taxing the working poor in Kentucky

Talk of taxes and tax reform is in the air again. At the federal level, the “Fiscal Cliff” of January 1st was more about political theater and procrastination than effective solutions. Less publicized, the most recent phase of ObamaCare brought some new taxes.

In addition, the 2% “holiday” on payroll/FICA taxes ended, resulting in much higher taxes for all workers. Politicians in DC generally ignore this most burdensome aspect of income taxation—15.3% of every dollar earned (up to a cap of $110,100). This is regrettable, especially since FICA hammers the working poor and those in the middle class. For example, someone earning $20,000 loses about $3,000; someone earning $60,000 loses about $9,000.

At the state level, Kentucky is talking about tax reform and higher taxes, given continuing budget shortfalls. Governor Beshear’s task force recommended a variety of new and expanded taxes to raise $659 million. This would be combined with $100 million in tax reductions on corporations and individuals—and a new “Earned Income Tax Credit” (EITC) which would make Kentucky the 25th state to pass this reform.

If I were king, tax reform would be a high priority—and any tax reform would reduce the burden on the working poor and start an EITC.

The EITC is a “tax credit” for “earned income”—monies paid to those in lower-income families who earn wages. The idea is to subsidize those who are working, but earning an income that is too low to support a family.

Often, people embrace the minimum wage as a policy to reach this goal. But a higher minimum wage also increases the cost of hiring low-skilled workers, making it more difficult to employ them. The EITC has the merit of keeping low-skilled workers attractive to firms, allowing them to build job market skills and pick up valuable job experiences, while subsidizing their earnings to help them support their family.

The federal government has a significant EITC—which offsets some or all of the FICA tax on low-income households. About half of the states also offer an EITC. States might embrace or expand an EITC to further offset the federal income tax policy—or beyond that, to subsidize those who are working but struggling to make ends meet.

In Kentucky, the state government imposes income taxes on parents and children at and near the poverty line. After the tax reform in 2005 led by Governor Fletcher, many of the poor were taken off the tax rolls. Before this, Kentucky was arguably the worst in the nation. But there’s still room for improvement. For a two-parent household of four at the poverty line, Kentucky has the 14th highest burden in the nation at $94. Looking at 125% of the poverty level, a one-parent household of three pays $555 (4th highest). And a two-parent household of four pays $1,021—tops in the nation. I guess it’s good to see Kentucky #1 in something!

The EITC and eliminating taxes on the working poor should make sense to liberals and conservatives. Those on the Left claim to care about the poor—although this is usually more about posing than policy. Those on the Right want to encourage hard work, efficiency, and so on. How can those on either side be fond of income taxes on those trying to survive on an income near the poverty line?