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(Dis)incentives for getting ahead? Longitudinal evidence on combined marginal tax rates facing low-income working families

For low-wage workers seeking upward mobility through increased earnings, the combination of rising income tax rates and reduced eligibility for means-tested programs combine to create combined marginal tax rates (CMTRs) that can reach and sometimes exceed 100 percent. This means that an additional dollar in income is partially, totally, or more than offset by net tax increases and benefit losses.

Tax and transfer programs are hypothesized to affect labor market behavior among the poor by influencing whether persons participate in the formal labor market at all (the "extensive margin") and by affecting the amount of hours or work intensity among those who do work (the "intensive margin"). There is strong and consistent evidence that anti-poverty work support programs such as the Earned Income Tax Credit and expansions of benefits to households with workers have encouraged poor families to enter the labor market.

Consensus has been much harder to reach on the impact of tax and transfer incentives on the intensive margin. In empirical studies of incentives in the tax system alone, low-income workers appear unresponsive to high MTRs, but research to date has also been hindered by lack of adequate data that includes both tax and transfer receipt information and identifying policy variation.

This paper examines the incentives created by the combination of a progressive tax system and the benefit schedules of common means-tested transfers. Using a unique proprietary data set consisting of three years of state human services caseload data merged with Unemployment Insurance and Department of Revenue data, we will present new longitudinal evidence on the distribution and persistence of high CMTRs, and examine the labor market behavior of workers who face high CMTRs, allowing for a descriptive test of employment and wage growth disincentives.

Understanding the combined effect of federal and state tax and transfer programs is important for policymakers who aim to improve low-income families' standards of living without dampening incentives for wage growth and upward mobility.