The Work Effects of Tax Cuts on Low-Income Single Mothers

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After the 1993 tax reform under President Clinton, single mothers worked fewer hours per year, but this decline was overwhelmed by a solid increase in low-income mothers going to work.

Reducing taxes on low-income single mothers can have an especially favorable effect: some of these women will leave welfare and get paid employment. In Evaluation of Four Tax Reforms in the United States: Labor Supply and Welfare Effects for Single Mothers (NBER Working Paper No. 10935), coauthors Nada Eissa, Henrik Kleven, and Claus Kreiner look at the tax acts of 1986, 1990, 1993, and 2001 and find that each added to the economic welfare well-being of the nation. Each reform reduced taxes owed by single mothers, thereby shrinking government revenues but also providing an incentive for them to substitute work for welfare payments.

The authors note that the tax reforms had much less of an impact on the number of hours worked by single mothers, even though the financial incentives were sizable, than on their decisions to work. After the 1993 tax reform under President Clinton, single mothers worked fewer hours per year, but this decline was overwhelmed by a solid increase in low-income mothers going to work. The authors argue that these work patterns may be explained by fixed costs of work, such as childcare, transportation, and time lost in commuting to, preparing for, or recovering from work.

The Tax Reform Act of 1986 represented the most fundamental change in the income tax system in nearly 40 years. It not only changed the income tax rate schedule, but also broadened the so-called "tax base" by eliminating or shrinking many tax deductions and other tax breaks. It lowered the marginal tax rate for lower-income taxpayers, and increased their personal exemptions and standard deductions. Further, it expanded the Earned Income Tax Credit (EITC), which provides special tax benefits to the working poor. By now, the EITC has evolved into the single largest cash transfer program for lower-income families at the federal level. In fact, almost two-thirds of single low-income mothers face no tax burden on their income from work.

Looking at the 1986 tax reform, the tax burden on poor working mothers fell 7.94 percent. But for every tax dollar lost or every extra dollar in EITC payments, the welfare real income gain (dollars added to the pockets of these mothers and thus to the nation's income) amounted to $9.38. In the later tax episodes, the welfare gain per dollar spent was somewhat smaller, mainly because the 1986 reform had already reduced the inefficiencies substantially. Nonetheless, the tax cut of 2001 under the Bush Administration did provide a substantial welfare gain of $1.69 for every tax dollar spent. For all four reforms considered, most of the welfare gains were created by more women going to work, rather than by changes in the number of hours worked by those already working.

By 2004, a worker filing a head-of-household tax return faced a federal income tax schedule with six tax brackets, and rates ranging from 10 to 35 percent. Earnings would be shielded from taxes by the standard deduction ($7,150) and by the personal exemption ($3,100 per person). If the taxpayer had two children, she would pay 10 percent in federal income taxes only on earnings above $16,450. She would face either no state income tax (in Florida or Texas) or as much as a 5 percent state income tax (in Massachusetts or Oregon).

Additionally, the authors note, this taxpayer would have paid payroll taxes for Social Security and Medicare of 7.65 percent on her first dollar of earnings. And, she would be eligible for the EITC. To be eligible, her Adjusted Gross Income (AGI) must fall below some limit ($33,692 if she has more than one child). The size of the credit depends on the amount of earned income and the number of qualifying children. The credit is refundable if the head of household has no federal tax liability.

Twenty years earlier, the authors add, this taxpayer would have faced a very different tax scheme, with a much smaller EITC and 15 income tax brackets - ranging from zero to 50 percent. For female household heads, the changes in the EITC since then have played a central role in improving their income position.

In their analysis, the authors make use of March Current Population Surveys by the Census Bureau involving the tax years 1985, 1990, 1993, and 2000. Their sample includes unmarried females (widowed, divorced, and never-married) who are between 18 and 49 and have children. The sample size boiled down to a range of 4,000 to 5,000 individuals across the years.

The authors' computation of individual, effective tax rates include federal, state, and payroll taxes, as well as cash assistance, food stamps, and Medicaid. Between 1985 and 2000, for these single mothers the average marginal tax rate, taking account of changes in benefits, drops from 57 percent to 32 percent

-- David R. Francis