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Tax Reform for Low-Wage Workers.
by Michael M. O. Seipel As a result of the recent implementation of work-oriented antipoverty programs, more welfare recipients can be expected to be working in low-wage jobs. With these jobs there is little hope that these workers' incomes will rise above the poverty level. One way to help support these low-wage workers is through tax reform. Although low-wage workers pay little or no federal tax, they still pay high payroll and local taxes. To help such workers keep more of their earnings, refundable taxes like earned income tax credit and child refund taxes should be expanded, and sales taxes on food should be eliminated. Key words: equity; poverty; tax reform; welfare reform; working poor people Welfare entitlement programs have lifted many people out of poverty and have opened the doors of economic opportunity for many, but these programs also have become increasingly unpopular. Consequently, welfare programs have come under serious attack, and the thrust of welfare programs subsequently has changed from entitlement transfer programs to work participation programs. On October 13, 1988, President Reagan signed into law the Family Support Act (P.L. 100-485). In essence, this law called for support of economic self-sufficiency activities among welfare recipients. To facilitate economic self-sufficiency, the act authorized the creation of the Job Opportunities and Basic Skills Training (JOBS) program. Under the JOBS program, Aid to Families with Dependent Children (AFDC) recipients were required to either work, look for work, or participate in the jobs training programs (Hagan & Lurie, 1995). Unlike the Work Incentive Programs of the 1970s, the JOBS program achieved a measure of success (Blank & Blum, 1997; Hagan & Lurie). States with innovative programs and administrative commitment to the JOBS program saw success, whereas others with significant constraints did not. On the whole, people who had limited child care services, health care provisions, and educational opportunities did not achieve the overall goals of the JOBS program ( Blank & Blum, 1997; Corbett, 1994-95; Hagan & Lurie). The effort to fight poverty through work was further strengthened by President Clinton's welfare reform measure. On August 22, 1996, President Clinton signed into law the Personal Responsibility and Work Opportunity Reconciliation Act (P.L. 104-193), which replaced AFDC with Temporary Assistance to Needy Families. The act focused on moving poor families from welfare to work. It required work in exchange for time-limited assistance and ultimately required people to be employed and become economically self-sufficient. The measure included the following features to achieve the central goal of the policy (Administration for Children and Families, 1996; Scholz, 1994-95): 1. Make work pay--To encourage people to work and continue working, this policy provides several economic incentives. Mainly, the administration proposed the expansion of earned income tax credit (EITC) and an increase of the minimum wage. 2. Job training and education--To facilitate the transition from welfare to work and to increase earning capability, the administration promised to provide training and education while recipients received welfare assistance. 3. Time-limited assistance--To prevent welfare recipients from staying on welfare indefinitely and to help them move toward employment, the new welfare mechanism provides only time-limited benefits. Once the time limit is reached, welfare recipients are expected to be employed. To facilitate this effort, recipients are assisted with child care, health care, and other support services during the time they seek employment. President Reagan's JOBS program, along with President Clinton's welfare reform and a number of state work initiatives, is a clear indication that traditional welfare entitlement programs are being replaced by work-oriented antipoverty programs. The new welfare reform measure mandated that 25 percent of the TANF recipients be involved in work-related activities by the end of fiscal year 1997. The participation rate then should increase by 5 percent per year until 2002, when the 50 percent participation level will have been reached. Because of this mandate, welfare recipients are already moving into the labor market. However, job opportunities and earning prospects for unskilled workers are limited. Although comprehensive data are not yet available, Burtless (1997) has noted that unskilled workers typically earn $6 to $7 per hour. Their income is substantially reduced, however, and falls below the poverty line when work-related costs (for example, child care, transportation, and so forth) and tax obligations are taken into account; hence, a large percentage of working poor people remain poor. If social workers are to be effective agents of social and economic justice, they must find an alternative mechanism to redistribute wealth within current political and economic realities. Because the emphasis