The Earned Income Tax Credit, the Child Tax Credit, and the Making Work Pay Tax Credit are only three entries in the long list of tax credits devoted to lessening the tax burden on lower-income families. While these tax credits add greater tax progressivity to the American income tax system
Download Audio as MP3 than is offered by the graduated statutory income tax rate schedule alone, they also add substantial complexity. In addition, they create substantial work disincentives for some low-income families by generating high marginal tax rates. What can be done to reduce the complexity and adverse work incentives associated with these credits without losing the additional progressivity they provide?
At this AEI event, Representative Tom Petri (R-Wisc.) will discuss the combined impact of low-income tax credits on work incentives. AEI director of economic policy studies Kevin A. Hassett, visiting scholar Lawrence B. Lindsey, and research fellow Aparna Mathur will present a paper that provides a roadmap for replacing the current system of tax credits with a single low-income tax credit that would provide tax progressivity while reducing complexity and work disincentives. Codirector of the Urban-Brookings Tax Policy Center Rosanne Altshuler and Cato Institute director of tax policy studies Chris Edwards will comment. AEI resident scholar Alan D. Viard will moderate.
||Registration and Breakfast
||U.S. Representative Tom Petri (R-Wisc.)
||Kevin A. Hassett, AEI
|Lawrence B. Lindsey, AEI
|Aparna Mathur, AEI|
|Discussants:||Rosanne Altshuler, Urban-Brookings Tax Policy Center|
|Chris Edwards, Cato Institute|
|Moderator:||Alan D. Viard, AEI|
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."
Rosanne Altshuler is a senior fellow at the Urban Institute and codirector of the Urban-Brookings Tax Policy Center. She is on leave from Rutgers University, where she is a professor of economics. Ms. Altshuler served as senior economist to the President's Advisory Panel of Federal Tax Reform in 2005 and has been a special adviser to the Joint Committee on Taxation as well as a consultant to the U.S. Treasury Department and Canadian Department of Finance. She has published numerous articles on the economics of taxation and edited the National Tax Journal, the leading academic tax journal, from 2001 through 2006.
Chris Edwards is the director of tax policy studies at the Cato Institute. He is a top expert on federal and state tax and budget issues. Before joining Cato in 2001, Mr. Edwards was senior economist on the congressional Joint Economic Committee, examining tax, budget, and entrepreneurship issues. From 1994 to 1998, he was a consultant and manager at PricewaterhouseCoopers, examining fiscal issues under consideration in Congress. From 1992 to 1994, he was an economist at the Tax Foundation. Mr. Edwards's articles on tax and budget policies have appeared in the Washington Post, the Wall Street Journal, the Los Angeles Times, Investor's Business Daily, and other newspapers. He is the author of Downsizing the Federal Government (Cato Institute, 2005) and coauthor of Global Tax Revolution (Cato Institute, 2008).
Kevin A. Hassett is the director of economic policy studies and a resident scholar at AEI. He is also a weekly columnist for Bloomberg. Before joining AEI, Mr. Hassett was a senior economist at the Board of Governors of the Federal Reserve System and an associate professor of economics and finance at Columbia Business School. He was an economic adviser to the George W. Bush campaign in the 2004 presidential election and was the chief economic adviser to Senator John McCain during the 2000 presidential primaries and the 2008 presidential campaign. He has also served as a policy consultant to the U.S. Department of the Treasury during both the former Bush and Clinton administrations. Mr. Hassett is a member of the Joint Committee on Taxation's Dynamic Scoring Advisory Panel. He is the author, coauthor, or editor of six books on economics and economic policy, including Toward Fundamental Tax Reform (AEI Press, 2005). He has published scholarly articles in The American Economic Review, Economic Journal, the Quarterly Journal of Economics, the Review of Economics and Statistics, the Journal of Public Economics, and many other professional journals. Mr. Hassett's popular writings have been published in the Wall Street Journal, The Atlantic Monthly, USA Today, the Washington Post, and numerous other outlets. His economic commentaries are regularly aired on radio and television, including recent appearances on the Today Show, CBS's Morning Show, The NewsHour with Jim Lehrer, Hardball, Moneyline, and Power Lunch.
Lawrence B. Lindsey is the president and CEO of the Lindsey Group and a visiting scholar at AEI. He has held leading positions in government, academia, and business. Prior to forming the Lindsey Group, he served as the assistant to the president and the director of the National Economic Council at the White House and was the chief economic adviser to the George W. Bush campaign during the 2000 presidential election. Mr. Lindsey also served as a governor of the Federal Reserve System from 1991 to 1997, as a special assistant to the president for domestic economic policy during the George H. W. Bush administration, and as a senior staff economist for tax policy at the Council of Economic Advisers during President Ronald Reagan's first term. Mr. Lindsey served for five years on the economics faculty of Harvard University and held the Arthur F. Burns Chair for Economic Research at AEI. From 1997 until 2001, he was the managing director of Economic Strategies, a global consulting firm. He is the author of numerous articles and three books: The Growth Experiment (Basic Books, 1991), Economic Puppetmasters (AEI Press, 1998), and What a President Should Know . . . but Most Learn Too Late (AEI Press, 2008).
Tom Petri (R-Wisc.), who represents Wisconsin's Sixth Congressional District, is serving his fifteenth term in the U.S. House of Representatives. He is the ranking Republican on the Aviation Subcommittee of the House Transportation and Infrastructure Committee. He served for twelve years as chairman of that committee's Highways, Transit and Pipelines Subcommittee and of an earlier subcommittee with similar responsibilities. He is a former vice chairman of the Transportation and Infrastructure Committee and of the House Committee on Education and the Workforce, now the Committee on Education and Labor. From 1987 through 1990, Representative Petri served as a member of the Committee on Standards of Official Conduct, better known as the House Ethics Committee. He is a former chairman of the House British-American Parliamentary Group, an official organization formed to strengthen relations with the British Parliament. Representative Petri's important legislative initiatives have included those in the areas of student loan reform, the allocation of money for federal highway spending, cost-sharing for federal water projects, tax and welfare reform, banking policy, campaign reform, and health care reform.
Alan D. Viard is a resident scholar at AEI. Prior to joining AEI, he was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. He has also worked for the Treasury Department's Office of Tax Analysis, the President's Council of Economic Advisers, and the Joint Committee on Taxation. Mr. Viard has written on a wide variety of tax and budget issues.