When Welfare is Disguised as a Tax Cut

John R. Lott, Jr.

The debate over taxes has gone off track. As often happens in Washington, it sounds like politicians are often not talking the same language. Confusion abounds over what constitutes a tax cut or a welfare payment.

Confusion exists over even simple facts such as whether the poor who would benefit from a proposed child tax credit actually pay any taxes. Republicans are even battling Republicans.

Let’s take the simplest factual question first. House Republicans claim that poor individuals do not pay income taxes, so how can they get a “tax cut”?

Democrats respond that while the poor don’t pay income taxes, they still pay social security and medicare taxes and should get a credit to compensate them for having to pay those taxes. The White House has taken sides dismissing House Republican objections, saying that “These families deserve help and [the President] wants to give it to them.”

To most people, it probably appears that both sides are right, it just depends upon where you want to draw the line.

Yet, both sides are not right. The poor’s payroll taxes are already more than subsidized by the income tax. The Earned Income Tax Credit was originally justified politically for precisely this reason.

Generous Refunds

Take a family of four, where both the husband and wife work, where one child has just started college and the other is under age 18. Indeed even without any new credits, this family will get more back from the government than they pay for income, social security and medicare until they make over $30,000.

At $21,000, they still get over $2,200 back from the government, over and above what they were paying in social security and payroll taxes. Passing the proposed child “tax credit” for this family will increase this giveback by another $400 because they have one child under 18. The new credits will be available for people earning between $10,500 and $26,625.

In the 1990s, we finally reformed welfare and tried to rein in its costs, but today the Earned Income Tax Credit has so ballooned that it represents twice as much money as spent by the traditional federal welfare program, the Aid for Families with Dependent Children. While government welfare programs officially put time limits on how long people can get welfare, the federal tax system makes the welfare payments tax relief and makes them permanent. What we learned from the success of the time limit getting people off of welfare appears to have been forgotten.

Welfare as Stimulus

President Bush’s justifications for the his tax cuts have helped muddle the whole debate on taxes by claiming that simply giving people more money will stimulate the economy. Lost is the notion of creating incentives to get people to work (lowering marginal tax rates). Using the essentially Keynesian reasoning advanced for the tax cuts, now even welfare payments appear to qualify as a stimulus for economic growth.

Editorials in the New York Times talk of “fat cats” getting their tax cuts and that “there won’t even be crumbs left over for the working folks.” Somehow a tax bill that ensures that high-income people will pay yet a greater share of the tax bill has been painted as unfair to poor people.

For that matter, the 2001 tax cut also shifted a greater share of the tax burden to higher income people. Even without the newest tax change, about 10 million more low-income people have been completely removed from having to pay income taxes from 2000 to 2003.

How many times can you pass transfer payments to offset payroll taxes? Apparently, the answer is more than once. Completely lost in these debates is the focus that Ronald Reagan brought to the issue of marginal rates. Without even the fig leaf of justifying the child tax credit as a tax cut for those paying payroll taxes, why not call the lump sum payment to low income people what it is: permanent welfare payments.

*John Lott, a resident scholar at the American Enterprise Institute, is the author of The Bias Against Guns.