EVENTS

Date:	Tuesday, May 12, 2009
Time:	9:00 AM -- 11:00 AM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

WASHINGTON, MAY 16, 2009--It is a well-understood problem among tax policy experts that the tax code near the bottom of the income distribution is a mess. There are dozens of credits, benefits, and deductions for which many low-income families qualify, but the myriad phase-ins, phase-outs and eligibility requirements generate tax code opacity, create perverse tax incentives, and provide serious tax preparation headaches. A recent AEI event brought together a group of experts, including Representative Tom Petri (R-Wisc.) and AEI visiting scholar Lawrence B. Lindsey, to provide a framework for resolving this thorny problem.

Congressman Petri illustrated the serious incentive problems generated by phasing out tax and transfer programs for low-income families. Using a single mother living in Wisconsin earning $19,000 in personal income as an example, Petri illustrated that an additional $6,000 in wages would cause her net income to decrease by $137 after taxes and other social benefits are accounted for. He went on to describe how perverse incentives in the tax code have negative social consequences for low-income families. "It discourages people from working, from getting education, from improving themselves," he said. "But the most significant impact is the impact that these rates have on marriage among lower-income people . . . and then on the children."

However, lengthening phase-outs (thus decreasing marginal tax rate hikes) is not necessarily a panacea either. AEI's Kevin A. Hassett noted that the need for phase-outs diminishes the ability to target tax benefits for the poor: "If we're really interested in pursuing social welfare with these policies, then why is it that almost half the revenue is going to people that we don't necessarily think of as poor?" In this way, one major part of solving the puzzle of the tax treatment of low-income individuals is finding the right balance between tax incentives and income group targeting.

Panelists were sharply divided on the question of whether phase-outs or "cliffs"--sharp benefits phase-outs that generate extremely high marginal tax rates--are optimal for tax benefits for low-income taxpayers. Aparna Mathur of AEI noted that the economics literature tends to prefer cliffs. "The literature suggests that having a rapid phase-out range would be part of the optimal design of a transfer program," she said.

Lindsey disagreed: "The fact that the economics profession is moving towards cliffs, which is exactly what we tried to move away from, is a sign to me that common sense says one thing and the profession is on the other."

Rosanne Altshuler warned about the incentive effects of a true cliff, in which workers actually lose income if they earn an additional dollar, but she noted that past academic studies of the current phase-out structure of the Earned Income Tax Credit show it had a minimal impact on work decisions, implying that more rapid phase-outs may be good policy.

Another source of disagreement among panelists was the selection of credits that should be rolled into a simplified credit solution. The proposal analyzed by Hassett, Lindsey, and Mathur attempted to consolidate all major credits available to low income families. Altshuler presented the plan of the President's Advisory Panel on Federal Tax Reform, which she codirected: a "family credit" (combining the credits that are sensitive to family size) and a "work credit" (which combines those focused on work incentives). Chris Edwards added that with the money saved from credit repeal, lowering the corporate tax rate could be more beneficial for low-income families through higher national income and elevated wages.

The panelists agreed unanimously that the complexity of the tax code for low-income people stands in the way of effective redistribution policy and that solving this problem should be a tax policy priority. "It's our duty somehow or another, politically and intellectually, to figure out ways to solve that problem," Petri concluded. "Or, we'll see a growing underclass of people with perverse moral incentives. That's a recipe for social disaster."

--SCOTT GANZ

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