Imagine you’re a single mom with one child who receives $19,300 a year in government benefits. A local business offers to hire you full-time at an hourly rate of $15 an hour. At 2,000 hours a year (40 hours for 50 weeks) you would earn $30,000. Should you take the job or stay on the government dole?
The additional $10,700 a year certainly sounds enticing. But because you would lose your benefits and have to pay taxes, your disposable income would be about 31 percent less, around $20,700. By working full-time you’d only earn $1,400 a year more than when you were on welfare. That means you are working full-time to earn an additional 70 cents more an hour than when you were unemployed. Why bother?
That 31 percent is the effective marginal tax rate for low- and moderate-income workers will face, on average, in 2016. The marginal tax rate is the percentage of an additional dollar of earnings that is unavailable to an individual because it is paid in taxes or offset by reduced benefits from government programs. As the Congressional Budget Office points out in a statement of the obvious, that rate affects people’s incentives to work: “In particular, when marginal tax rates are high, people tend to respond to the smaller financial gain from employment by working fewer hours, altering the intensity of their work, or not working at all.”
As Robert VerBruggen notes, that marginal rate remains high well above the poverty line:
In general, once you hit the poverty line, you’ll face a flat tax of a bit above 30 percent — at least until you reach 450 percent of poverty, which is where the data here end. (Roughly two-thirds of the population falls below that mark, which this year is about $109,000 for a family of four.)
And the situation will be very bad for some. Between 50 and 150 percent of the poverty level, more than 10 percent of workers will pay a marginal rate above 50 percent.
The CBO report has an in-depth explanation of the marginal tax rate and its effect on the poor.