By: Nate Golden and Max Ghenis
See original article here
Federal income tax rates range from 10 percent in the lowest income bracket to 37 percent at the highest bracket. At the state level, Maryland levies progressive rates ranging from 2 percent to 5.75 percent. This might suggest that the rich face substantially higher tax rates than the poor. Yet, a holistic examination of the income tax code reveals the opposite: Low-income households face the steepest tax rates, and Maryland makes it worse.
What explains this counterintuitive trend? Means testing: a determination of whether a household is eligible for the full amount, partial amount, or none of a government benefit based on their income. For example, the Earned Income Tax Credit withdraws $21 for each $100 of earnings above $19,520, for parents with two children. This is equivalent to taxing that parent at a 21 percent rate. Either way, the recipient loses $21 for every $100 they earn. A means test is a tax.
When we combine all of the means tested credits and benefit programs with explicit income taxes, we can calculate a household’s marginal tax rate: the amount of additional tax paid for every additional dollar earned. A study from the Congressional Budget Office found that marginal tax rates on low-income households frequently exceed 50 percent and sometimes 80 or even 100 percent due to means tested benefits. Such severe marginal tax rates essentially trap low-income folks near the poverty threshold. If you only get to keep $200 for every $1,000 you earn, your incentive to work more nearly disappears.
A new Maryland tax model, created by PolicyEngine, allows the public to compute their own marginal tax rates.
Our new research, conducted at the UBI Center using PolicyEngine, finds that Maryland especially discourages low-income parents from working.
For example, if a single parent of two working full-time at minimum wage chooses to work one more hour per week, they would earn $650 more per year, but their net income after taxes and benefits rises only $86 per year. They face a marginal tax rate of 87%, of which Maryland taxes explain about one sixth. Their hourly wage isn’t $12.50, it’s $1.65.
Maryland exacerbates this problem largely by matching means tested federal programs such as the Earned Income Tax Credit and the Child and Dependent Care Credit. While matching federal programs offers more simplicity than creating new means tested programs (such as Maryland’s Poverty Line Credit), it also amplifies the federal programs’ work disincentives. As a result of this matching, Maryland’s top marginal tax rate isn’t 5.75% paid by the richest, but 15.3% paid by families with income around $40,000 to $60,000.
As the 2023 legislative session approaches, state legislators should prioritize shifting the tax burden away from low-income families. Now may be the perfect chance to do so. The enhanced Earned Income Tax Credit and Child Tax Credit are both set to expire this tax year and many legislators see updates to these programs as a top priority. Instead of continuing to means test these programs, Maryland can create a single universal child benefit that avoids taxing the poor at higher rates through means testing. Legislators could apply similar updates to Maryland’s Child and Dependent Care Credit and Poverty Level Credit, or consolidate these programs into a more generous child benefit.
Policymakers means test programs to lower the spending number. Touting that one’s new means tested credit only costs $20 million instead of $200 million may win votes from fiscal conservatives, but it fails to understand the economics at play. The real cost of a new spending program is not the big spending number, it is the economic distortion from the taxes required for its funding. We cannot escape these costs by creating implicit means tested taxes over explicit ones.
A more equitable and transparent policy approach is to provide universal benefits and claw back money from high-income households through explicit taxation.
Rather than continuing to opaquely tax the poor, Maryland lawmakers should seize the opportunity for substantive reform and embrace universal programs.
About the authors: Golden is a Baltimore City Schools teacher, the president of the Maryland Child Alliance, and a research associate at the UBI Center. Ghenis is the founder and president of the UBI Center.