state welfare reform: integrating tax credits and...
TRANSCRIPT
STATE WELFARE REFORM: INTEGRATING TAX CREDITS AND INCOME TRANSFERS PAUL WILSON* & ROBERT CLINE**
INTRODUCTION
A major goal of welfare reform is the provision of greater incentives to move from welfare to self-sufficiency. A com- mon reform strategy is to increase work incentives by raising the amount that a low-income family can gain by working. There are three distinct ways to do this: reform AFDC itself; provide low-income workers with guaranteed access to low- cost health insurance; and/or provide targeted tax credits to low-income work- ing families through the federal and state tax systems. Recent incremental re- forms have used each of these three ap- proaches, with changes in the tax sys- tem having the most powerful impact. This piecemeal approach to reform has created a complex system of overlapping and uncoordinated programs, as summa- rized in Table 1. Changes in individual programs have been made with little un- derstanding of how they interact and af- fect the entire system.
This paper examines the impact of the combined tax and transfer systems on
*St Olaf College, Northfield, MN 55057
**Minnesota Department of Revenue, Tax Research, St Paul,
MN 55146
Minnesota’s low-income families, ex- tending earlier Minnesota studies by Steuerle and Wilson (1987) and Michael and Manzi (1993). It then discusses the potential for integrating the tax credit and direct transfer programs at the state level. Minnesota is a leader in using its tax system to provide targeted benefits to low-income families. It has also pro- gressed further than most states in health care reform by introducing a state-funded, sliding-scale health insur- ance subsidy for low-income families not qualifying for Medicaid. Ongoing discus- sions by state policymakers are exploring how the integration of the tax and transfer systems might reduce complex- ity, lower administrative costs, and in- crease the power of work incentives. With a refundable child and dependent care credit, a state earned income tax credit, a generous property tax credit, and a subsidized health insurance pro- gram, Minnesota provides an excellent case study for an initial discussion of the issues related to integrating tax credit and transfer programs.
The first section of this paper describes the components of the tax and transfer system in Minnesota. The second section
655
TABL
E 1
DES
CR
IPTI
ON
O
F TA
X AN
D
TRAN
SFER
PR
OG
RAM
S IN
MIN
NES
OTA
(S
ING
LE
PAR
ENT
WIT
H
TWO
C
HIL
DR
EN)
Proa
ram
An
nual
Be
nefit
s Pr
ogra
m
Def
initi
on
of
“Inco
me”
R
educ
tion
in B
enef
its
Asse
t Te
st
Acco
untin
g Pe
riod
Aid
to
Fam
ilies
with
D
epen
dent
C
hiid
ren
(AFD
Cj
$6,3
84
if no
ot
her
inco
me.
Food
st
amps
$3
,505
if
no
othe
r in
com
e.
($&7
5,7
if no
in
com
e ex
cept
2 M
edic
aid
Free
in
sura
nce
cost
ing
abou
t 83
,000
fo
r th
e fa
mily
.
com
preh
ensi
ve
cash
in
com
e le
ss c
hild
ca
re
com
preh
ensi
ve
cash
in
com
e le
ss 2
0 pe
rcen
t of
ea
rnin
gs,
child
ca
re,
and
exce
ss
hous
ing
cost
s
com
preh
ensi
ve
cash
in
com
e le
ss
child
ca
re
com
preh
ensi
ve
cash
in
com
e
Each
$10
0 of
pr
ogra
m
inco
me
(afte
r fir
st
$1,0
80)
redu
ces
bene
fits
by $
100;
no
be
nefit
s if
com
preh
ensi
ve
inco
me
>$11
,810
.
Each
$10
0 of
pr
ogra
m
inco
me
(afte
r fir
st
$1,5
24)
redu
ces
bene
fits
by $
30;
no
bene
fits
if co
mpr
ehen
sive
in
com
e >$
15,4
31
(130
pe
rcen
t of
po
verty
le
vel).
Pare
nt
elig
ible
on
ly
if pr
ogra
m
inco
me
r-$8,
5!2
(133
pe
rcen
t of
m
axim
um
AFD
C
bene
fit);
Chi
idre
R a
ges
I-5
only
if
prog
ram
in
com
e ~$
15,7
87
(133
pe
rcen
t of
po
verty
le
vel).
Phas
ed
out
at
inco
mes
be
twee
n $0
and
$3
2,64
0.
Each
$1
00
of
inco
me
redu
ces
subX
yXyb
$tw
een$
2(at
lo
w
inco
mes
) an
d $2
1 (a
t hi
gh
inco
mes
).
yes
mon
th
mon
th
yes
mon
th
mon
th
Prog
ram
An
nual
Be
nefit
s
TABL
E 1,
Con
tinue
d
Prog
ram
D
efin
ition
of
“In
com
e”
Red
uctio
n in
Ben
efits
Y 3 As
set
Acco
untin
g Pe
riod
9 Te
st
s.
Fede
ral
Earn
ed
Inco
me
Tax
Cre
dit
(EIT
C)
Min
neso
ta
Wor
king
Fa
mily
C
redi
t (W
FC)
Fede
ral
Chi
ld
and
Dep
ende
nt
Car
e C
redi
t (C
DC
C)
Min
neso
ta
Chi
ld
and
Dep
en-
dent
C
are
Cre
dit
(CD
CC
)
Prop
erty
Ta
x R
efun
d fo
r R
ent-
ers
(PTR
)
Ref
unda
ble
cred
it eq
ual
to
40
perc
ent
of
earn
ings
(li
mite
d to
fir
st
$8,4
25
of
earn
ings
). M
axi-
mum
cr
edit
equa
ls
$3,3
70
(199
6).
Ref
unda
ble
cred
it eq
ual
to
6 pe
rcen
t of
ea
rnin
gs
(lim
ited
to
first
$8
,425
of
ea
rnin
gs).
Max
i- m
um
cred
it eq
uals
$5
66.
Non
refu
ndab
le
cred
it eq
ual
to
betw
een
20 a
nd
30 p
erce
nt
of
up
to
$4,8
00
in
elig
ible
ch
ild
care
ex
pens
es.
Ref
unda
ble
cred
it eq
ual
to
be-
twee
n 20
and
30
per
cent
of
up
to
$4
,800
in
elig
ible
ch
ild
care
ex
pens
es.
Ref
unda
ble
cred
it of
up
to
$1
,000
of
land
lord
’s
prop
erty
ta
x on
th
e re
ntal
un
it.
fede
ral
adju
sted
gr
oss
inco
me
(FAG
I)
fede
ral
adju
sted
gr
oss
inco
me
(FAG
I)
fede
ral
adju
sted
gr
oss
inco
me
(FAG
I)
FAG
I fo
r cr
edit
rate
; co
mpr
e-
hens
ive
cash
in
com
e fo
r ph
ase-
ou
t of
th
e m
axim
um
cred
it
com
preh
ensi
ve
cash
in
com
e
Max
imum
$3
,370
cr
edit
re-
duce
d by
$2
1.06
fo
r ea
ch
$100
of
FA
GI
in
exce
ss
of
$11,
000.
(C
ompl
etel
y ph
ased
ou
t w
hen
FAG
I =
$27,
000.
)
Max
imum
$5
66
cred
it re
duce
d by
$3
.16
for
each
61
00
of
FAG
I in
ex
cess
of
$1
1,00
0.
