Economist and blogger Arnold Kling points to three principles that conservatives attempt to apply to government welfare benefits:
1. Use “means testing” in order to provide a significant benefit that is aimed at the poor.
2. Keep the marginal tax rate low.
3. Keep the budget cost low.
The problem, as Kling points out, is that you can’t have all three. Means-testing raises implicit marginal tax rates – see this CBO report, which shows that a single mother may pay effective marginal tax rates of up to 95%– but the only way to lower them is to extend benefits up the income scale, which raises the budget cost. You can’t have it all.
So you have to make choices. In this 2011 National Affairs article I argued that the incentive costs of means testing – at least for entitlement benefits like Social Security and Medicare – are prohibitively high. While means-testing looks like it could reduce entitlement costs quickly and significantly, implicit marginal tax rates approach 50%, on top of the explicit taxes individuals pay. In short, no one affected by the means-test would choose to work – at a time when working more and retiring later can contribute to income security in retirement.
In a recent National Affairs piece I outlined a different route: a limited but universal government-provided retirement benefit, set at the poverty threshold and paid to every retiree regardless of income or work history. Since the plan is universal, there’s no phase-out and thus no implicit marginal tax. Since the benefit is relatively modest, the explicit taxes need to finance it are lower than what we currently pay for social security. And unlike the current program, which leaves around 9% of seniors in poverty, the universal benefit would essentially eliminate poverty in old age.
Does this mean I’ve “solved” Kling’s benefit puzzle? No – there is no mathematical solution. But I think it’s a pretty good set of trade-offs for policymakers to consider.