of the current welfare reform has moved from entitlements to work, social workers must now pay closer attention to tax codes as one mechanism that can protect the economic well-being of working poor people, who are primarily in the secondary labor market. Belcher and Fandetti (1995) agreed that tax codes can be an effective tool of antipoverty efforts. They believed that lowering corporate taxes helps create jobs, which lift people out of poverty. Therefore, they argued that social workers should support tax policies that can create a competitive economic climate in which corporate America can succeed, leading to jobs and prosperity for poor people. Although their argument has merit, because it is not based entirely on historical evidence, their claim should be viewed with skepticism. Karger and Stoesz (1998) noted that many favorable corporate tax policies of the 1980s did not necessarily create new jobs or prosperity for working poor people. Instead, corporations used the tax savings to carry out mergers and takeovers and to transfer operations abroad. These activities have created huge budget deficits and loss of well-paying jobs for workers in the United States. In a similar vein, Huff and Johnson (1993) pointed out that in the 1980s more than 2 trillion d ollars were distributed to corporations to create better competitive economic conditions, but most of the money ended up in stockholders' pockets. Although reducing tax burdens on corporations has some potential for creating jobs, historical evidence indicates that not all tax-cutting policies created jobs and prosperity for the worker. However, there is increasing evidence that tax measures designed to support individual workers can improve the economic well-being of low-income families. Therefore, tax policies should be designed to help working poor people continue working, to help them keep more of their earnings, and to facilitate prosperity. Three such tax policies are the EITC, elimination of the sales tax on food, and the refundable child tax credit. Earned Income Tax Credit Two of the most significant antipoverty tax policies implemented during the past few decades were the EITC legislation of 1975 (P.L. 94-164) and the tax reform act of 1986 (Omnibus Budget Reconciliation Act, P.L. 99-509). With the EITC, working poor people received refunds even if they owed no federal income tax. The refunds offset largely what they paid in payroll taxes. Moreover, the 1986 tax law lowered substantially tax obligations through an increase in the standard deduction and an increase in personal exemptions by indexing to the cost of living. Hence, most working poor people had virtually no tax obligations (Danziger, 1990). As a result of these antipoverty tax measures, federal income and payroll taxes for a family of four with earnings equal to the poverty level dropped from 10.1 percent in 1984 to 2.1 percent in 1988 and to only 0.3 percent in 1992. With the major expansion of EITC in 1996, the combined tax rate for low-income families was 8.6 percent. As a result, low-income families received an average annual refund of $1,400, even if the families paid no federal taxes (Plotnick, 1997). The original EITC benefit equaled 10 percent of earnings up to the first $4,000, or a maximum refund of $400. By 1996 a family with two children received 40 percent of the first $8,890 of earnings or a maximum refund of $3,556. Then the credit declined by 21 cents per dollar over $11,610 until it phased out at an income of $28,495. The EITC program has been popular since its inception, and it continues to receive strong support from liberals and to some extent from conservatives. Liberals support it because it is viewed as a positive mechanism to create fairness in the tax system by redistributing resources from the affluent to poor families. Conservatives, although they are not willing to promote it, support it because benefits are tied to work, and it encourages working poor people to stay in the labor market (Plotnick, 1997; Scholz, 1993-94). EITC provided tax benefits to nearly 19 million poor families in 1996 and has been shown to be an effective antipoverty program (Plotnick, 1997). With the figures obtained from the census data, Greenstein and Shapiro (1998) reported that EITC has lifted 4.6 million low-income people out of poverty. Of those, 2.4 million were children. In addition, EITC has been shown to encourage working poor people to stay employed. Similarly, Porter et al. (1998) found that EITC had lowered the number of children receiving cash benefits and food stamps. All these benefits occurred with a few problems. Scholz (1993-94) noted that some of the problems were with manipulation of income, labor participation, and family formation by the recipients to maximize the benefits, but he saw no widespread problems. Scholz suggested that with a few administrative modifications, the problems could be minimized. In addition to administrative reforms to minimize the problems found, I recommend that all states adopt their own EITC programs, thus minimizing the