Monday, October 22, 2012

Make More by Working Less? Not as Uncommon as You'd Think

Consider a married dual-earner couple with two young children.  Both adults earn $600 per week when at work full-time, which is near the left-middle of the full-time earnings distribution.[1]  When both are employed all year, as they normally are, the family’s income exceeds $60,000, is about triple the poverty line, and exceeds the income of a majority of families in America.  Nevertheless, this couple illustrates how just a small bit of program participation can completely erase the financial reward from working.
When at work, they spend $100 per week for the care of the children and each spend $50 commuting (about $5 for a one way trip to work).[2]  If one of the adults were not at work, these costs fall by a total of $150 per week as the non-employed spouse takes care of the children and does not commute to work.
In the middle of 2009 (26 weeks into the year, with 26 weeks to go), one of the spouses is laid off, and is entitled to $289 per week for the first ninety-nine weeks that she is unemployed.[3]  The best job she can find in the short term pays $500 per week: a 17% pay cut.  What would she and her family gain financially by starting a job immediately, rather than waiting until 2010 to seriously consider going back to work?
First of all, working the second half of 2009 would provide $500 per week in pre-tax income, and $461.75 weekly after payroll taxes.  As compared to not working receiving $289 UI per week, that’s a difference of $172.75 after payroll taxes.  But working will require some expenditures on childcare and commuting, which I have estimated as a combined $150 per week.  Without accounting for any other federal or state income taxes, we have that working a full-time work week adds a mere $12.75 to the family’s disposable income.  In case you are looking at this on hourly basis, that’s about 32 cents per hour, and we have not yet begun to count personal income taxes!
Working the second half of 2009 would make taxable income of $36,850 ($59,800 family earnings minus a standard deduction of $8,350 minus $3,650 for each of the four family members) rather than $28,964 ($46,800 family earnings plus the $5114 worth of UI that is taxable minus the aforementioned deduction and exemptions).  Ignoring tax credits for the moment, working involves $1,183 more federal income taxes (i.e., this family is in 15 percent bracket regardless of the work decision) and about $237 more state income taxes for calendar year 2009.  That’s $54.62 extra taxes for each week worked.
Regardless of when the laid off spouse goes back to work, this family has calendar year earned income of less than $110,000 and therefore qualifies for the full “Making Work Pay” credit and the full amount of the child tax credits (totaling $2,000).  The Earned Income Tax Credit is zero regardless of the work decision because family calendar year wages exceed $41,000.  So the bottom line financially for this family is that sending the laid off spouse back to work immediately results in less disposable income ($32 per week less if income tax withholding coincides with the actual tax liability) for the remainder of calendar year 2009 than they would have if the spouse remained unemployed for the remainder of the year.  Of the pre-tax $500 that would be earned per week, $50 goes to commuting, $100 to childcare, and $38 to payroll taxes, and $55 for extra personal income taxes that would not be owed on unemployment benefits, leaving $257 after work expenses and taxes that could be avoided by not working.  Unemployment insurance pays better – $289 per week – for up to ninety-nine weeks.
Tens of millions of people participate in Medicaid and SNAP (food stamps) when a bread-winner is unemployed, but to be conservative and keep the illustration simple, above I assume that this family does not participate in dozens of government anti-poverty programs: they only participate in UI and claim any credits that are available to them on Form 1040.  Nevertheless, their financial reward to working is negative – they have to spend less in order to be able to afford to work more.  This illustrates why government safety net programs have quite a large effect on work incentives, and why even a small program can turn work from a net financial positive to a net financial negative.
If the person losing her job in this example had not been married, but still had the two kids and still had the same earnings opportunities, not working would provide even more disposable income because the person would be on the phase-out portion of the EITC schedule as a result of being unmarried.  Even if childcare were free, work would still have no financial reward.
The Redistribution Recession has many more examples like these, and estimates how common they are in the non-elderly U.S. adult population.

[1] Among non-elderly household heads and spouses employed full-time during the reference week and sampled by one of the twelve 2007 CPS monthly surveys, $600 was at the 35th percentile of their weekly earnings.  Among heads and spouses less than age 40 (and thereby more typical of persons with young children), $600 was at the 40th percentile.
[2] For simplicity, my tax calculation below does not explicitly consider the child care expense tax credit; the $100 weekly child care expense should be interpreted as net of the credit (if any).
[3] The typical replacement rate is 44%, plus the $25 per week Federal Additional Compensation bonus provided by the ARRA.


Bruce said...

Oh please. You're so proud of yourself that you created a situation where unemployment insurance might temporarily work out better than employment.

Three questions:

1. Do you have any significant number of examples of people who take advantage of this type of situation? My guess is that it's around 10% of unemployed. Name me a government program more efficient than that.

2. You're forgetting 'opportunity costs'. If you remain unemployed, you're going to probably have a harder time getting a job later. And if you take the job, you might get a raise within six months, making the job worth taking.

3. The fact that there are still something like 4 applicants out there for every job opening suggests that your idea is more applicable in theory than in practice.

But hey, I'm no economist, so what do I know.

NOTE: I'm a computer programmer, and the only time I was unemployed and checked on UI, it was so little I didn't even bother to collect it.

Mint said...

This contrived example is all fine and dandy, except for the fact that there aren't any $500/wk job openings out there with a dearth of applicants. Additional incentive to work achieves nothing.

This kind of disincentive is exactly the type we need to shift available jobs to those who need them the most, as people who haven't had a $600/wk job in the previous couple years or are new to the workforce (and ineligible for UI) are more likely to take an opportunity.

If there's only one job for two applicants, it makes far more sense for a youth with no family get a job and have the parent stay home to take care of kids than, in the case of reduced UI, have an idle youth with no assistance and a parent juggle a job and parenting.

Finally, consider that only a fraction of all unemployed workers have this disincentive to work. If the gov't was to reduce UI to increase incentive to work (which, as mentioned above, is a goal of dubious value anyway), it would be hurting ALL recipients. Taking away that income would have a serious hit on aggregate demand, which would result in layoffs and thus do the opposite of what was intended.