More True Colors - Subsidies that Vanish

Jay's post on the personal impact of the Senate's current health care reform proposals was an excellent example showing people what they could gain from the current proposals. Lots of people make around $54,000 a year and have a family of four. It's a great snapshot of the effect of subsidies. If you get free money from someone else, what's not to like?

In my mind, the real problem is not just that they are proposing taking from the rich to give to the poor. It's the incentives that this system sets up. Suppose you are a hard working employee in a stable job making $54,000 a year supporting your family of four, just like one in the example. You have a few more dollars in your pocket thanks to passage of this bill. According to the chart, reproduced here, you have either $9,000 or $4500 more in your pocket than if no bill had passed. Now suppose that you have an opportunity to earn more money, say another $30,000, by working harder and smarter, getting a raise, moving to a more challenging but rewarding position, having your spouse go back to work, or otherwise trying to improve your lot in life. What happens to your after tax, after subsidy, take home pay? From what I've heard about the health care bill, the subsidy decreases as your income goes up, disappearing by around $88,000 per year. Are you any better off than you were making $54,000? A little bit, but almost all your increase in earnings is absorbed by the decrease in subsidy, increase in tax rates, and other government takings. Why should you bother to work harder if you get no more money in your pocket? The answer is, for the majority of moderately hard working people, you won't. And American will become a nation of people who have no incentive to work harder. That is a very scary thing to contemplate.

Greg Mankiw recognized this issue two months ago:

Jim Capretta looks at the Baucus healthcare bill and concludes that, because the subsidies phase out as income rises, it imposes an effective marginal tax rate on income of about 30 percent for many families. Add that figure to the income tax, the payroll tax, and the phase-out of the EITC and "the effective, implicit tax rate for workers between 100 and 200 percent of the federal poverty line would quickly approach 70 percent -- not even counting food stamps and housing vouchers."

Indeed, Jim seems to understate matters, as he includes only the employee half of the payroll tax. Including both the employee and employer halves, as economic theory says is appropriate, appears to give a marginal tax rate closer to 80 percent. And, of course, many states impose income and sales taxes as well, and these would further raise the overall marginal tax rate.

Greg goes on to recognize that the marginal tax rate, if you consider the removal of subsidies a tax, reaches 75% on those making the common amount of $54,000 per year for a family of four. If they take advantage of very generous federal higher education subsidies available to them at this level of earnings, the rate can reach 100% with no trouble at all. We will create a permanent underclass of dependent citizens who fear working harder because any additional income will vanish into the air.
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