(Com
- pl
etel
y ph
ased
ou
t w
hen
FAG
I =
$27,
000.
)
30%
cr
edit
rate
if
FAG
I <$
lO,O
OO
. C
redi
t ra
te
is
re-
duce
d by
1 p
erce
nt
for
each
ad
- di
tiona
l $2
,000
of
FA
GI
be-
twee
n $1
0,00
0 an
d $3
0,00
0.
Cre
dit
rate
is
20
perc
ent
whe
n FA
GI
exce
eds
$30,
000.
Cre
dit
rate
s re
duce
d in
sam
e w
ay
as
fede
ral
CD
CC
ra
tes.
M
axi-
mum
cr
edit
redu
ced
by
$10.
30
for
each
$1
00
incr
ease
in
co
m-
preh
ensi
ve
inco
me
betw
een
$15,
180
and
$28,
830.
(N
o cr
edit
if in
com
e >$
28.8
30.)
Cre
dit
redu
ced
as
inco
me
rises
fro
m
$0 t
o $3
5,00
0.
Each
$1
00
incr
ease
in
inc
ome
redu
ces
cred
it by
be
twee
n $1
.50
(at
low
in
- co
mes
) an
d 66
(a
t hi
gher
in
- co
mes
).
no
no
year
year
no
year
no
year
no
year
uses a unique database to exarnine the overlap among programs and to show how benefits are distributed by poverty decile. The third section illustrates how federal and Minnesota tax credits, com- bined with Minnesota’s sliding-scale health insurance subsidy, now offset much of the work drsincentives created by AFDC, food stamps, and Medicaid. It also illustrates how these tax credits and the health Insurance subsidy reduce work incentives at higher income levels as they are phased out. The concluding sections examine issues raised in inte- grating tax credit and direct transfer programs and describe initial efforts at integrating the two at the state level.
ALTERNATIVE PATHS ‘TO RESTORING WORK INCENTIVES
Families qualifying for AFDC have always faced strong work disincentives. Since 1982, the benefit-reduction rate for AFDC has been ‘100 percent. Each dollar of earnings beyond $90 per month re- duces AFDC benefits (net of day care costs) by a full dollar, so little is gained by working. These strong work disincen- tives are common knowledge, but low- ering the benefit-reduction rate is costly. A lower benefit-reduction rate would either increase the number of working households qualifying for AFDC, thereby raising the cost to the government (and making more people subject to the earnings disincenltives); or it would re- quire a cut in benefits for nonworking recipients, hurting those most in need. Furthermore, economists have generally concluded that AFDC households will re- spond little to increased work incentives within the current transfer system (Mof- fitt, 1992). Given this relatively small es- timated response, economic efficiency argues for a rapid phaseout of benefits (a high benefit-reduction rate).’
Despite these arguments, both the fed- eral and state governments have acted
to increase work incentives. From a pol- icy perspective, a system that fails to re- ward those attemptin to make the
Ip transition from welfa e to work. is unac- ceptable to most people, whether liberal or conservative. Increasing the net gain from working is there/fore a common feature of recent reforms in AFDC, in subsidized health insurance programs, and (most emphatical/y) in targeted tax credits.
Since 1990, over 20 states have received waivers of federal reqluirements’ to en- able the states to exderiment in their AFDC and food stam’ programs.’ Min-
I nesota’s experiment, ike those in at least 13 of the other Istates, inc:reases work incentives by reducing the AFDC benefit-reduction rates. Each dollar of earnings will reduce the combined AFDC and food stamp payment by only $0.62, so the family gains $0.38.3 This experi- mental program, begun in April 1994, will enroll up to ten oercent of Minne- sota’s AFDC families. iln addition, experi- ments are under way~at both state and federal levels to integrate AFDC and food stamp programs~. This paper does not include a discussion of these AFDC reform experiments. Instead, it examines the existing AFDC an food stamp pro- grams for the other 0 percent of Min nesota’s AFDC famili B s, for whom the benefit-reduction rate1 remains at 100 perceni (as shown in ,Table 1).
Recent federal changes in Medicaid have also been designed t reduce work dis- incentives. Until rece 4 tly, workers who earned their way off pelfare lost Medi- caid eligibility immedibtely. This sudden and total loss of Medicaid coverage cre- ated serious work disincentives, because low-wage jobs rarely include employer- provided health insurance. Federal changes in Medicaid eligibility rules (ef- fective in 1990) have ~significantly re- duced this problem. F/ledicaid eligibility is now extended for d full year if a fam-
658
I THE STATES, TAXES, AND THE FEDERAL SOCIAL AGENDA
ily loses eligibility because of increased earnings. In addition, federal law in- creased the income levels at which young children lose Medicaid coverage, and Minnesota raised these limits even further in 1991.
Minnesota’s sliding-scale health insur- ance program (MinnesotaCare), begun in 1992, goes even further in reducing the impact of losing Medicaid coverage (See Cline, 1993). MinnesotaCare provides subsidized insurance for families with in- comes up to 275 percent of the poverty level who have no access to employer- provided insurance (and do not qualify for Medicaid). The subsidy phases out as income increases, with families paying an insurance premium ranging from 1.5 percent of income (at 133 percent of the poverty threshold) to 8.8 percent (at 275 percent of poverty). This program eliminates the “cliff” that occurs when earning a few more dollars results (a year later) in the loss of Medicaid eligi- bility. Instead, MinnesotaCare phases out the health insurance subsidy slowly as income rises. MinnesotaCare is a large entitlement program. By 1997, up to 136,000 Minnesota households could be receiving over $300 million of insurance subsidies through MinnesotaCare.
Federal and state tax credits also have a major impact on work incentives, offset- ting much of the work disincentives cre- ated by the AFDC and food stamp pro- grams. Most important are the expanded federal and state earned in- come tax credits. When fully phased in (in 1996), the recently expanded federal earned income tax credit (EITC) will pro- vide a two-child, low-income working family with a 40 percent subsidy on the first $8,425 in earnings. The EITC is re- fundable, providing benefits to working families who owe no income tax (and would otherwise not file a tax return). For a family with two children, it effec-
tively raises the minimum wage from $4.25 per hour to $5.95 (for the first 1,980 hours of work). The EITC is phased out at a marginal tax rate of 21.06 percent for incomes between $11,000 and $27,000.4
Minnesota’s state EITC, called the Work- ing Family Credit (WFC), now equals 15 percent of the federal EITC. For a family with two children, this raises the wage subsidy from 40 percent to 46 percent (and effectively raises the minimum wage to $6.20 per hour). It also in- creases the phaseout rate from 21.06 percent to 24.22 percent. The 1993 ex- pansion of the federal EITC, coupled with the simultaneous increase in Min- nesota’s credit from ten to 15 percent of the federal, will increase state WFC payments from $12 million in fiscal year 1993 to an estimated $36 million in fis- cal year 1997. This tripling of the size of the Minnesota program has occurred without a detailed examination or public discussion of its structure and interaction with other tax credit and transfer pro- grams.
