Poverty & Income

Definition of Poverty The definition of poverty used by the United States federal government is based on a set of money income thresholds that vary with family size & composition. For example, there is a particular poverty threshold for a family of 4 with 2 children. A four-person family with two children and cash income below its threshold would be classified as poor.

The U. S. poverty rate in 2013 was 14.5%. The poverty rate is the percent of persons who are classified as poor. The U. S. poverty rate in 2013 was 14.5%.

The poverty rate varies with Sex. From: http://www.census.gov/hhes/www/poverty/data/incpovhlth/2013/table3.pdf

Poverty varies with race & ethnicity. From: DeNavas-Walt, C., Proctor, B.D., and Smith, J.C., U.S. Census Bureau, Current Population Reports, P60-239, Income, Poverty, and Health Insurance Coverage in the United States: 2010, U.S. Government Printing Office, Washington, DC,2011.

Poverty varies with age. Prior to 1975, the rate for those over 65 was higher than for other age groups. Since that time, the rate has been highest for those under 18.

Why have the relative poverty rates by age group changed over time? At least part of the change is due to inflation adjustments. The elderly have been covered under programs such as Social Security & Medicare, whose benefits are indexed to the Consumer Price Index (CPI), so they keep up with inflation. Children, on the other hand, have been covered by programs such as TANF (Temporary Assistance to Needy Families), Medicaid, & Food Stamps, which have not been indexed to the CPI. Consequently, the value of these benefits has declined in real terms.

Poverty varies with region. From: http://www.census.gov/hhes/www/poverty/data/incpovhlth/2013/table3.pdf

Poverty varies with educational attainment. From: http://www.census.gov/cps/data/cpstablecreator.html

Poverty varies with family type. From: DeNavas-Walt, C., Proctor, B.D., and Smith, J.C., U.S. Census Bureau, Current Population Reports, P60-239, Income, Poverty, and Health Insurance Coverage in the United States: 2010, U.S. Government Printing Office, Washington, DC,2011.

As we have seen, poverty rates for female-headed households in the U.S. are higher than poverty rates for other households. Some people believe that encouraging these women to marry is the solution to this problem. A question arises however: If marriage is a good route to better economic status, why do so many poor women remain single or become divorced? The article by Brown & Kesselring explores that question.

“Female Headship and the Economic Status of Young Men in the United States, 1977-2001” by Christopher Brown & Randall Kesselring Journal of Economic Issues, 2003, Vol. 37, pp. 343-351.

B & K show that since 1977, there has been a drop in the “breadwinner ratio,” the number of males per 1,000 females (aged 22-34) that qualify as marriageable based on an income test.

Trends behind the drop in the breadwinner ratio Falling average incomes for males aged 22-34. Rising within-group earnings inequality for this population.

Both the mean and the median income of males aged 22-34 were substantially lower in 1992 than in 1977. Despite a long period of economic expansion after 1992, the mean & median remained lower in 2001 than in 1977.

Income inequality has risen among males aged 22-34 as well. (Higher values of the Gini coefficient & the Theil index indicate greater inequality.)

An important factor underlying the widening disparity of incomes among workers in the past 3 decades is “skill-based” technical change. This change has contributed to an increase in earnings of college graduates relative to high school graduates.

Other factors influencing income inequality may include: 1. Import penetration & relocation of production facilities abroad, Political resistance to an increased minimum wage, Seniority clauses in collective bargaining agreements, and Lack of union building in the growing service sector.

We see that the “breadwinner ratios” have fallen. For example, for incomes over $20,000, the ratio for all races dropped from 677 in 1977 to 549 in 2001. The ratios are particular low for blacks. For blacks, the ratio dropped from 394 in 1977 to 356 in 2001.

Brown & Kesselring’s Conclusion “Public policy that aims to increase the proportion of children living in traditional, two-parent households cannot be successful unless it addresses the economic opportunities (or lack thereof) available to young men. The option to marry, if it exists at all, is most often a bad one [economically] for poor single mothers.”