effect of other tax burdens faced by low-income workers. Although working poor people may have no federal tax obligations, they still are burdened excessively with regressive state and local taxes. Unlike the more progressive federal taxes, state and local taxes generally are regressive; consequently, poor people are taxed at a higher rate than wealthy people. A nationwide tax study released by Citizens for Tax Justice (1996) showed that low-income families paid a much higher share of their income in state and local taxes than wealthy people did. The study showed that the average tax rate for affluent families was 7.9 percent, whereas the tax rate for poor families was 12.5 percent. In Utah the tax rate for a family of four with an income below $9,000 is 13 percent, whereas the same size family with an income over $100,000 has a tax rate of just 8 percent (Mangu m, Weathers, Bell, & Lazerus, 1996). This disparity appears to be the rule rather than the exception, and only a few states are making any effort to create more equitable tax structures (Citizens for Tax Justice, 1996; Johnson & Lay, 1997). There are now nine states (Iowa, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Wisconsin) with state EITCs. In five (Massachusetts, Minnesota, New York, Vermont, and Wisconsin) the credit also is refundable, as it is in the federal program. This means that eligible families will receive a cash refund even if they owe no state taxes (Lazeke, 1998). Adoption of such state EITC measures by all the states would further lighten the tax burden of low-income families and help reduce the poverty rate. Sales Tax Another way low-income families pay proportionately higher taxes than affluent people is through consumption taxes. Because low-income families spend more of their income on consumer items than affluent people, most of their income is subject to regressive state and local sales taxes (Lay, Lazere, Greenstein, & Gold, 1993). Moreover, poor people did not receive any significant sales tax breaks during the economic recovery of the 1990s. In contrast to the up-and-down movement of state personal income taxes in the 1990s, sales tax rates increased steadily during the first half of the 1990s. During this time the average state tax rose from 4.8 percent in 1990 to 5.1 percent in 1993 and increased again to 5.2 percent in 1997 (Johnson & Lay, 1997). A study initiated by the special commission on tax reform of the Commonwealth of Massachusetts showed that households with incomes less than $5,000 paid more than five times as much sales tax (proportional to income) than did households with incomes of more than $75,000 (Reschovsky, 1986). To relieve low-income families of the burden of the state sales tax and to create fairer and more equitable taxation, sales taxes on food and other purchase items should be in part or completely refunded. Because sales tax on food is regressive and affects poor families disproportionately, low-income families should be exempt from tax on food. This can be accomplished by providing refundable tax credits as a part of the personal income tax process. States without income tax may use a separate application to receive refunds. Already 26 states have eliminated food taxes altogether, and eight states provide tax credits to the targeted low-income families. Without question, collecting taxes on food is an important source of revenue for many states, but the relative importance of this tax to the state and the proportion to all taxes collected by the state differ widely. About two-thirds of all states that have a food tax collected 10 percent to 20 percent of total sales taxes from food, and sales taxes from food r anged from a low of 3.2 percent in Illinois to a high of 28.6 percent in Missouri ("New study," 1992). For various reasons, some states had a smaller portion of their taxes from sales tax on food. Among others, the most important reason was that states that collected less on food tax had broader tax bases, so they were able to make up the differences from other sources. To further relieve low-income families from regressive sales taxes, some form of refundable sales tax credit also should be offered to specially targeted low-income families. Several states have made such refunds available to disabled or elderly people or to low-income families (Law et al., 1993). Food tax and general sales tax relief for targeted populations have been implemented in several states without significantly compromising the level of mandated state services by having more progressive taxation in state income tax and identifying additional sales tax revenue sources (Kahan & Greenstein, 1987). Identifying and broadening additional tax bases can be a positive solution for the state and for low-income families. With this approach, states can provide tax relief to low-income families without losing significant tax revenues. In some states, sales taxes are now imposed on haircuts, laundry services, and even attorney services. Imposing taxes on these types of services are less burdensome to low-income