The Minnesota tax system includes two other tax credits that are also targeted toward low-income families. First is Min- nesota’s child and dependent care credit (CDCC). Unlike the federal child care credit, the Minnesota credit is tightly tar- geted toward low-income families. It starts with the dollar amount of the fed- eral credit, but the Minnesota CDCC dif- fers in two important respects: (1) the Minnesota credit is refundable; and (2) the credit is completely phased out at an income level near $29,000. This credit pays up to 30 percent of eligible child care expenses for low-income families, even those who pay no state income tax. In the phaseout range, the state CDCC creates another set of positive
659
marginal tax rates (10.3 percent for a family with two or more children).
Table 2 contrasts the distribution of the Minnesota credit with that of the federal child care credit, showing how its bene- fits are tightly targeted to lower-income households. The federal CDCC is usually justified as a reduction in taxable income to account for an expense of working, but the state CDCC is clearly a transfer targeted at low-income working fami- lies.5
The other Minnesota tax credit targeted to low-income households is the prop- erty tax credit (PTR) for renters. This circuit-breaker refund program pays a portion (declining from 91 to 50 percent as income rises) of property taxes ex- ceeding a threshold percent of income (1 .O percent up to 3.5 percent). The PTR is refundable, with a maximum of $1,000. It is phased out with income, with no credit fair renters where income exceeds $35,000.
DISTRIBUTION OF TRANSFERS AND CREDITS
The first step in evaluating the feasibility of integrating tax and transfer programs is to identify the distribution and actual overlap of current programs. This infor- mation is also important in understand- ing the actual level of marginal tax rates faced by taxpayers receiving income transfers and tax credits. A unique data- base recently developed by the Tax Re- search Division of the Minnesota Depart.- ment of Revenue can be used to identify this distribution in Minnesota. The data- base matches tax return and income transfer information by social security number for a stratified sample of house- holds selected to represent the Minne- sota population. (Minnesota Department of Revenue, 1993).
The primary sources of information for this income distribution database are the
individual income tax returns (federal and state) and property tax refund forms filed with the Department of Revenue. Social security numbers were used to link other income sources with taxpayer information, including social security benefits, public assistance payments (AFDC, general assista,nce, and supple- mental aid), workers’ compensation, and unemployment compensation. This data- base is used to identify the number of recipients and dollar a,mounts of selected tax credits and transfer payments re- ceived by Minnesota households in 1990.
The earned income tax credits (both state and federal) have been greatly ex- panded since 1990. To see the impact of that expansion, the database was used to estimate what each family’s EITC and WFC would have1 been in 1990 based on 1996 law (deflated to 1990 dolYars).6
Table 3 provides an overview of the scope and cost of Minnesota’s transfer and tax credit system. Over 550,000 Minnesota households (27 percent of the population) receive cash transfers and tax credits from at least one pro- gram. Benefits totaled almost $1 .l bil- lion, including MinnesotaCare subsidies. As shovvn in Table 3, the combined cost of the expanded EITC and WFC in Min- nesota, almost $200 million, would have been 60 percent as large as AFDC trans- fers in 1990.
Table 3 also provides some information on the overlap of the tax and transfer system in Minnesota. The overlap cate- gories focus on AFDC recipients, EITC recipients, and those receiving both EITC and AFDC. Almost 20,000 households received both AFDC and EITC benefits during calendar year 1990. This repre- sents almost 25 percent of all AFDC re- cipients, far larger than the proportion of Minnesota AFDC recipients working
2 n-l
TABL
E 2
4 C
OM
PAR
ISO
N
OF
FED
ERAL
AN
D
MIN
NES
OTA
C
HIL
D
AND
D
EPEN
DEN
T C
ARE
CR
EDIT
S, T
AX
YEAR
19
94
u z F2
Tota
l R
etur
ns
Tota
l Am
ount
D
istri
butio
n (In
81,
000s
) D
olla
rs
per
Ret
urn
E To
tal
Ret
urns
To
tal
Dol
lars
?
FAG
I St
ate
Fede
ral
Stat
e Fe
dera
l St
ate
Fede
ral
Stat
e Fe
dera
l St
ate
Fede
ral
; U
nder
$1
0,00
0 3,
296
11
$1,1
86
60
$360
$0
10
%
0%
13%
0%
C
I
$1 o
,oO
O-
$20,
000
12,5
04
10,1
53
4,07
4 3,
247
326
320
38
7 3
45
6 $
$20,
000-
$3
0,00
0 16
,912
18
,379
3,
775
6,29
1 22
3 34
2 52
13
42
12
g
$30,
000-
$4
0,00
0 0
22,3
81
0 7,
251
0 32
4 0
16
0 14
$4
0,00
0-
$50,
000
0 24
,334
0
9,19
5 0
378
0 18
0
17
$50,
000-
$7
5,00
0 0
42,4
14
0 18
,139
0
428
0 31
0
34
$75,
000-
8 10
0,00
0 0
14,9
42
0 6,
736
0 45
1 0
11
0 13
O
ver
$100
,000
0
5,27
8 0
2,15
6 0
A?!.!
-
- -
- 0
4 0
4
Tota
l 32
,712
13
7,88
1 $9
,035
65
3,01
5 $2
76
5384
10
0%
100%
10
0%
100%
Not
e:
42
perc
ent
of
all
retu
rns
with
M
inne
sota
C
hild
an
d De
pend
ent
Car
e C
redi
ts
have
no
po
sitiv
e ta
x lia
bilit
ies
and
rece
ive
a re
fund
able
cr
edit
equa
l to
38
pe
rcen
t of
to
tal
cred
it co
sts.
TABLE 3 MINNESOTA CASH TRANSFERS AND TAX CREDITS
Type of Transfer/Credit Number
of Households
Transfer/Credit Amount
Total Average
(Thousands) ($ Millions)
Total Recipients EITC/WFCa 130.5 $195.4 $1,497 PTR (Renters) 241.4 76.0 315 GA 76.5 93.0 1,216 AFDC 81 .O 331.8 4,096 Federal CDCC 135.4 50.0 369 Minnesota CDCC 32.0 8.5 266 MinnesotaCareb 136.1 303.3 2,229
Total Amount gl,os8.0
Single Program Recipients EITC 77.4 $110.5 $1,428 PTR 178.5 53.6 300 GA 55.8 69.1 1,237 AFDC 36.6 145.9 3,986 CDCC 112.1 43.7 390
Multiple Program Recipients EITC and PTR or CDCC 32.6 $63.5 $1,948 AFDC and EITC 19.8 107.6 5,546 AFDC and PTR or CDCC 30.1 173.8 5,774
Total Households Receiving Transfers or Credits’ 553.9
Total Households 2,072.5 _------.--- --.-- -..- ‘EITC and WFC estimates are based on 1990 recipients and 1996 federal EITC parameters with dollars deflated to 1990 levels. bNumber of rectpients and dollar amounts are based on estimates of levels of participation and costs projected for fts- cal vear 1999: the dollalr amounts were deflated to 1990 levels. ‘Exiludes MinnesotaCare recipients.
in a given month (13 4 percent).7 The difference between the proportion of AFDC recipients working in a single month and the portion working at some time during the year reflects the high turnover rates in AFDC and points out the different time perspectives In annual tax credit and monthly transfer pro- grams. Over 30,000 AFDC households (37 percent of the total) received either property tax refunds or a child and de- pendent care creldit. The overlap be- tween EITC (WFC) and PTR or CDCC in- cluded 33,000 households.
