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
Lifetime Marginal Net Tax Rates for Working Spouses
"The marginal net tax rate reflects the penalties for working over the course of a lifetime."
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. We want to 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 the marginal net tax rate.
"Second-earner spouses face extremely high marginal tax rates."
A selection of these rates is shown in Table I. A more complete array is depicted in Table A-I in the appendix. The first thing to note about Table I is that the marginal tax rates faced by second-earner spouses are extremely high:
- Consider a male earning $20,000 a year.
- If his wife enters the labor market and earns $10,000 a year, her marginal net tax rate is 122 percent.
- For every dollar she earns, the couple will forgo $1.22 in increased taxes and reduced benefits.
"Marginal net tax rates tend to be higher for lower-income couples."
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 lost transfer benefits.
The second thing to notice about Table I is that marginal net tax rates are typically higher for couples with lower incomes. For example:
- If a husband and wife both earn $20,000, the wife faces an 81 percent marginal net tax rate; the rate drops to 55 percent if her earnings rise to $50,000. [See Figure I.]
- The wife of a man who earns $50,000 faces a 51 percent marginal net tax rate if she earns $10,000, but a 48 percent tax rate if she earns $50,000.
- The wife of a man who earns $100,000 faces a 61 percent tax rate if she earns $10,000, but only 56 percent if she earns $50,000.
"At most income levels, marrying another worker creates a strong disincentive to work."
Why do marginal tax rates decline as the spouse earns more income? This is the opposite of what one might expect. The answer, as we shall see, is that as her earnings rise the family loses many means-tested benefits. The system is progressive in the sense that it provides substantial benefits - even to those who do not work at all. But it withdraws those benefits rapidly as income rises. Thus the price of a generous welfare state is a structure of very high marginal tax rates that impose large penalties on those who work and produce.
The third thing to note about Table I is that the mere act of marrying another wage earner can create strong disincentives to work. As Figure II shows:
- 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 a minimum wage, her marginal tax rate is 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 is 106 percent.
Figure III shows that being married to a high-income husband also can produce very high marginal tax rates, even if the wife's income is very low. For example:
- A woman whose husband earns $100,000 a year faces a 61 percent tax rate - even if her earnings are close to the minimum wage.
- This woman will have to forgo more than half of all she earns in taxes and lost benefits no matter how little she earns.
Figure IV shows that only in the middle-income range does being married to a wage-earning spouse lower net marginal tax rates;
- A woman who earns $30,000 faces a 76 percent marginal tax rate so long as her husband does not work; if he also earns $30,000, her marginal tax rate falls to 44 percent.
- If she earns $40,000, the differential tax rates are 65 percent (nonworking husband) versus 43 percent (working husband).
These figures are consistent with an observation made about the tax system by McCaffery: The system encourages women in high-income families not to work and women in low-income families not to marry.12