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Congress Considers Trade-offs between Welfare, Tax Breaks and Work

June 28, 2012

The House Ways and Means Human Resources and Select Revenue Measures Subcommittees held a joint hearing to discuss how welfare and tax benefits can discourage work.

While the subject of the hearing seemed designed to infuriate Democrats on the subcommittees, the hearing actually turned out to be a fairly high-minded discussion, including testimony from proponents of keeping tax breaks like the Earned Income Tax Credit in place, along with welfare programs designed to support single parents.

Part of the discussion involved a so-called “cliff” or “dead zone” faced by the poor in which they lose tax or welfare benefits if they earn more at work, effectively reducing the income they need to support themselves and their families.

“Today we will consider whether the multitude of current welfare and tax credit programs create effective ladders of opportunity, or are missing important rungs by effectively discouraging work and higher earnings for millions of families,” said Rep. Geoff Davis, R-Ky., who chairs the Human Resources Subcommittee, at the start of Wednesday’s hearing.

One of the witnesses, Clifford Thies, a professor of economics and finance at Shenandoah University, described an income “dead zone” in which a family earning $40,000 per year is barely better off financially than a family not working at all, once all welfare benefits and tax credits are taken into account. Thies proposed combining welfare reform with tax reform so that part or all of the funds going to the EITC be used instead to pay Social Security taxes of low-income Americans who would qualify for the EITC, including both the employee and employer contribution. “This proposal would create a zero bracket in the payroll tax for qualifying workers,” he suggested.

Duncan Smith, the Secretary of State for Work and Pensions in the United Kingdom, testified about how welfare benefits had contributed to the U.K.’s budget deficit. A member of Prime Minister David Cameron’s Conservative government, he criticized his predecessors in Gordon Brown’s Labor government. “The last government lost control of welfare spending,” said Smith. “They sought to micromanage the system and the result was a benefit system of such fiendish complexity that too many chose a life on benefits over work. This was compounded by a lack of conditionality, so far too many were able to sit on benefits unchallenged, and was made worse by the pursuit of a poverty target which cost more and more just to stand still. The safety net had become a cage.”

Rep. Gwen Moore, D-Wis., testified about her own experiences on welfare and criticized the premise of the hearing. She referred to the idea of cutting off tax and welfare benefits to widows and orphans as “Dickensian.”

“I have personal experience living in poverty and raising young children as a single mother while working, going to school, and sometimes relying on welfare to get by,” said Moore. “I can tell you that I didn’t sit down after a long day of work to calculate the ‘marginal tax rate’ of government benefits to determine my choices. I think that the panelists here today—who make it sound like low-income women get home every night and pore over a spreadsheet to figure out how much they’ll be taxed on the next dollar they earn, or their next dollar in benefits—need a bit of a reality check. They’re showing very little understanding of the day-to-day factors that affect people’s decisions about work, child care, education and much more.”

Jared Bernstein, a senior fellow at the Center on Budget and Policy Priorities, fielded many of the questions in a panel discussion that closed out the hearing. A former member of the Obama administration, he was formerly chief economist and economic advisor to Vice President Joe Biden.

He cited studies that found the Earned Income Tax Credit actually incentivizes labor force participation of single parents, especially mothers, rather than discouraging work.

“Research also investigated the role of the early 1990s EITC expansion in helping to incentivize single parents, mostly moms, to move from welfare to work,” said Bernstein. “One study found that the refundable tax credit had a larger effect than the welfare law in generating the considerable employment gains that occurred in those years. Both the EITC and Child Tax Credit are only available to working parents. Thus, they have unambiguously strong work incentives at the ‘extensive’ margin, meaning they significantly increase the incentive of non-workers to enter the labor market.”

Eugene Steuerle, a senior fellow at the Urban Institute, agreed that the EITC encourages labor force participation, but not at higher pay rates. “Work subsidies such as the EITC generally encourage work for those who might otherwise not work or simply reside on welfare, but may tend to discourage work at higher income levels, particularly for second jobs in a family or moving to full time work,” he said. “Design matters greatly. For instance, Medicaid will discourage work among the disabled more than a subsidy system such as adopted in health reform; on the other hand, health reform will probably encourage more people to retire early. Perhaps one of the most important conclusions is that for the same amount of cost, a program that requires work will indeed lead to more work more than one that does not. EITC and welfare reform have done better on the work front than did [Aid to Families with Dependent Children].”

Ike Brannon, director of economic policy at the American Action Forum, told the hearing that higher tax rates create disincentives for work and deter labor force participation. “While the bulk of the academic research and political debate tends to focus on the marginal tax rates on small businesses and upper income households, the truth is that even middle and lower-income households can face high effective marginal tax rates exceeding 40 percent, thanks to the phase-outs of poorly designed welfare and entitlement programs,” he said. “Regardless of a person’s income, high marginal tax rates deter work, effort and reported income.”

Rep. Pat Tiberi, R-Ohio, who chairs the Select Revenue Measures Subcommittee, said he used to rely on the social safety net. “I know first-hand of the need for a safety net,” he said. “When I was in high school, my father lost his job and lost his pension. My sisters and I were on the free and reduced lunch program at our high school. These programs gave our family hope. But my parents got back on their feet, and their hard work is again being rewarded. What is dangerous with the Tax Code is that it appears to be saying to people who are down on their luck that they will be penalized if they turn their luck around.”

“Is the EITC perfect?” asked Rep. Richard Neal, D-Mass., the ranking Democratic member of the Select Revenue Measures Subcommittee. “Of course not. There's no provision in our Tax Code that's perfect.  And I'm open to working with my Republican colleagues to strengthen the credit.”

He said he is working on legislation that would extend for one year the recent enhancements to the EITC and child tax credit that would otherwise expire at the end of the year and invited his Republican colleagues to join him in that effort.

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