consequences:
- Earning more today typically leads to more saving and, therefore, more assets and more income from assets in the future; however, that higher future capital income will result in higher future income taxes.
- More assets and more income in the future also will mean fewer future benefits from entitlement programs that are linked to the income and assets of the recipients (such as Medicaid).
- Earning more today typically will lead to more consumption in the future because asset accumulation makes more consumption possible; however, that higher consumption will result in higher consumption taxes.
- Earning more today will lead to higher Social Security benefits in the future.
- More non-Social Security income in the future, caused by higher earnings and more saving today, will increase the tax on future Social Security benefits.
Calculating the Costs and Benefits of Working. As the above list indicates, understanding the full consequences of deciding to work requires taking into account all future taxes workers will pay plus all future transfer payments workers will lose as a result of that decision. To illustrate this lifetime analysis, we have chosen a representative two-earner couple. The couple is assumed to rent in the early years and eventually buy a house. They have two children, who grow up and attend college. Over time, the couple has many opportunities to interact with the tax system by, for example, taking advantage of the mortgage interest deduction and the child tax credit, deciding whether to itemize deductions, paying payroll (FICA or Federal Insurance Contributions Act) taxes, paying state income taxes, and using their after-tax earnings to pay sales taxes.
"Various welfare benefits, tax deductions and tax credits are phased out as income rises."
We assume that couples enter the labor market at a specific wage and that their income grows by 1 percent per year in real terms, and we consider this couple at different income levels. For example, if they earn a low income they benefit from the Earned Income Tax Credit (EITC) and the credit for retirement account contributions. If they earn a high income, they are penalized by the phase-out of itemized deductions and by the alternative minimum tax. We approach entitlement benefits in a similar way. If they earn a low income, the family qualifies for "welfare" benefits including cash assistance, Food Stamps and Medicaid. As their level of income or assets rises, these benefits phase out.
Our approach is also probabilistic. In any given year, there is some chance one or both spouses will die. The death of a spouse triggers entitlement benefits for the remaining spouse and the children (such as survivor benefits under Social Security). These benefits are also affected by what the deceased spouse was earning. We calculate expected taxes and expected benefits for the couple. We do so by calculating the taxes and benefits for each possible lifetime. To get an expected result, we sum over all possible lifetimes, each weighted by its probability of occurring.
Our approach is also comprehensive. We include every major tax and transfer program. In the case of taxes, we include employer-paid taxes, whether corporate income taxes or employer-paid FICA taxes.
The Complexity of U.S. Tax and Transfer Benefit Programs. It is difficult to exaggerate the complexity of the tax and transfer programs American workers face. Mastering the federal income tax alone is a major challenge because it has so many special provisions. These include the inflation-indexation of tax brackets, the partial and graduated taxation of Social Security benefits above two noninflation-indexed thresholds, the treatment of retirement account contributions and withdrawals, the phase-out of itemized deductions, the EITC, the child tax credit, the alternative minimum tax, and the recently legislated credit to low-income households for contributing to retirement accounts.
As if the federal income tax were not difficult enough to decipher, almost all states have income taxes with their own special provisions. For example, Massachusetts has an exemption for the elderly, a child deduction, a rental deduction, and a deduction for employee-paid payroll taxes. An explanation of the major tax programs is provided in our previous NCPA study.6
As the various interrelated social welfare programs have grown, the U.S. system of transfer benefits has become extremely complicated. It now includes Food Stamps, Medicaid, traditional welfare (renamed TANF or Temporary Assistance for Needy Families), Supplemental Security Income (SSI), housing assistance programs, the Low-Income Home Energy Assistance Program (LIHEAP), the Special Supplemental Nutrition Program for Women, Infants and Children (WIC), and several other programs. An explanation of the major entitlement programs is included in our previous NCPA study.7
"The decision to work has lifetime effects on taxes and benefits."
Software Program. Understanding the effective net tax on work requires an intertemporal model capable of carefully determining tax and transfer payments at each stage of a person's life cycle, based in part on economic choices in prior periods. This study uses ESPlanner, a financial planning software program developed by Economic Security Planning, to study the net tax levied on workers with different earning capacities. ESPlanner smooths households' living standards subject to constraints on their capacities to borrow. In so doing, it makes highly detailed, year-by-year federal and state income tax and Social Security benefit calculations.8