Other significant overlaps cannot be esti- mated with the Minnesota database, be- cause it includes only cash programs. Al- most all AFDC families receive food stamps and Medicaid. According to the
Green I3ook, 39 percent of all Minnesota AFDC households live in subsidized housing, while another ten percent are homeowners.8 Those In subsidized hous- ing are not generally eligible for a prop- erty tax refund, explaiining the low over- lap between PTR and ,AFDC. Almost all of ,the AFDC households who are home- owners will receive homeowner property tax refunds (not shown in Table 3). The overlap between the MinnesotaCare health insurance subsiidy and EITC or CDCC is also likely to be large. The lim- ited overlap between AFDC and these other programs should also be stressed, given the desire to increase work incen- tives for those leavings AFDC (and for other low-income ho#eholds not quali- fying for AFDC). As shown in Table 3, non-AFQC households comprise 85 per-
I THE STATES, TAXES, AND THE FEDERAL SOCIAL AGENDA
cent of those receiving EITC and the vast majority of those receiving child care credits and property tax refunds. Accord- ing to the Green Book, only half of those receiving food stamps also receive AFDC, and only one-quarter of those liv- ing in subsidized housing are on AFDC. There is also little overlap between MinnesotaCare and AFDC. Yet, each of these programs provides substantial ben- efits to those just beyond the income limits of AFDC.
Table 4 presents the 1990 distribution of Minnesota transfer payments and tax credits by population deciles based on federal poverty levels. The first decile, for example, includes the poorest ten per- cent of households in Minnesota-those with comprehensive money income be- low 60 percent of the poverty threshold.
In 1990, the poverty thresholds were $6,652 for an individual and $13,359 for a family of four, so the first decile includes single people with incomes be- low $3,390 and families of four with in- comes below $8,015.
The distribution and overlap in Minneso- ta’s tax credit and transfer systems help to identify two distinct dimensions of the integration discussion. For AFDC re- cipients, the focus is on coordinating welfare transfers and tax credits and re- ducing work disincentives as recipients move .into jobs. Coordination and inte- gration for these people could be imple- mented through the current welfare ad- ministrative structure. But for non-AFDC taxpayers, the focus is on coordinating tax credits, which are more effectively administered by federal and state tax
TABLE 4 MINNESOTA DISTRIBUTION OF 1991 TAX CREDITS AND CASH TRANSFERS BY
POVERTY THRESHOLD DECILES” (Amounts in Millions, Number of Recipients in Thousands)
Seventh First Second Third Fourth Fifth Sixth to Tenth Total
Percent of Poverty 61%
Earned income Tax Credit Amount $24.2 Number of recipients 11.1
Property Tax Refund (Renters) Amount $6.8 Number of recipients 22.9
General Assistance Amount $45.5 Number of recipients 51.2
AFDC Amount $124.7 Number of recipients 32.7
Child and Dependent Care Credits Amount $0.6 Number of recipients 1.8
MinnesotaCare Amount $0.0 Number of recipients 0.0
Total Amount $201.8
105% 153% 205% 259% 313% over 313%
671.1 $64.4 $29.5 $5.5 $0.4 $0.3 31.5 40.9 33.4 12.1 0.8 0.7
$195.4 130.5
$14.5 51.1
$17.8 49.5
$15.8 43.4
$10.0 28.4
$6.2 $4.8 23.3 22.7
$75.9 241.3
$16.8 14.1
$10.8 5.4
$9.3 2.4
$5.0 1.2
$3.7 $1.9 0.6 1.5
$93.0 76.4
$128.4 28.4
$51.4 11.8
$18.1 4.8
$3.4 1.4
$3.2 $2.7 0.7 1.1
$331.9 80.9
$0.9 4.9
$3.5 13.7
$9.4 27.7
$7.5 23.8
$6.9 $29.9 19.7 75.9
$58.7 167.5
$87.9 33.0
$103.8 45.1
$80.8 40.0
$25.4 14.0
$5.4 $0.0 4.0 0.0
$303.3 136.1
$319.6 $251.7 $162.9 $56.8 $25.8 $39.6 $1,058.2
‘The MinnesotaCare distribution by decile is based on Department of Human Services projections; all other distribu- tions are from the Minnesota Tax Incidence Study database.
663
agencies. However, with the significant expansion of the ElTC/WFC and the adoption of subsidized health insurance for non-AFDC taxpayers, there is a new transition zone between transfers and credits, whrch will require a coordinated effort by welfare and tax agencies to achieve income transfer and work incen- tive objectives.
THE IMPACT OF THE TAX AND TRANSFER SYSTEM ON THE GAIN FROM WORK
To illustrate the combined impact of the tax and transfer system on work incen- tives, consider a hypothetical single par- ent with two children, living in Minne- sota, who qualifies for AFDC. How much would this parent gain by working, con- sidering the interactions between trans- fer programs and federal and state tax credits? In the analysis that follows, we consider two variations on this question:
(1) What is the total gain from working full time (compared to not working at all)?
(2) What is the marginal gain from working additional hours for some- one already employed?
To simplify the analysis, we make the following additional assumptions: (1) day care costs equal 20 percent of earnings; (2) the family rents an (unsubsidized) apartment for $400 per month; (3) the family files a head of household tax re- turn without iternizing deductions; and (4) the potential job does not include employer-provided health insurance (so the family will qualify for MinnesotaCare subsidized insurance if Medicaid eligibil- ity ends).”
Total Gain from Work
Table 5 calculates taxes, transfers, and tax credits for this hypothetical family (in 1994), assuming several different poten- tial wage rates and hours of work. With
no earnings, this family receives $6,384 in AFDC benefits and $2,757 in food stamps, for a total of’ $9,141. The entire farnily also qualifies for Medicaid. Be- cause working may ehd the family’s elk- gibility for Medicaid, we need to place a value on these Medic
$ id benefits. The
calculations in Table assume that Med- icaid is valued at costc$1,550 per adult and $725 per child.“~ Adding this $3,000 benefit to AFDC and food stamps gives a total of $12,14’1 in direct transfers (see Table 5, column 1).
Working full-time at a minimum-wage job, this individual would earn $8,840. After paying $676 in social security taxes, $1,768 for child care, and losing $5,992 in AFDC (but ~gaining $215 in food stamps”), the family’s net income before credits is $12,760, an increase of only $619. In the absence of the tax credits, the gain from work amounts to only seven percent of total earnings (see column 3). The tax credits greatly in- crease the gain from work, however. This full-time minimum-wage worker re- ceives 163,370 in federal EITC, a Minne- sota Working Family Credit of $506, and a Minnesota refundable child care credit of $530. The family’s1 property tax re- fund declines by $35,~ but the credits add a net total of $41371 to the gain from work. Earning $8,840 results in a net increase of $4,99b after all transfers and credits, equal to 156.4 percent of earnings. The tax credits have lowered the cost of working from 93.0 percent of earnings to 43.6 percent of earn- ings.”
