Poverty Should Have Risen

Casey B. Mulligan is an economics professor at the University of Chicago. He is the author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy.”

When measured to include taxes and government benefits, poverty did not rise between 2007 and 2011, and that shows why government policy is seriously off track.

When somebody earns, say, $10,000 by working, he should keep some of it for himself and his family rather than handing it all over to the government. By the same reasoning, when someone loses $10,000 by not working, he should get some help from the government or from others in the forms of reduced taxes and enhanced benefits but still should bear a portion of that loss himself.

Economists debate the fraction of wages that workers should keep for themselves, because the optimal fraction is a trade-off between incentives, insurance, support of public goods, freedom and other factors. Libertarians and other believers in small governments might set the fraction at 80 percent or more. Other economists think that incentives have an effect on behavior, but incentive effects are small, so we can safely set the fraction at 30 percent, or even a bit less.

But I thought economists agreed that the fraction should not be zero, so that people losing money by not working would bear a portion of the loss. If people with declining incomes found them entirely replaced by government help, that amounts to 100 percent taxation (providing more benefits as income falls is sometimes called “implicit taxation”).

As James Tobin, a John F. Kennedy adviser, Nobel laureate and leading Keynesian economist of his day, said in a 1965 article, a 100 percent tax rate causes “needless waste and demoralization,” adding:

This application of the means test is bad economics as well as bad sociology. It is almost as if our present programs of public assistance had been consciously contrived to perpetuate the conditions they are supposed to alleviate.

Professor Tobin called the 100 percent tax situation demoralizing because the affected people find that all of the benefits of their hard work and success go to the government in the form of more tax receipts and fewer benefit payments. The unintended result would be less work and more families earning less than the poverty line, which is why Professor Tobin described such policies as perpetuating poverty.

If, as economists recommend, everybody’s tax rate is effectively less than 100 percent, then someone with disposable income of, say, 110 percent of the poverty line should find himself falling into poverty when he loses his job. His living standards would not fall to zero because he should be getting some help in terms of reduced taxes and increased benefits. But optimally his disposable income would fall to 80 percent of the poverty line, and perhaps below, until he found a new job.

Under the Obama administration, workers with disposable income in the neighborhood of the poverty line did not, on average, see their job losses during the recession translate into significant reductions in their disposable income.

As Jared Bernstein put it, America had “the deepest recession since the Great Depression and poverty didn’t go up.” He shows that the percentage of people in households with disposable income less than the poverty line was 15 percent in 2011, just as it was in 2007 before the recession began. In fact, the percentage fell a bit after 2008 when the stimulus law went into effect.

The results suggest that the government was helping too much. If they had been following the advice of Professor Tobin and all other economists who say they believe that tax rates should be less than 100 percent, the fraction of households with disposable income below the poverty line would have risen as a consequence of millions of lost jobs, just less than it would have without any government help.

Mr. Bernstein, one of the Obama administration advisers who designed the stimulus law and said it would quickly push the unemployment rate below 8 percent, appears to be unaware that it is possible for the government to help too much by creating the kind of situation Professor Tobin described and depress the economy in the process. Mr. Bernstein fails to mention incentives in any way and instead describes the poverty results as “a real accomplishment and a sign of a far more civilized society.”

Erasing incentives is not the way to a civilized society but rather to an impoverished one.