One in four low-wage workers, face lifetime marginal net tax rates above 70 percent, effectively locking them into poverty

See WSJ editorial.

"Critics of the welfare state sometimes call it a “poverty trap,” and here’s what that means in practice. “One in four low-wage workers,” according to a new study, “face lifetime marginal net tax rates above 70 percent, effectively locking them into poverty.” Incentives matter, and bad ones sap the motivation to climb the opportunity ladder.

The study, published by the National Bureau of Economic Research, has five authors, including David Altig, the director of research at the Atlanta Federal Reserve, Alan Auerbach, a UC Berkeley economist, and Laurence Kotlikoff, a Boston University professor and former Reagan adviser. “The U.S. has a plethora of federal and state tax and benefit programs, each with its own work incentives and disincentives,” they write. These policies were “adopted with apparently no regard to their collective impact.”

Social Security, for example, “has 2,728 primary rules governing the receipt of its 12 benefits, plus tens of thousands of secondary rules.” A person who earns an extra buck, they continue, might lose 22 cents from the earned-income tax credit, or forfeit thousands in Medicaid benefits, or face almost $800 in higher Medicare premiums, “and the list goes on.”

The authors calculate that, with levies and transfers considered, the overall median one-year marginal net tax rate is 37.6%. The rate covering earnings over the estimated remaining lifetime is higher, 43.2%. This reflects the later double taxation of savings, such as after a capital gain. Also, making money one year can mean losing future aid from programs with asset limitations, including food stamps and Supplemental Security Income. For the richest 5%, the authors say the one-year median marginal net tax rate is 43.7%, while the lifetime median is 53%.

That’s bad, but it’s worse for many people at the bottom, where a quarter of the time the lifetime marginal net tax rate exceeds 70%. By earning an extra $1,000, “one in four of our poorest households, regardless of age, make between two and three times as much for the government than they make for themselves.”"