In an op-ed in today’s New York Times Harvard’s Greg Mankiw gives a good example of how government transfer programs increase marginal tax rates. He uses the same example assigned to Stanford’s introductory students in their homework last week–the Senate Finance Committee’s health care plan. Both Mankiw’s op-ed and the homework consider the marginal tax rate increase implicit in the plan. Students in introductory economics courses around the country are hearing a lot about the health care debate, which is what makes Greg’s column a good reading assignment.
Mankiw considers a family whose income rises from $54,000 to $66,000 and who loses $2,800 in government-provided health care benefits by earning $12,000 more income. The marginal tax rate is the lost benefit divided by the increase in income, which is a high 23 percent (2800 divided by 12000). The high marginal tax rate is a disincentive to work more.
The homework example has an even higher marginal tax rate and a larger disincentive. It consides a poorer familiy whose income rises from $24,000 to $48,000 and thus loses $7,300 in government-provided health care benefits according to the Senate plan. The marginal tax rate is 30 percent (7400 divided by 24000).
So the increase in marginal tax rates in the Senate plan is higher for poorer families.