families because such people tend to use these services less than the more affluent people (Kahan & Greenstein). The sales tax relief recommended here makes sense for several reasons. First, by expanding the tax base, states can afford to either reduce or eliminate sales taxes on food, without compromising other state services. Second, because states are able to generate revenues and redistribute resources, local jurisdictions will not be burdened disproportionally with the loss of revenues from the sales tax on food. Third, most of the benefits go only to the low-income people. Fourth, sales tax relief should not be difficult or expensive to administer. The existing state tax commissions should be able to manage it without significant reorganization. Finally, there is no work disincentive built into the program. Refundable Child Tax Credit Rainwater and Smeeding's (1995) Luxembourg income study of 18 Western industrialized nations showed that the United States was the only nation that did not have some type of universal child allowance payment system. In a similar vein, the United States allocates a smaller portion of its economic output toward antipoverty transfer programs than other Western industrialized countries. The lack of such financial support programs may be one reason poverty among children is so high in the United States. In fact, the Luxembourg study showed that the poverty rate among children in the United States (21.5 percent) was by far the highest. Australia had the second highest poverty rate with l4 percent. Three countries were between 11 percent and 14 percent, and the other 13 countries were in the 5 percent to 10 percent range (Plotnick, 1997). Although many Western industrialized nations provide financial support for children through some type of universal allowance payments, financial support for raising children in the United States comes in the form of personal income tax deductions found in tax codes. This arrangement is not ideal, but it is still helpful to families. However, Lewit et al. (1997) noted that this policy provides benefits to families with high incomes but generally is not available to low-income families who have no federal tax liabilities. Consequently, poor families have to rely on welfare programs like time-limited TANF. However, in the current political climate, even welfare programs like TANF may not be available in the future to defray the cost of raising children. To strengthen low-income families, the child tax credit refund proposed under the original Contract with America should be made available to low-income families, even if they have no federal tax liabilities. Under this provision, a $500 credit per child would be applied against combined federal tax liabilities and payroll taxes before EITC is calculated. This measure would extend a full $500 per child tax credit to people who earn $20,000 (all figures in 1997 dollars) or more and a partial credit to those who earn between $17,500 and $20,000. Although this provision is not as far reaching as the $1,000 refundable tax credit for all children recommended by the National Commission on Children (1991), it is still an improvement over the child tax credit act recently passed. Although a $1,000 refundable tax credit would benefit low-income families, given the current posture of Congress, it may not support a $44 billion (twice the cost of the present child tax credit) spending program (Lewit, Terman, & Behrman, 1 997). The Taxpayer Relief Act (P.L. 105-34) signed into law by President Clinton on August 6, 1997, makes child tax credit available to those who owe federal income taxes but generally not payroll taxes and owe that only after EITC is calculated against federal income taxes (Citizens for Tax Justice, 1997). As a consequence, the new tax law cuts or denies benefits to many additional children in low- and low- to middle-income families who were eligible under the child tax credit measure proposed in the Contract with America and the similar measure adopted by Congress in 1995. The new measure signed into law by President Clinton either denies or cuts credit to those who earn too little. For instance, a two-parent family of four would not qualify for any child tax credit until their income reached $20,000, and the full credit is extended only to those who earn more than $24,000. Moreover, the child tax credit would apply only to the remaining federal tax liability after EITC has been calculated against the family's federal tax. In this situation the family receives a substantially smaller refund or none at all (Citizens for Tax Justice, 1997; Greenstein & Lav, 1997). However, in some instances, low-income families with three or more children may get a partial child tax credit benefit to offset payroll taxes in excess of EITC, but this would affect few families. The Citizens for Tax Justice (1997) noted that such benefits would reach only about 38 percent of the families making between $12,800 and $22,600, and the level of benefit would average about $282 per child, whereas under th e