Thursday, March 4, 2010

Does "Making Work Pay" Actually Make Work Pay, or Raise GDP?

The "Stimulus" law's single most expensive provision was "Making Work Pay". It is a $400 tax credit to persons with ANNUAL earnings in between $6452 and $75000, and lesser amounts for persons earning outside the range (reaching zero at $0 and $95000).

So this provision does encourage people to earn somewhere in between $6452 and $75000, rather than earning outside the range. In order to understand how that relates to "making work pay", we need to know whether it does more to pull incomes down into that range from above, as opposed to pushing them up from below.

One question is how many people earn zero for the year, but are on the margin for working. This is difficult to know exactly but, for example, the 2009 CPS demographic supplement says that 10 percent of men aged 25-54 in 2008 earned zero that year. Only 3 percent of men and women aged 25-54 in the labor force (but not necessarily working) in March 2009 had zero earnings for 2008. So let's say that the number of persons who might consider changing their annual earnings from zero to a positive amount is equal to 5 percent of the labor force, or about 7.8 million people.

Another 20.5 million people had earnings between 0 and $6452 for calendar 2008. So we have a total of about 28 million people encourage to work, or work more.

8.4 million people earned between $75K and $95K in calendar 2008.

So clearly there are more people induced to earn more rather than less, and we can conclude that "making work pay" did push in the direction of raising the national employment rate (how much is a much more complicated question).

Note that the types of people encouraged to work more are different than the types of people encourage to work less, so it is possible that "making work pay" could reduce GDP even while it raises national employment.

The 8.4 million people earning $75K and $95K in calendar 2008 had an average income of $83K, as compared to $3K for those 20 million earning $1-6452 (who knows what the 7.8 million who earned zero would have earned if they had worked). Obviously, $400 seems like more to the latter group, and therefore would tend to motivate a greater change in hours or weeks worked for them: a rough adjustment for this compares the marginal tax rates for the two groups. The former group's marginal tax rate was 2% (ie, they lost $20 of tax credit for every $1000 they earned), and the latter group's was -6.2% (they gained 62 dollars of credit for every $1000 they earned).

So the income-weighted average marginal tax rate for the two groups was (8.4*83*.02 - 28*3*.062)/(8.4*83+28*3)= +1.1 percent. In other words, on net Making Work Pay probably REDUCED the supply of income, because its income-weighted average marginal tax rate was positive, rather than negative.

In summary, a good guess says that "Making Work Pay" may have increased national employment and hours, but it is highly unlikely that it increased GDP. The Treasury cost of the program was not only the $116 billion budgeted, but also the loss of other tax revenues due to the net disincentive to earn.

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