The above full-time, minimum-wage worker would still be covered by Medi- caid. The Importance of MinnesotaCare in restoring work inc by the case of a t
ntives is illustrated full- ime worker at 150
percent of the minimum wage (see col- umn 4 in Table 5). At this level of earn- ings, the family loses ‘all AFDC and the parent’s Medicaid benefits (valued at $1,550). Net income before credits and MinnesotaCare rises by only six percent
TABL
E 5
TOTA
L G
AIN
FR
OM
W
OR
K (S
ING
LE P
AREN
T PL
US
TWO
C
HIL
DR
EN)
Wag
e R
ate
(Per
cent
of
m
inim
um
wag
e)
Hou
rs
per
Wee
k
- $4
.25
100%
20
-
0 SO
0%
$10.
63
$12.
75
$17.
00
=I
250%
30
0%
400%
a
40
$4,4
20
37%
$4.2
5 $6
.38
$8.5
0 10
0%
150%
20
0%
40
40
40
58.8
40
$13,
260
$17,
680
74%
11
2%
149%
40
$22,
100
186%
$2
6,52
0 22
3%
40
2 s3
5,oo
O
a 29
5%
P u
$0
$338
$6
76
----a
-- 83
38
8676
$0
$884
$1
,768
$1,0
14
114
-&- $2
,652
$1,3
53
777
311
62,4
41
$3,5
36
$1,6
91
1,44
0 57
6 ‘8
3,70
7
$2,0
29
2,10
3
3$7k
$4,4
20
$4,8
00
$2,6
78
2 3,
375
ITi
1,35
0 z
J7,4
03
$
84,8
00
$6,3
84
$3,9
28
2,75
7 2,
669
3,00
0 3,
000
812,
141
99,5
97
$12,
141
$12,
795
$0
$0
8392
2,
972
3,00
0 86
.364
12,7
60
$0
$12,
760
$2,0
50
1,45
0 ‘6
3,50
0
$12,
934
$1,4
54
$14,
388
$1,4
50
81,4
50
$13,
153
$1,3
22
$14,
475
Bo
Net
In
com
e be
fore
C
redi
ts
$12,
141
$12,
795
$13,
973
$1,9
32
$15,
905
bo
60
$16,
747
$22,
797
$1,4
40
SO
$18,
187
$22,
797
$1,7
68
$3,3
70
265
506
$960
$712
--$
m--
265
686
‘B2,
984
530
677
85,0
83
$17,
843
$2,8
94
61,9
63
434
294
114
777
743
919
593
474
84,7
78
84,4
27
$1,0
32
155
1017
72
0 35
8 -Y
tzy%
r
6101
15
1,
008
252
195
‘81,
571
Net
In
com
e Af
ter
Cre
dits
$1
2,85
3 $1
5,77
9 $1
9,16
6 $1
8,90
2 $1
9,18
7 $1
9,75
8
-.Yfs
a-
$23,
757
14.8
%
7.0%
6.
0%
5.7%
8.
3%
17.4
%
30.4
%
14.8
7.
0 16
.9
13.2
17
.0
22.8
30
.4
66.2
56
.4
47.6
34
.2
28.7
26
.0
31.2
Earn
ings
Pe
rcen
t of
po
verty
le
vel
Taxe
s (b
efor
e C
redi
ts)
Soci
al
Secu
rity
(em
ploy
ee
shar
e)
Fede
ral
inco
me
tax
Stat
e in
com
e ta
x To
tal
Chi
ld
Car
e C
ost
(bef
ore
Cre
dits
)
Dire
ct
Tran
sfer
Pa
ymen
ts
AFD
C
Food
st
amps
M
;did
ia;id
(v
alue
d at
co
st)
Net
In
com
e be
fore
C
redi
ts
or
Min
neso
taC
are
Min
neso
taC
are
Hea
lth
insu
ranc
e Su
bsid
y
Tax
Cre
dits
Fe
dera
l EI
TC
Stat
e EI
TC
Fede
ral
child
ca
re
cred
it St
ate
child
ca
re
cred
it Pr
oper
ty
tax
refu
nd
(rent
ers)
To
tal
Cre
dits
Tota
l G
ain
from
W
ork
(Per
cent
of
Ea
rnin
gs)
Befo
re
cred
its
or
Min
neso
taC
are
Afte
r M
inne
sota
Car
e Af
ter
Min
neso
taC
are
and
tax
cred
its
of earnings. With MinnesotaCare, the gain rises to 16.9 percent of earnings, and the tax credits increase it further to 47.6 percent. Clearly, the existence of MinnesotaCare and the tax credits has succeeded in offsetting much of the work disincentives created by the wel- fare system.13
Figure 1 illustrates1 the results of Table 5 graphically, showing how effectively MinnesotaCare and the tax credits re- store work incentives in each of these seven cases, offsetting much of the work disincentives of phaseouts for AFDC and food stamps, the social secu- rity tax, and income taxes (before cred- its). Figure 2 shows the impact of MinnesotaCare and the tax credits on the total gain from work at every earn-
ings level up to $35,000.14 Minnesota- Care and the tax credits raise the total gain from working at @very level of earnings.
Marginal Gain from Work
Using tax credits to restore work. incen- tives for low-income workers comes at a cost, of course. A tax credit that pro- vides work inc:entives while it is phased in will create work disi centives while it is phased out. Targete I tax credits are no magic bullet. The additional work in- centives for those beloinl the poverty level are paid for by raising the marginal tax rates on those somlewhat above the poverty level. In this seInse, the tax cred- its have much the same effect as a re- duction in the benefit-reduction rate in the AFDfE program. Cloaking a policy in
FIGURE 1 Total Gain from Work as Percent of Earnings
(Single Parent plus Two Children)
80
56.4 r-1 I
$4,420 $8,840
41.6
;I
34.2 31.2
$13,260 $17,680 $22,100 $26,5/20 $35,000 Total Earnings
Before MinnesotaCare and Tax Credits
Increase Due To cl
Increase Due To MinnesotaCare Tax Credits
660
I THE STATES, TAXES, AND THE FEDERAL SOCIAL AGENDA
FIGURE 2 Total Gain from Work
(Single Parent plus Two Children)
12,000
10,000
1 8 6,~
c
d . 4,000
54~
0 4,420 8,840 13,260 17,680 22,100 26,520 35,m
TOtdEhllgS
----- -___
new clothes may disguise the trade-offs, but it does not eliminate them.”
before MinnesotaCare and the tax cred- its is approximately the same as the total gain after MinnesotaCare and the tax ’
The marginal gain from work is shown credits. As a result, any increase in the by the slope of the lines in Figure 2. At marginal gain from work at lower levels an income of $35,000, the total gain of earnings (shown as a steeper positive
667
slope) must be matched by a decrease in the marginal gain at higher incomes (shown as a flatter slope). Note the flat- ness of the line representing the total gain after tax credits and MinnesotaCare between $13,260 and $26,520.
Table 6 shows the marginal cost of work for this hypothetical family faced with the combined tax and ,transfer system. The first column in Table 6 shows the impact of a small increase in hours worked if the parent was initially work- ing half-time at the minimum wage. If earnings rose by !$lOO, the social secu- rity tax would take $7.65, child care would take an additional $20, and AFDC benefits would fall by $80 (while food stamps would rise by $9). Before consid- ering the tax credits, the $100 of add/- tional earnings would raise net income by only $1.35. However, the federal and state ElTCs would add $46 to earnings, while Minnesota’s refundable day care credit would add an additional $6. The property tax credit would fall by $1.50. After all credits, the net impact of the extra $100 in earnings is a gain of over $51.85.
