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Understanding Marginal Tax Rates and Government Benefits

Some Washington policymakers are increasingly focused on whether government benefits for low- and moderate-income people create disincentives to work — in particular, when these benefits phase down as the earnings of beneficiaries rise, our new commentary notes.  That phase-down rate is often called the “marginal tax rate” because it resembles a tax — benefits fall as earnings rise.  As we explain:
[P]olicymakers across the ideological spectrum share concerns about marginal tax rates and agree that, all else being equal, lower marginal tax rates are preferable to higher ones.  Unfortunately, all else is not equal, and lowering marginal tax rates entails significant and very challenging policy trade-offs. . . . [M]arginal tax rates are the product not of bad policy design but rather of competing policy goals:  providing needed assistance to financially struggling individuals and families and limiting costs by not providing help to those with more adequate income.  Any serious discussion of the marginal tax rate issue must grapple with the fundamental tension between limiting assistance, controlling costs, and reducing marginal tax rates. No such serious discussion is likely to result, however, from exaggeration of the marginal tax rates that most low-income families face, overstatement of the impact those marginal rates have on actual work behavior by low-income households, or glossing over the tough policy trade-offs that policymakers must face when seeking to reduce marginal rates.
Click here for the full commentary.