Does it Pay to Work More?

Policy Reports | Taxes

No. 310
Tuesday, April 15, 2008
by Laurence J. Kotlikoff and David S. Rapson

Potential Loss of Means-Tested Benefits from Additional Labor Income

Since households must meet an income test to qualify for many assistance programs, earning an additional dollar of income can render an individual ineligible for certain benefits.  Eligibility requirements for benefit programs vary by state.  Calculations in this paper are based on rules for the Commonwealth of Massachusetts in 2005.  The non-Social Security benefit programs included are Transitional Aid to Families with Dependent Children, food stamps, Supplemental Security Income, Medicaid and Medicare.  The federal income tax’s Earned Income Tax Credit and its Saver’s Credit are incorporated with other tax credits, exemptions and deductions in calculating federal income tax liabilities.

"Earning an additional $100 a month can render a family ineligible for welfare or food stamp benefits."

Transitional Aid to Families with Dependent Children (TAFDC).  TAFDC is Massachusetts’ version of the Temporary Assistance to Needy Families (TANF) program, a federal block grant to states that provides cash assistance to low-income pregnant women living alone, or to families with a dependent child.  States are allowed some flexibility in determining eligibility and the length of benefit payments.  In Massachusetts, benefits are limited to 24 months over a five-year period.  TAFDC applicants must pass two income tests: 1) Gross income (including unearned income such as unemployment compensation or interest from a savings account) must not exceed 185 per­cent of the federal poverty level for a household, and 2) gross income minus certain deductions (such as dependent care deductions) must not exceed 100 percent of the poverty level.  The federal poverty level is the income required to purchase basic necessities such as food and shelter.  The poverty level varies by family size and is adjusted for inflation.  For example:

  • If a family of three (adult with two children) has countable monthly income of $600, they will receive the difference between the maximum monthly welfare benefit and their income — $33 a month.4
  • However, if the family earns an additional $100 from working additional hours, they will lose the $33 benefit, making their marginal tax rate on $100 at least 33 percent.

Food Stamp Program.  The federal Food Stamp Program requires applicants to meet an income test.  Their income cannot exceed 200 percent of the federal poverty level.5 Households must satisfy both state and federal requirements to qualify for food stamps.  Food stamp payments are determined by subtracting 30 percent of the household’s net monthly income (gross income after deductions) from the maximum monthly benefit for a particular family size.  For example, suppose a single woman with one child under the age of 19 is eligible for a maximum monthly benefit of $298.

  • If her monthly net income is $875, she is eligible to receive about $35 a month in food stamps.
  • However, if she earns an additional $100 from working more hours, she loses her food stamp benefit.

Supplemental Security Income (SSI).  SSI is a federal assistance program for low-income individuals age 65 or older, or the disabled of any age.  SSI eligibility is subject to income and asset limits.  After deductions, the monthly income limit (including unearned income such as unemployment benefits) is $708 for a single person and $1,071 for a couple.6 The income limit is equal to the maximum benefit payment for a household, and benefits are determined by subtracting countable income from this maximum benefit level.7 Therefore, an additional dollar of income causes the household to lose a dollar in benefits.

Low-Income Home Energy Assistance Program (LIHEAP).  LIHEAP is a block grant program of the federal government that allocates funds among the states to operate various home energy assistance programs for needy households.  The funds may be used for the purposes of home heating and cooling assistance, energy-crisis intervention, low-cost weatherization or other energy-related home repairs.

Households are eligible for LIHEAP if their incomes are no greater than 150 percent of the poverty level or 60 percent of the state median income.  The states have flexibility in setting their income eligibility at or below this maximum standard.  In Massachusetts, the average benefit per recipient is $480.

Emergency Aid to Elders, Disabled and Children (EAEDC).8 EAEDC is a Massachusetts program that provides cash assistance in addi­tion to medical benefits.9 EAEDC benefits are available to the elderly, the disabled and families with needy children who do not receive or who are waiting to receive other benefits, such as SSI.  EAEDC is also available to those who do not qualify for TAFDC due to family restrictions.10 A family of four whose monthly income does not exceed $578.20 will receive the difference between their countable income and the income limit.

"Earning an additional $1 can eliminate Medicaid eligibility."

Medicaid.  Medicaid is a joint federal-state program that provides medical care to the poor.  Each state establishes its own eligibility standards and general rules, but they are required to cover those with negligible in­comes.  Under the MassHealth Standard Program, coverage differs according to the characteristics of household members and monthly income before taxes and deductions.  Households consisting of a pregnant woman and infant are covered if income does not exceed 200 percent of the federal poverty level; households with non-infant children less than 19 years old are eligible at 150 percent of poverty; and households that include parents and their children under age 19 qualify at 133 percent of poverty.

For example, consider a two-parent family that earns $25,736 per year in labor income and has two dependent children.  In Massachusetts, this family is eligible to receive nearly $14,000 in transfers, most of which come from Medicaid.  Earning an additional dollar, or indeed, an extra penny, causes the family to lose Medicaid eligibility.

"Most low-income families can’t get a tax credit that rewards saving."

Saver’s Credit.  The Saver’s Credit is a federal program intended to help low-income people save.  But because of the complexity of the tax code and interactions with other benefit programs, few people actually qualify for the Saver’s Credit.  The program allows single households with adjusted gross incomes of less than $25,000 and married households with adjusted gross incomes of less than $50,000 to receive a match of up to 50 cents from the federal government for every dollar they contribute to a retirement plan, such as an IRA, 401(k), 403(b), SIMPLE, SEP or 457 plan.11

The Saver’s Credit is not refundable, and is only available to households with a positive tax liability.  Consider a 30-year-old couple with two children, earning a total household income of $25,000 a year.  When filing their 2005 tax return:

  • They qualify for the standard personal exemption (married, filing jointly), plus child tax credits.
  • As a result, they will owe no federal taxes, but will also be ineli­gible for the Saver’s Credit.
  • Even those with a minimal tax liability will benefit little from the Saver’s Credit in comparison to high-income couples who benefit sub­stantially from tax-deferred savings plans.

Earned Income Tax Credit.  The Earned Income Tax Credit (EITC) is a refundable credit for low-income individuals and families that have some wage income.  “Refundable” means they receive the credit when they file tax returns regardless of whether or not they owe taxes.  In 2005, two-child couples with adjusted gross incomes of up to $37,263 and singles with adjusted gross incomes of up to $35,263 qualified for the EITC.

Medicare.  Medicare is a federal health insurance program for the elderly and disabled.  It incorporates two parts:  Hospital Insurance (HI), also known as “Part A,” and Supplementary Medical insurance (SMI), known as “Part B.”  Hospital Insurance is generally provided automatically to individuals age 65 and over who are entitled to Social Security benefits.  Part A helps pay for care in hospitals, skilled nursing facilities, hospice and some home health care.

Enrolling in SMI is optional; part B helps pay for doctors, outpatient hospital care, clinical laboratory tests, durable medical equipment, most supplies and some other services not covered by Part A.

Medicare Part A is primarily financed through a mandatory 2.9 percent payroll tax.  Part B is financed in part by participant premium payments of $78.20 per month regardless of benefits received.  It is assumed that at age 65 both husband and wife enroll in both Part A and Part B.

Read Article as PDF