At higher rncome levels, however, each of these tax credits is phased out. Dur- ing the phaseout, the credits reduce the incentive to work The EITC and WFC are phased out between $11,000 and $27,000. In that range, each $100 of extra earnings recluces the family’s com- bined EITC and WFC by $24.22. Minne- sota’s refundable child care credit is phased out between $15,180 (or some- what higher, depending on child care costs) and $28,830. Once the phaseout begins, each additional $100 of earnings reduces this family’s credit by $10.30. If this Minnesota family earned $26,520 and worked a little more to earn an ex- tra $100, the family’s state and local tax payments (net of property tax refund) will rise by almost $70.16 In addition, if the family were receiving subsidized
668
health insurance through Minnesota- Care, the insurance prjemium would rise by almost $20. Adding child care and other work expenses, ihe marginal gain from work is negative~(see Table 6, col- umn 6). At an income of $35,000, how- ever, after the phaseout of the credits and the MInnesotaCare subsidy is com- pleted, the marginal gain from work is large and positive, equal to about half of gross earnings.
Figures 3, 4, and 5 graphically show the marginal cost of working. Figure 3 shows the marginal cost of working (as a percentage of gross earnings) before credits and MinnesotaCare. Figure 4 shows the individual contribution of MinnesotaCare and each tax credit to the marginal cost of working. Figure 5 shows the marginal cost of working af- ter credits and MinnesotaCare. For a half-time worker at the minimurn wage, the tax credits raise the marginal gain from 1.35 percent of earnings to 51.85 percent of earnings. For a full-time minimurn-wage worker, the marginal gain from work also increased, but only slightly. At higher levels of earnings, however, the tax credits substantially re- duce the marginal gain from work.
Incentive Effects and Tax-Transfer Design
Will workers respond to the positive and negative work incentives shown in these tables? The apparent power of tax cred- its may be diluted for three reasons: lack of information, filing complexity, and delay in receiving #benefits.
The earnings-reduction rates under AFDC and food stamps are well known, but people have less klnowledge of tax credits and their phaseout rates. A major public information campaign in Minne- sota has successfully abvertised the ben- efits available through’the earned in- come tax credits, but very few people understand how the phaseouts work. As
TABL
E 6
GAI
N
FRO
M
WO
RKI
NG
A
FEW
AD
DIT
ION
AL
HO
UR
S AS
PER
CEN
T O
F AD
DIT
ION
AL
EAR
NIN
GS
(SIN
GLE
PA
REN
T PL
US
TWO
C
HIL
DR
EN)
200%
40
25
0%
40
$22,
188
212%
300%
40
$26,
520
255%
400%
40
s35.
8w
295%
Wag
e (P
erce
nt
of
Min
imum
W
age)
H
ours
/ W
eek
Earn
ings
Pe
rcen
t of
po
verty
le
vel
Taxe
s (b
efor
e C
redi
ts)
Soci
al
Secu
rity
(em
ploy
ee
shar
e)
Fede
ral
inco
me
tax
Stat
e in
com
e ta
x To
tal
Chi
ld
Caf
e C
ost
(bef
ore
Cre
dits
)
AFD
C
and
Food
St
amps
AF
DC
Fo
od
stam
ps
Tota
l
Mar
gina
l C
ost
of
Wor
k,
befo
re
Cre
dits
(F
igur
e 3)
Tax
Cre
dits
an
d H
ealth
C
are
Subs
idy
Fede
ral
EITC
St
ate
EITC
Fe
dera
l ch
ild
care
cr
edit
Stat
e ch
ild
care
cr
edit
Prop
erty
ta
x re
fund
(re
nter
s)
Min
neso
taC
are
Tota
l C
redi
ts
and
Subs
idy
(Fig
ure
4)
Mar
gina
l C
osts
of
Wor
k af
ter
Cre
dits
(F
igur
e 5)
Mar
gina
l G
ain
from
W
ork
(afte
r C
redi
ts)
100%
20
$4,4
20
42%
100%
40
s8.8
40
85%
150%
40
$13,
268 127%
$1
7,68
0 170%
7.65
%
15.0
0 6.
00
28.6
5%
7.65
%
7.65
%
7.65
%
15.0
0 6.
00
28.6
5%
20%
7.65
%
15.0
0 6.
00
28.6
5%
20%
7.65
%
15.0
0 6.
00
28.6
5%
20%
7.65
%
15.0
0 6.
00
28.6
5%
20%
7.65
%
20%
7.65
%
20%
20
%
80%
-9
71%
98.6
5%
80%
-6
74%
101.
65%
27%
27
%
75.6
5%
0% 48
.65%
0%
0% 48
.65%
0% 48
.65%
48
.65%
-40.
00%
0.
00%
-6
.00
0.00
0.
00
0.00
-6
.00
-6.0
0 1.
50
1.50
21.0
6%
21.0
6%
21.0
6%
21.0
6%
3.16
3.
16
3.16
3.
16
-15.
00
- 15
.00
-4.6
0 0.
00
-4.4
0 -3
.60
10.3
0 10
.30
2.40
2.
40
2.90
4.
60
19.1
0 58
.22%
13
.50
46.3
2%
0.00
2.
10
-4.5
0%
9.32
%
2.40
10
.42%
0.
00
-50.
50%
0.
00%
48.6
5%
51.3
5%
48.1
5%
51.8
5%
97.1
5%
2.85
%
84.9
7%
15.0
3%
59.0
7%
94.9
7%
5.03
%
106.
87%
-6.8
7%
40.9
3%
FIGURE 3 Marginal Cost of Work before Tax Credits and Health Care Subsidy
(Single Parent plus Two Children)
20
0 $4,420 $8,840 513,260 $17,680
Total Earnings $22,100 $26,420 $35,000 ~ _-------____ ------ --__i_
Tax Jsefore Credit AFDC + Food Stamps - c J Day Care Coqts 1
noted by Lipman and Williamson (1994), the complexity of the system of tax credits hides the high marginal tax rates during their phaseout, reducing any work disincentive effects.
Filing complexity reduces the power of tax credits by discouraging participation. Refundable tax credits require a family to complete tax returns even though they would not otherwise need to file. Given the large benefits provided by the federal EITC, participation rates are high (but so are error rates).j7 Filing complex- ity is more of a problem for Minnesota’s child care credit, vvhich requires comple- tion of both the federal CDCC form (whether the famiAy is eligible or not) and the state CDCC form. The Minne- sota credit IS phased out based on com- prehensive cash income (not adjusted gross income), adding further complex- ity. The property tax refund also phases
out based on a comprehensive rneasure of income.
The impact of tax credits is also limited by their delayed timing. Benefits are generally received in ttie following year, in the form of a tax re, und. k This con- trasts starkly with dire+ transfer pro- grams, where benefits Iare received monthly. The delay in dealizing these tax benefits may seriously /Irode the power of the tax credits if potential workers face cash flow problems.
