ARE IMPLICIT TAX RATES FOR EARNINGS-CONDITIONED TRANSFER PROGRAMS ADDITIVE?

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    • Abstract:
      This article argues that the customary procedure for calculating the cumulative tax rate can overstate the magnitude of the overall tax rate perceived by income-transfer recipients and thus, the severity of the work disincentive problem associated with cumulative tax rates. In addition, the article presents a conceptually appropriate alternative approach to computing overall implicit tax rates. The pitfalls of the additive method of computing overall tax rates can be illustrated within the context of a simplified model of the choice problem confronting a hypothetical transfer recipient. The recipient's decision variables are leisure time, L, and two commodities, F and M (which, for heuristic purposes, might be thought of as food and medical care). In addition to earned income, the recipient receives benefits from two earnings-conditioned transfer programs. The article considers two situations. First, we assume that both programs provide cash transfers; then we examine the case in which one of the programs provides in-kind benefits and the other transfers cash. To anticipate the results, the authors show that the overall implicit tax rate perceived by the recipient can be less than the sum of the individual rates whenever any of the earnings-conditioned transfers are in-kind.