Megan McArdle passes along an example of how poor folks respond to the extremely high Marginal Tax Rates that they face
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
Because I am a soulless geek I am going to walk right pass the heart break in this story to point out that this woman is describing an income effect not a substitution effect.
She is not saying that at the very low rate of return it wasn’t worth her time to work more. No.
She is saying that the tax and benefit structure was designed so that she could no longer afford to purchase the things she had been able to before.
Moreover, here is the kicker. Her natural response to this was to attempt to increase labor supply.
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.
She faced a marginal tax rate in excess of 100%. This meant as her earned income went up she got poorer. What did she do? She tried to earn even more income.
It was only we she failed at the attempt to make ends meet by supplying ever more labor to the free market that she try to go back to making less money.