COORDINATION OF S$TE TAX AND TRANSFER PROGRAMS~
The expansion of feder I and state EITC programs raises import nt questions about the interaction a i d coordination of the two principal stdte cash transfer programs, AFDC and the ElTC/WFC. The
I THE STATES, TAXES, AND THE FEDERAL SOCIAL AGENDA
FIGURE 4 Impact of Tax Credits and Health Care Subsidy
(Single Parent plus Children)
cw ’ I 1 I 1 I I I
$4,420 $8,840 513,260 517,680 $22,100 $26,520 635.ooo Total Ehmings
state BITC C3 Federal Dep. Cam Cr.
cl hIinnesomCare
AFDC program, like food stamps and other direct transfers, provides monthly transfer payments through a labor- intensive, county administered system that gathers ongoing detailed informa- tion about the eligibility status of recipi- ents. Eligibility requirements are com- plex, benefits are based on a comprehensive measure of income, and there is a strict asset test. In contrast, tax credits are administered through the state or federal income tax system with annual returns and payments and with less recipient information on assets and income and less ongoing compliance monitoring.18 The difference between di- rect transfer programs and tax credits are highlighted in Table 1.
Successful integration must first reconcile two fundamentally different views of the correct accounting period for determin- ing eligibility and transfer/credit
amounts. AFDC and food stamps both use a monthly accounting of income to calculate benefits. By definition, tax credits use an annual accounting frame. If an AFDC family earns a high income in one month, that is never deemed to reduce the family’s past AFDC payment. In other words, AFDC is not based on an averaging of monthly incomes. Each month stands alone. In contrast, annual tax credits cannot be calculated as the sum of 12 separately determined monthly tax credits based on monthly incomes. Yet as Wiseman (1993) has co- gently argued, a 12-month delay in re- ceiving tax credits may seriously erode their value as a work incentive. Integrat- ing the tax and transfer systems requires a way to provide tax benefits on a monthly basis.
Early attempts to provide monthly tax credits have been unsuccessful. When
671
FIGURE 5 Marginal Cost of Work after Tax Credits and Health Care Subsidy
(Single Parent plus Two Chlldrtw)
140 r-----
$4,420 $8,840 $13,260 $17,680 $22,100 $26,520 $35,OOa Total h-nings
the advance payment option for the EITC was introduced in 1979, Campbell and Pierce (1980, lp. 7) described the objective of this employer-based monthly payment option as follows: “It is based on the belief that the poor cannot af- ford a one-year accounting period. By increasing take-home pay more promptly, the provision for advance pay- ment is intended to provide greater in- centive to work.” Whether by choice of EITC recipients or lack of support by em- ployers, however, less than one percent of EITC recipients currently participate in the advance payment mechanism.
Another important issue in coordinating tax and transfer systems is the definition of income. Because they are not gener- ally based on a comprehensive measure of income, tax credits have difficulty in targeting the “working poor.” Use of
federal adjusted gross ipcome to deter- mine eligibility for the dITC/WFC can re- sult in tax credits being paid to house- holds with little earned ~income but significant wages and salaries and un- earned income. This can occur if net tax losses from farming, sole proprietorships, or other pass-through qctivities offset wages and salaries. Thq EITC does not have comprehensive income and asset tests like AFDC, so benefits cannot be as effectively targeted.
One possible approach to coordinating transfer and credit programs could be to adopt a more comprehhnsive definition of money income and tlo institute an as- set test in the operation of the ElTC. This @change would adopt more of the targeting approach fouid in the admin- istration of AFDC and other transfer pro- grams. O’Neil and Nelqstuen (1994)
672
I THE STATES, TAXES, AND THE FEDERAL SOCIAL AGENDA
have recently suggested this change to reduce EITC payments to recipients with low earnings but significant wealth. What this suggestion points out is that an integrated, coordinated tax-transfer system may have structural and adminis- trative features that draw from both the current income transfer and tax credit systems.
Two of Minnesota’s tax credits are al- ready based on a comprehensive mea- sure of income. Both the Minnesota child care credit and the property tax re- fund calculate benefits based on a defi- nition of income that includes compo- nents not otherwise reported on tax forms. They have already taken this im- portant step toward an integrated ap- proach, though the Department of Reve- nue has difficulty checking the validity of these components of comprehensive in- come.
STATE PROPOSALS TO INTEGRATE TAX AND INCOME TRANSFER PROGRAMS
A number of states are beginning to ex- periment with integration of the tax- transfer systems. The Michigan Depart- ment of Social Services has developed a proposal that would integrate the EITC advance payment for families with chil- dren into the existing public assistance program. Under the proposal, recipients of AFDC, state family assistance, and food stamps would voluntarily apply to the Department of Social Services, in- stead of employers, for the advance pay- ment. Recipients would report monthly earnings to the Department and would be sent separate monthly checks identi- fied as advance EITC payments. Before payment, the Department would review a recipient’s earnings and verify that the recipient was not receiving advance pay- ments from an employer on the same earnings. Department workers would in- form public assistance recipients of the advance payment program, explain how
to avoid overpayments, and provide in- formation necessary to file annual fed- eral income and EITC forms. By integrat- ing the EITC advance payment option with the public assistance structure, Michigan expects to increase participa- tion and improve compliance in the EITC program. The anticipated benefits for public assistance recipients include in- creased monthly cash flow and greater work incentives.
A similar concept for increasing the role of tax agencies in the advance EITC sys- tem is outlined in Holt (1992). Under this proposal developed by the Milwau- kee Advance Payment Working Group, employers would send monthly wage re- ports including social security numbers for employees filing W-5 forms (advance EITC) to the IRS or other contracted ser- vice. The processing agency would use additional information from the W-5 forms, such as wage data for a family’s second earner, to more accurately calcu- late the advance EITC. The IRS or other agency could either pay the advance payment directly to the recipient or no- tify employers of the correct amount to be included in monthly paychecks. The wage reporting system described in the Milwaukee study could significantly shorten the wage reporting lag inherent in using payroll tax data.
In Minnesota, the Departments of Hu- man Services, Revenue, and Jobs and Training have been jointly studying the feasibility of providing a monthly ad- vance payment option for all recipients of the federal EITC and the state WFC through state agencies. The nonem- ployer-based advanced payment system is being discussed as part of a broader proposal to integrate and coordinate a number of state and federal cash trans- fer and tax credits programs targeted to lower-income households. The long-run objective is to integrate four tax credit programs (EITC, WFC, CDCC, and PTR)
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into a centralized monthly cash transfer system. The credits would also be coor- dinated with public assbstance and other monthly transfer programs to create a unified, monthly tax-transfer system in Minnesota “’
Similar to the Michigan proposal, the Minnesota working group is recom- mending an initial pilot project that would provide coordinated tax credits and transfers for AFDC recipients. Monthly information on income earnings and expenses is currently available for these recipients and could be used to determine monthly prepayments for working AFDC recipients and to verify eligibility. Lessons learned from this pilot project would guide the development of an expanded system covering the entire population of households eligible for the tax credit programs.