Contract with America or 1995 measure, the same family would have received the EITC refund and a $500 credit per child, even if the family had no tax liability after EITC was applied (Shapiro & Greenstein, 1997a, 1997b). Some argue that the child tax credit should not go to families who pay no taxes. Although many low-income families may have no federal tax liabilities, according to a Joint Tax Committee report, the vast majority of people who earn between $10,000 and $20,000 will owe an estimated $191 billion in payroll taxes, excise taxes, and some federal taxes between the years 1997 and 2002. Those with a $20,000 to $30,000 income will pay $442 billion in taxes over the same period (Shapiro & Greenstein, 1997a, 1997b). To offset such tax obligations, a full child tax refund should be extended to low-income families, although they may not owe any federal taxes. There are several advantages to this kind of tax policy. First, the tax credit can defray some costs of raising children. Second, it creates incentives for low-income workers to stay in the labor market, because their benefits are unaffected by additional earnings. Third, this policy does not create stigma, because it would be available to almost all families. Fourth, because the IRS operates this program, there is no need to create an additional layer of social welfare bureaucracy. Role of Social Worker in Shaping Tax Policies Tax policies can be a potent force for redistributing national resources and setting domestic priorities. In other words, they can be an important instrument of social change. In the past, certain tax policies increased entitlement spending, as was the case in the 1960s. With different tax policies in the 1980s, social spending decreased while defense spending increased. Developing tax policies is complex and requires the efforts of many people. Participants may include the president of the United States, Congress, special interest groups, and concerned citizens. However, social workers have not been well informed about tax policies and have played limited roles in shaping them. As a result of the inattention paid by social workers to tax matters, the economic imbalance between poor and affluent people has increased dramatically during the past few decades (Huff & Johnson, 1993). The current tax system continues to favor affluent citizens, and there is no indication that this pattern will reverse itself soon. If this pattern continues, fighting poverty will be an even more difficult task for social workers. Therefore, to wage a more effective fight against poverty, social workers must broaden their work by engaging themselves in the development of tax policies. Social workers must become more aware of tax policies and promote social justice by advocating favorable tax polici es for poor people. Following are a few ways that social workers can get involved in shaping tax policies: 1. Write to representatives and express social work positions on tax policies. Then encourage them to forward that information to the Joint Tax Committee. 2. Study editorials on the issue, then write your own or respond to them. 3. Advertise social work positions in newsletters, newspapers, and other media outlets. 4. Publish research and position papers in social work journals. 5. Create and communicate social work positions on Web sites. 6. Communicate social work positions through e-mail, fax, and letters to the Joint Tax Committee. 7. Get involved in cooperative activities (for example, writing, speechmaking, testifying, and so forth) with various advocacy and nonprofit policy study organizations like Citizens for Tax Justice, the Urban Institute, or the Center on Budget and Policy Priority. Conclusion Because of the increased opposition to longstanding welfare entitlement programs, coupled with the recent implementation of numerous federal- and state-initiated work-oriented antipoverty programs, social workers now need to find a way to reward low-income workers for staying in the labor market and to help them rise above poverty. One way to help support low-income workers and their families is through reforming tax codes. Recent tax reforms have lifted significantly federal tax burdens for many low-income families. But many of these families still pay a significant portion of their incomes on payroll taxes and other regressive taxes. Additional tax deductions do not benefit these families, because they generally do not owe any federal taxes. However, expansion of refundable taxes like EITC, child refundable tax, and the elimination of regressive sales tax on food would be more beneficial to these low-income families. Because of the recent welfare reform measures, more former welfare recipients will be working in low-wage jobs. With these jobs there is little hope that these workers will rise above the poverty level. Although many issues can affect the income of working poor people, a well-designed tax reform can help them continue working and retain more of their earnings. Michael M. O. 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