Marginal taxation and incentives

When we hear about marginal taxation, it is almost always in the context of the wealthy. There has been a lot of arguments over whether or not very high marginal taxes on the wealthy discourages them to work to a degree significant enough that it is adverse to society. That is an interesting, complex question in itself that people often simplify in such a way as favor their own foregone conclusions.

Now, what we hear less about is the effective marginal taxes on the poor. It's true that those earning very little pays little or no income tax. However, they do lose benefits as their income increase, meaning that some end up in the ridiculous situation of ending up losing more in benefits then they gain in a pay raise. A marginal tax rate of more than 100 percent. Now I think we can all agree -- that's a strong incentive to distort behavior. Via the Unpronounceable One:

“Despite the EITC and child credit, the poverty trap is still very much a reality in the U.S. A woman called me out of the blue last week and told me her self-sufficiency counselor had suggested she get in touch with me. She had moved from a $25,000 a year job to a $35,000 a year job, and suddenly she couldn’t make ends meet any more. I told her I didn’t know what I could do for her, but agreed to meet with her. She showed me all her pay stubs etc. She really did come out behind by several hundred dollars a month. She lost free health insurance and instead had to pay $230 a month for her employer-provided health insurance. Her rent associated with her section 8 voucher went up by 30% of the income gain (which is the rule). She lost the ($280 a month) subsidized child care voucher she had for after-school care for her child. She lost around $1600 a year of the EITC. She paid payroll tax on the additional income. Finally, the new job was in Boston, and she lived in a suburb. So now she has $300 a month of additional gas and parking charges. She asked me if she should go back to earning $25,000. I told her that she should first try to find a $35k job closer to home. Also, she apparently can’t fully reverse her decision to take the higher paying job because she can’t get the child care voucher back (the waiting list is several years long she thinks). She is really stuck. She tried taking an additional weekend job, but the combination of losing 30 percent in increased rent and paying for someone to take care of her child meant it didn’t help much either.

I think everybody, right and left, agrees that this case is a damned shame and something should be done. Of course, we'll probably disagree on what should be done.