Friday, July 25, 2014

Pence’s call for tax reform in Indiana

Governor Mike Pence is calling for a review of the State’s tax code. His top goals are to simplify the code and to promote economic development—two worthy pursuits. 

First, if the government is going to take our money, then it should do so as gently as possible. The U.S. income tax code is notoriously burdensome in terms of the billions of hours and dollars required to complete the paperwork. Governments will tax our money, but they shouldn’t unnecessarily tax our time too. 

Second, all things equal, fiscal and regulatory policies should minimize the damage to the economy and increase the possibilities of economic development. It is important for policy-makers to strive for this goal. 

But while Indiana’s leaders are looking at tax reform, they should achieve one other goal: eliminating the income tax burden on working poor households. 

These days, it is common to make loud (and vague) complaints about the “gap between the rich and the poor”. Related to that, it is popular to advocate a higher minimum wage. But a higher minimum is a very mixed bag. 

To name two reasons (among many): First, the minimum wage has both benefits and costs. By artificially increasing the price of less-skilled, it will be less attractive to firms. Depending on the context, firms may respond by increasing prices to consumers or reducing other forms of compensation (e.g., free uniforms, discounts on product). But if these are not sufficient, firms will eliminate jobs. 

It’s a shame to help some vulnerable people by harming other vulnerable people. This hurts those who lose jobs—short-term and then long-term, by taking away their opportunities to build skills, cutting off the first few rungs of the economic ladder that would allow them to move to the middle class. 

Second, the minimum wage is poorly-targeted—impacting middle-class teens and the elderly, as well as poor heads of households. Policy prescriptions should be as precisely targeted as possible, limiting the costs of the policy and concentrating the benefits of the policy appropriately.

Fortunately, there is a better policy alternative: eliminating taxation on working poor households. By far, the most onerous burden comes from the FICA payroll taxes on income that are used to support the Social Security and Medicare of current retirees. These take 15.3% of every dollar earned by the working poor—more than $3,000 annually from a head-of-household at the poverty line. It always amazes me that so-called champions of the working poor rarely talk about this devastating policy issue. 

Of course, Hoosier leaders can’t do much about a nasty federal policy. But they shouldn’t add to those burdens by imposing state income taxes on the same vulnerable people. At present, Indiana is one of a handful of states that impose taxes on hard-working, lower-skilled, heads-of-household at the poverty line. 

A decade ago, Indiana added an earned income tax credit (EITC) to offset much of this burden. But Indiana legislators should take the next step. They should remove all working poor households from the tax rolls and freeing up the EITC to do what it was designed to do: subsidize working-poor households. Poor households would have more money in their pocket—without the risk of being priced out of the labor market by a higher minimum wage. This would be a win-win for the working poor and the Hoosier economy.


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