Over time, many programs and policies have been developed in the U. S Over time, many programs and policies have been developed in the U.S. to reduce poverty and assist those in poverty. These programs include: AFDC – Aid to Families with Dependent Children (U.S. Welfare program from 1935 to 1996), TANF – Temporary Assistance to Needy Families (current U.S. Welfare program), SNAP – Supplemental Nutrition Assistance Program (Food Stamp Program), and EITC – Earned Income Tax Credit.

3 Goals of Welfare Programs 1. Alleviate poverty. 2. Provide incentives to work. 3. Limit costs by keeping down number of recipients. These goals are in conflict. This conflict is sometimes referred to as the “iron triangle of welfare.”

It is impossible to simultaneously have 1. a low tax rate on additional earnings of welfare recipients to encourage work, 2. a high welfare guarantee (maximum payment) to raise families out of poverty, and 3. a low break-even level of income (maximum income level at which benefits are still available) in order to limit the number of eligible individuals and thus program costs.

Benefits Received = Guarantee - (tax rate) (earnings) Suppose the guarantee is 10,000 and the tax rate is 100% or 1.00. That means that for every dollar earned on a job, the welfare payment is reduced by a dollar. Break-even earnings can be found by solving for earnings when the benefit = 0. 0 = 10,000 - 1.00(earnings) So break-even earnings would be 10,000.

Example Consider 3 options, A, B, & C. Option Annual Welfare Welfare Tax Rate Break-even Guarantee (in percent) Earnings A $10,000 100 $10,000 B $10,000 50 $20,000 C $5,000 50 $10,000

Option Annual Welfare Welfare Tax Rate Break-even Guarantee Option Annual Welfare Welfare Tax Rate Break-even Guarantee (in percent) Earnings A $10,000 100 $10,000 B $10,000 50 $20,000 C $ 5,000 50 $10,000 The high tax rate in option A provides little incentive to work. In option B, the lower tax rate increases work incentives. With the same guarantee as in A, the earnings threshold for eligibility (break-even earnings) increases and so do costs. Option C has a low tax rate and therefore good work incentives, and the low guarantee keeps costs down, but the resulting reduction in the earnings threshold and in the number of eligible individuals implies that there will be many more families in poverty.

Earned Income Tax Credit (EITC) EITC is a federal program that raises income and encourages individuals with low potential wages to seek employment. It is a refundable tax credit based on household earnings. Unlike most tax credits which benefit only households with income high enough to pay taxes, this credit provides a refund if the amount of the credit exceeds taxes owed, thereby particularly benefiting low-income households. The amount of the credit varies according to the presence of children and earnings.

2003 Earned Income Tax Credit (EITC) For a single person with 0 kids, the credit is 7.7% of earnings up to $382 credit (earnings 4950–5000), stays at $382 up to earnings of $6250, declines at a rate of 7.7% until it reaches 0 at $11,230. For a single person with 1 kid, the credit is 34% of earnings up to $2547 credit (earnings 7450–7500), stays at $2547 up to earnings of $13,750, declines at a rate of 16% until it reaches 0 at $29,650. Notice that for a person with a kid, the credit percentages are much higher, and the plateau and maximum levels are also considerably higher.

Compare EITC subsidies for Single People & Married Couples with 2 Kids For a single person with 2 kids, the credit is 40% of earnings up to $4204 credit (earnings 10,500–10,550), stays at $4204 up to earnings of $13,750, declines at a rate of 20% until it reaches 0 at $33,692. For a married couple with 2 kids, the credit stays at $4204 up to earnings of $14,750, declines at a rate of 20% until it reaches 0 at $34,692. Notice that for a married couple, the credit percentages are the same, and the plateau level is the same but lasts longer. So the couple can receive a credit up to a higher earnings level than can the single person. It is not twice the amount, however.

Effects of the Earned Income Tax Credit (EITC) on Hours Worked

Income & Substitution Effects Review Recall: As income rises, consumption of normal goods rises, including nonmarket time. So the income effect of higher income is working less, while the income effect of lower income is working more. Substitution effects are based on relative prices. So when the relative price of nonmarket time increases, the substitution effect is to consume less and work more. When the price of nonmarket time falls, the substitution effect is to consume more and work less.

Low Earning Households For households with earnings in the lowest of the three eligibility sections, the EITC subsidizes earnings at a rate of 40%. Both income and the effective wage are increased. The income effect of the higher income is to work less. The substitution effect of the higher effective wage is to work more. The substitution effect, in this case, is likely to be greater than the income effect. So hours worked would probably increase.

