Work Disincentives, Still Crazy After All These Years

Work Disincentives, Still Crazy After All These Years

By ARTHUR LAFFER

It is tempting to dismiss the role played by incentives in economics, but the persistence of poverty in the inner city and elsewhere is difficult to explain with any other view of human behavior. Poor people, like everyone else, respond to incentives. The dilemma is how to introduce market incentives while still maintaining a generous system of helping those in need.

The first step is to consider the role played by disincentives, whether they are disincentives to work because government benefits fall away as income rises, or disincentives that make employers reluctant to hire entry-level workers likely to come from the ranks of the young unemployed.

More than three decades ago, I began enumerating a myriad of government "needs tested" programs that diminished welfare benefits as their recipients earned more income. The loss of government benefits made earning more income less attractive to many low-income families, an effect similar to that of raising marginal tax rates.

In the intervening years, alas, very little has changed. Gary Alexander, secretary of public welfare for the State of Pennsylvania, made that quite clear in a July presentation to the American Enterprise Institute entitled "Welfare's Failure and the Solution," an analysis of the welfare benefits plus wages of a single mother of two young children living in Pennsylvania.

Mr. Alexander reports that a single mother of two in the Keystone State earning no wages will obtain welfare benefits—such as food stamps, child care and Medicaid services—worth more than $45,000 annually. If the woman begins earning wages, her total annual income, including the value of her welfare benefits, will rise as well—up to about $9,000 in wages. But the next $5,000 in wages will not increase her total income, because she will lose some Medicaid and other benefits. In short, she faces the equivalent of a 100% marginal tax.

From about $14,000 to $29,000 of gross wages, she will also lose government benefits such that her total annual income will rise only about $5,000—an effective marginal tax rate of 67%. At $29,000 of wages, the woman will realize a little less than $57,000 in net income plus benefits. Once she earns more than $29,000 in wages her housing subsidies and food subsidies drop way down. With wages above $43,000, her child-care subsidies disappear, and once her wages top $57,000 her family will no longer qualify for the Children's Health Insurance Program.

What this means is that her total income—welfare benefits plus wages, minus taxes—won't reach $57,000 until her gross wage income rises to $69,000. In other words, the money earned by her between $29,000 and $69,000 faces a marginal tax rate, on average, of 100%. She receives no net benefit from her labor. Now if that doesn't motivate you to get up and go to work, I don't know what will.

This example is particular to a single mother in Pennsylvania with two children, but the principles apply generally across the country. People with low incomes who receive various forms of welfare subsidies in any number of states—with and without children, whether married or not—face enormous disincentives in trying to improve their lives by working. And these barriers to self-improvement through work have been rising over time.

According to the most recent Census Bureau data, the percentage of the American population in 2011 living below the poverty line was 15%, tied for a 50-year high and well above the 11.4% in the late 1970s when I began calling attention to "needs tested" disincentives to work.

Using employment as a share of total population for especially vulnerable demographics, the consequences of poorly thought-out policies are stark.

Consider the predicament of teenagers 16 to 19 years old, whose employment-to-population ratio has been 26%—about one in four young people employed—for the past three years. In the period 1975-2002, the ratio was in a healthier 40%-50% range. For African-Americans 16 to 19 years old, the employment-to-population ratio for the past four years has been in the anemic 14.5% to 16.5% range.

Minimum-wage laws ostensibly intended to help the young and poor may have put a bit more money in the pockets of those who found work, but study after study indicates that governmental minimum-wage interventions discourage employers from hiring.

How to counter these disincentives? My preferred solution is to enact a form of enterprise zone where marginal tax rates would be greatly lowered for both employers and employees in areas with high poverty. For starters, employer and employee payroll taxes could be eliminated for people who both live and work in the enterprise zones. There would be scant revenue loss to the U.S. Treasury because few people are working in these areas anyway.

Second, tax rates on corporate profits and personal income could also be reduced in the enterprise zones for businesses and employees whose principal residence is in the enterprise zone. Potential workers need employers after all. Once these residents see that their pay will not be whittled away by payroll and income taxes, they will not be so disinclined to sacrifice the government benefits that would recede as their income increases.

Developing business and life skills through on-the-job training is crucial for populations suffering generational poverty. To help make youth employment in the country's poorest areas more attractive, enterprise zones should eliminate job-killing state and federal minimum wage requirements for workers under 21. (The "youth minimum wage" provision allows payment of $4.25 an hour to workers under age 20 instead of the federal $7.25 minimum wage, but the rate expires after 90 days.)

After being unemployed for a number of years, poor, unskilled youths often become unemployable. And, after being unemployable for a number of years, many of them quite understandably become hostile to the world, and society has to spend fortunes protecting itself from them. It is a dispiriting Catch-22.

In the spirit of the late, great New York Rep. Jack Kemp, the time is right to take up the cause of a bipartisan pro-growth agenda for America's pockets of poverty.