Clifford Thies explores The Dead Zone where the implicit marginal tax rate crests over 100 percent:
To say that antipoverty programs in the United States are perverted may be an understatement. When you take into account the loss of means-tested benefits (e.g., cash assistance, food stamps, housing subsidies, and health insurance), and the taxes that people pay on earned income, the return to working is essentially zero for those in the lower two quintiles of the income distribution.For many of the working poor, the implicit marginal tax rate is greater than 100 percent. The long-run consequence of undermining the positive incentive to work is, of course, the creation of an underclass acclimated to not working; the supplement of cash and noncash benefits with income from crime and the underground economy; and the government resorting to negative incentives such as mandatory work programs.
Below, I show the relationship between earned income and after-tax income plus subsidies for a hypothetical Virginia family of three, consisting of one adult and two minor children. As you can see, the relationship is essentially flat from $0 to about $40,000 in earned income.
To see exactly what is happening, I developed the following chart. It shows the implicit tax paid on the last $10,000 of earned income (initially by comparison to the welfare grant and then by comparison to income less taxes plus subsidies).
At A, the marginal tax rate is quite high, essentially because of the generosity of the package of cash and noncash benefits provided to those on welfare. At B, the marginal tax rate is relatively low (!) because of the Earned Income Tax Credit (EITC). From B to D, we (or, rather, the working poor) are in the Dead Zone, with implicit marginal tax rates mostly exceeding 100 percent.How stupid and evil must our elected representatives be to do this to the working poor! Actually, this being a democracy, there is nobody to blame but the electorate. Especially the left-liberal do-gooders. Since Milton Friedman developed the negative income tax, waaay back in the 1950s, there can be no excuse for any educated person to not be aware of the fact that taxes and means-tested benefits destroy the lower classes’ positive incentive to work.
Arnold Kling adds that Greg Mankiw shows that health care reform will make this worse.