Middle Earning Households For households with earnings in the EITC plateau, the EITC provides the maximum credit. So income is increased by the same EITC amount regardless of whether the individuals work a few more hours or not. So there is no change in the effective wage and thus, there is no substitution effect. There is only the income effect of the higher income. So these individuals would work less.

Households in Highest Earnings Range among those Eligible for EITC For households with earnings in the highest section eligible for EITC the EITC reduces the credit by a specific fraction for every additional dollar earned. So total income is increased, and therefore the income effect is to work less. However, the additional income from another hour worked is reduced. So the effective wage and the price of nonmarket time is reduced and the substitution effect is to work less also.

So the effect of the EITC varies with the phase of the schedule faced. The evidence indicates that the EITC provides a strong incentive for single mothers to enter the paid labor force. On the other hand, second earners in married-couple families, often place the family in the phase-out section of the credit.

Taxes & Marriage

Horizontal equity a common rule for fair taxation treating those in similar circumstances the same violated by our current income tax & social security systems

Income Tax Policy While money income is subject to taxation, under the present income tax system, the value of goods & services produced in the home is not taxed. This creates an incentive for families to adopt the traditional division of labor because then the woman’s contribution to the family is not taxed, whereas it is if she brings home a paycheck instead. Consider the following two situations.

Situation 1 Couple 1: Clark & Clara each earn $30,000, & together they produce $10,000 worth of goods & services in the household, for a total value of $70,000. Couple 2: Dennis earns $40,000 & Denise is a full-time homemaker who produces $30,000 worth of goods & services in the home, for a total value of $70,000. Although both couples are consuming the same value of goods & services, Clark & Clara pay more taxes than Dennis & Denise, because the first couple is taxed on $60,000, & the second is taxed on $40,000.

Situation 2 Couple 3: Edward & Edna each earn $25,000, & together they produce $10,000 worth of goods & services in the household, for a total value of $60,000. Couple 4: Frank earns $50,000 & Francine is a full-time homemaker who produces $30,000 worth of goods & services in the home, for a total value of $80,000. Taxable income for both couples is $50,000, so both couples pay the same taxes, even though for Frank & Francine, consumption of goods & services is greater.

In situation 1, the 2 couples were taxed different amounts, although their households had the same consumption levels. In situation 2, the 2 couples were taxed the same amount, although their households had different consumption levels.

Marriage Penalty The penalty is the additional taxes a couple paid if they were married, compared to what they paid if they were single. It occurred because income tax brackets for married couples were less than twice the brackets for singles, & the standard deduction for married couples was less than twice that for singles. Couples with fairly equal incomes tended to pay larger penalties. In 2003, the tax structure was changed to eliminate most of this type of marriage penalty.

Marriage Bonus For some couples, taxes are lower if they are married than if they are single. The difference is referred to as a marriage bonus. Bonuses occur when spouses have very different income levels. Bonuses occur under progressive tax systems, where wealthier people pay proportionately larger shares of their incomes in taxes.

Marriage Bonus Example (Using 2003 Tax Tables) Bert has an income of 60,000. He pays $11,816 in income taxes. Bertha is not employed & has no income. She pays no income taxes. If Bert & Bertha married, they would pay taxes of $8,626. What is their marriage bonus? $11,816 - $8,626 = $3,190

Marriage Effects & the EITC The EITC may rise or fall as a result of marriage. It therefore may create a marriage incentive or disincentive.

Example 1 (Based on 2003 EITC) Georgina has 2 children & no earnings, & therefore no EITC. George has no children, and earns $12,000 (enough to receive no EITC). If they marry, they receive an EITC of $4,204.

Example 2 (Based on 2003 EITC) Harriet has 2 children, earns $12,000, & receives an EITC of $4,204. Harold has no children, earns $12,000 & receives no EITC. If they marry, they receive an EITC of $2,036, or $2,168 less.

Example 3 (Based on 2003 EITC) Anne has 2 children, earns $15,000, and receives an EITC of $3,931. Andrew has no children, earns $20,000 & receives no EITC. If they marry, they receive no EITC.