So, in a Facebook post yesterday I ranted about our current tax and welfare systems and how they effectively lock the poor into being poor via extremely high marginal tax rates. Here are some rough calculations for anyone interested:
https://docs.google.com/spreadsheet/ccc?key=0Apl8DLdr-IEodGpoUmdYTUFURjd2QTdrdW9ZV3QwWWc&usp=sharing
Using simply the earned income tax credit and the ACA healthcare subsidy for a family of 4 with parents of age 30 and two children, you can come out to marginal tax rates between 40% and 60% of income. A simple example illustrating the difficulty that this imposes on escaping the lower rungs of the socio-economic ladder considers a family of 4 where the parents are earning a combined $25,000 and one parent is going to school to get a 4-year degree. Anyone who is either a parent or a student can attest to the fact that neither of these things is a cakewalk and combining the two is stressful and difficult. Assuming it takes $60,000 in subsidized loans at 4% (so no accrued interest, payments begin after graduation, etc) and it's a 20-year payoff window, this family will have an additional $363.50 payment every month (or an additional $4,630 per annum) added to their fixed expenses. The national 'malemployment' rate for recent college grads is ~36% -- that is to say that 36% of college graduates don't find jobs that require a degree but end up working in non-degree requiring jobs. For this worker, he has a 36% chance that he ends up at the same job. Of course, this figure is averaged and students graduating in accounting, engineering, and computer science are not in nearly as bad shape.
Let's be optimistic and say that our fictional family-man (or woman) is majoring in accounting and will graduate in exactly 4 years with no major hiccups or hurdles encountered. The average starting wage for an accountant out of college is $53,300, let's be nice and round that up to $55,000. So, this family is on the upper end of the positive outcomes for a family starting with effectively nothing.
At $25,000, the family can barely scrape by. They'll qualify for some level of EBT (too many inputs for me to estimate, but it is greater than zero). Additionally, they'll qualify for the EITC (expected net annual rebate of $2,059). And finally, they'll be granted a subsidy for healthcare of $8,475. At the end of the year, their total real earnings will be salary + net rebate + healthcare subsidy - social security tax - medicare tax = $25,000 + $2,059 + $8,475 - $1,550 - $362.50 = $33,622.
After getting the raise to $55,000, the family should be in significantly better shape, correct? Move into a better neighborhood with a better school system... but no. The family will lose access to EBT and they will lose their EITC credit. Their healthcare subsidy will be significantly reduced to $4,864. And, to top it all off, they've had to take on debt in order to get here, adding annual costs of $4,630 per year (for 20 years!). So, their new net income becomes: 55,000 + 4,864 - 7,357.50 - 3,410 -797.50 - 4,630 = $43,936. All of that work netted this family a net annual increase of $10,000 in annual living improvements. A lot of people will say, "That's great, and then his wages will continue to go up and he'll move into the middle class!"
Let's make another assumption. Let's assume that a typical person has a discount rate of 15%. Why so high? Because millions of people maintain balances of their credit cards when they don't need to at rates higher than 15%, suggesting that the immediate gratification value is somewhere around there. So now, let's discount the next 25 years of earnings at a rate of 15% (that will take this 30-YO to 55) and determine the net present value of his investment... At the 15% discount rate, assuming 4 years of zero additional earnings (I'm not counting the stress and trouble of getting the degree negatively), you're looking at an investment value of $38,000. Four years of hardship will net this man and his family a lifestyle improvement of $38,000 over 25 years, without considering the loss of EBT, the implications on his children's FAFSA results, the stress of college + parenting, or anything else, and this investment.
In other words, if you gave this man the choice between $38,000 today and the college life, he could be as well off in the long term, utility-wise, taking the $38,000.
Let's consider a different scenario: A man and his wife have two children and the wife already has a very good job and so combined they are earning $75,000 annually. They receive a modest healthcare subsidy of $1,375 but qualify for no other assistance. Their annual net income comes out to: $80,000 + $1,375 - 11,857 - 4,960 - 1,160 = $63,398. The husband goes to school, gets an accounting degree in 4 years, and comes out earning $55,000 annually, which increases their annual income by $30,000 (assuming he earned $25,000 before) to $110,000. Net, this looks like: $110,000 - 19,357 - 6,820 - 1,595 - 4,630 = 77,864, an increase of $14,446. Given their income, they would not qualify for subsidized loans, so let's assume that they paid the interest annually and took out $60,000 in loans. Using the same 15% rate and penalizing the first 4 years with the student loan interest amount (60000 * .04 = $2,400 per year of up-front investment costs), this family gets a 25-year net present value improvement of $46,355. The same degree at higher costs and with an easier lifestyle nets this family $10,000 more in net present value than it does the poor family. If you bump the initial salary from $75,000 to $85,000, the return actually improves more.
What this indicates, is that our current subsidy + tax system actually provides the rich with more incentives to get richer than to the poor. That is completely ass-backwards. That poor family scraping by on $25,000 a year should benefit significantly more from a college degree than the family that is solidly middle-class, yet, under our current regime that is not the case.
We have a subsidy and taxation system in place that actively dissuades the poor from striving for a better lifestyle because it does not make it easier for them to get a degree and improve themselves, it only helps them sustain.
Adding various deductions and other tax adjustments would improve the return for both families, but the standard point remains true where the middle-class family benefits more from the investment than the poor family.
In part two, I plan to address ways in which to improve the system so as to maintain a social safety net while creating a framework for the poor to climb the ladder.
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Note 12/20/2013:
You could argue that both returns would be higher for either family given increasing wages, but I've also assumed no periods of unemployment and no inflation. Also, since I'm measuring the differential, while the 55K job's wages should grow 'faster' due to higher demand for that position than the 25K; yet, this differential will grow slower than the rate at which the 55K job grows alone. Again, only meant as a quick calculation, but these are some potential criticisms.
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