The details of a unified tax-transfer sys- tem are still being debated, but the fol- lowing general characteristics of the sys- tem are emerging frorn the interagency discussions :
(1)
(2)
(3)
(4)
Households would file a single, sim- plified form to qualify for all of the credits simultaneously. Eligibility re- quirements and definitions would be coordinated to reduce the informa- tion needed to apply for the credits. The Departmient of Revenue would be primarily responsible for process- ing applications and determining monthly prepayments. Recipients would receive a single, monthly check. Ideally, electronic fund trans- fers would be used in the payment process. With IRS approval, administration of the EITC advance payment system would be moved from employers to the Department of Revenue. At the end of the year, a simplified, final return would be filed with the Department of Revenue to reconcile
(5)
(6)
(7)
03)
advance payments with actual cred- its To prevent unacceptable levels of fraud and noncompliance in the ad- vance payment system, a timely, cost-effective method of verifying monthly data will have to be devel- oped. This will require a new part- nership among state agencies and with the IRS and may involve an al- ternative federal/$tate wage report- ing system. A system of partial advance pay- ments of the tota) expected credits should be used ta avoid significant positive liabilities on annual returns. Reductions in state payments for federal income tax withholding and FICA could be us e d to fund the EITC monthly advance payment. Outreach efforts of the Department of Revenue, Depattment of Human Services, IRS, and other state agen- cies should be coordinated to maxi- mize participation in the advance payment program.
The Minnesota proposals to convert tax credits to monthly advance payments are designed to encourage the movement from welfare to the workforce by pro- viding monthly income supplements for low4ncome workers. However, as clearly pointed out earlier in this paper, these targeted credit programs also come with high marginal tax rates in the phaseout ranges that may create a significant work disincentive. An mportant policy issue needing further study is the extent to which an expansioni in monthly ad- vance payments will increase the visibil- ity, and therefore the disincentive effects of the phaseouts.
Conclusion
Minnesota’s experience with the uncoor- dinated growth in tax credit and income transfer programs has #identified a num- ber of issues that must be addressed to
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I THE STATES, TAXES, AND THE FEDERAL SOCIAL AGENDA
integrate the two systems. The tax and transfer systems involve different objec- tives and administrative features that must be reconciled in the process of in- tegration. States are now beginning to explore ways to achieve greater simplifi- cation, administrative cost savings, in- creased work incentives, and effective targeting of benefits in this complex sys- tem. This discussion of the operation and characteristics of the Minnesota tax- transfer system suggests that, because the tax and welfare systems are now so intertwined, fundamental welfare reform will require simultaneous and significant changes in both systems.
ENDNOTES
The authors would like to thank members of the Tax Research Division for their significant contributions to the paper. Tom Rosholt pro- vided detailed computer analysis of the distri- bution of taxes and transfers. Bobbi O’Keefe developed graphics for the paper. Finally, the authors would like to thank Mary Buechner for her invaluable assistance in the prepara- tion of the entire document.
’ The efficiency argument for a high earnings- reduction rate is summarized in Sheiner (1994). Although Sheiner focuses on the phasing out of health insurance subsidies, the same analysis can be applied to the phaseout of other transfer programs.
* These state experiments are described in Min- nesota House of Representatives (1994).
j The net gain would actually be higher, as ex- plained below, because tax credits would out- weigh the social security tax on the extra earnings.
4 For3 more detailed discussion of the recent expansion in the EITC, see Scholz (1994) and Munnell (1994).
5 A 1994 change in the Minnesota CDCC ex- tends eligibility to two-parent families in which one parent stays home to care for a child under one year of age. This so-called “stay-at-home-moms” provision obviously cre- ates a new work disincentive.
6 Starting in 1994, childless couples and single persons over the age of 25 will also be eligi- ble for a smaller EITC and WFC. Because the sample lacks information on age, these bene- fits are not included in the numbers pre- sented in Table 3.
’ U.S. House of Representatives, Green Book (1991, Table 37, p. 710).
a U.S. House of Representatives, Green Book (1991, Table 38, p. 712). It is also assumed that work is spread evenly over the entire year, so monthly benefits can be calculated at annual rates. The one-year extension of Medicaid benefits and the added work incentives during the first four months on AFDC are ignored. Only the employee share of social security tax is included. The health insurance package through MinnesotaCare is assumed equivalent to Med- icaid, so the only difference is in the premium charged. Unless the employer pays at least half of the cost of health insurance, the fam- ily would be eligible for MinnesotaCare, which would often be less costly than buying insurance through the employer.
10 Costs are from the 1993 Green Book (U.S. House of Representatives, 1993, Table 24, p. 1664). The costs refer to AFDC children and AFDC adults in Minnesota in 1991, adjusted upward to account for inflation between 1991 and 1994. This may overstate the value of Medicaid to the extent that the uninsured would still receive subsidized health care, funded either by charity or through higher prices paid by insured households. The increase in food stamps as income rises illustrates the complex interaction among transfer programs. If earnings increase by $100, AFDC falls by $80 (because day care costs, which rise by $20, are deductible). In determining food stamp benefits, net income is defined as
Earnrngs - O.Z(earnings) + AFDC - child care costs - excess housing costs
The $100 increase in earnings causes AFDC to fall by $80, child care costs to rise by $20, and excess housing costs to rise by $10. So food stamp net income falls by $30. Given the 30 percent phaseout rate for food stamps, the famrly will receive $9 more in food stamps.
‘* Ironrcally, if child care costs were zero (per- haps because a grandparent is willing to watch the children), the family’s net income before tax credits and MinnesotaCare would actually fall by 0.9 percent of gross earnings. (The family would no longer receive AFDC, and the parent would lose Medicaid cover- age.) MinnesotaCare turns that 0.9 percent loss into a 16.1 percent gain. The tax credits increase the gain further to 59.5 percent of gross earnings.
l3 In the absence of child care costs,
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14
15
16
/ Anne L. Alstott (1994) provides an excellent discussion of the institutional differences and constraints that make the integration of AFDC and EITC programs difficult. These differences include a more narrowly defined income con- cept for the EITC, no asset test for the EITC, a more limited EITC deftnition of household income, annual versus monthly accounting periods, and different levels of voluntary com- pliance. Integration issues are also discussed in Steuerle (1990) and Forman (I 993). As discussed earlier, Minnesota has just be- gun an experimenl:al program to issue single monthly checks fair AFDC, food stamps, and housing subsidies.
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47 No. 3 (September, 1994): 609-620. Campbell, Colin D. and William L. Pierce. The Earned Income Credif. Washington, D.C.: Ameri- can Enterprise Institute, 1980. Cline, Robert. “State Financing of Health Care Reform.” Proceedings of the 85th AIVNJJ/ Con- ference. Columbus, OH: National Tax Associa- tion, 1993, 52 -59. Forman, Jonathan Barry. “Synchronizing Social Welfare Programs and Tax Provisions.” Tax Notes (April 19, 1993): 417-23. Holt, Stephen D. “Improvement of the Advance Payment Option of the Earned Income Credit.” Tax Notes (December 14, 1992): 1583-88. Holtzblatt, Janet. “Administenng Refundable
MinnesotaCare raises the gain from work from 17.0 to 27.9 percent. The tax credits In- crease it further to 52.1 percent of gross earnings. The lowest line in Figure 2 (“Before credits and MinnesotaCare”) has three vertical “cliffs.” The first (at $10,640) occurs when the parent loses Medicaid eligibility. The sec- ond (at $15,431) occurs when the family loses eligibility for food stamps. The third (at $19,784) occurs when the two children lose Medicaid eligibility Tax credits such as the EITC may also create strong marriage penalties. See Steuerle and Juffras (1991) for a good discussion of these additional incentive problems. These numbers ignore any increase in income tax rates needed to finance the tax credits. For a discussion of compliance issues, see Holtzblatt (1992).
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