Why Means Testing Threatens Growth

Andrew Biggs doesn't like means testing.  For example, Biggs analyzes a Heritage Foundation plan to reform entitlements and balance the budget, which includes a flat tax (hurrah) and means testing (hiss) in terms of implicit tax rates on elderly workers. Their flat tax rate would be 25 percent, but because of means testing, "total marginal tax rates in retirement could reach 72%."  

... there is reason to believe that people are more responsive to marginal tax rates during or near retirement — when the option not to work is clearly available — than during their prime working years, when the need to support a family and save for retirement means that most people will work as much as they can. In a 2008 study of workers over the age of 70, Lucie Schmidt of Williams College and Purvi Sevak of Hunter College found that "a reduction in the marginal tax rate that would increase the payoff to working by 10% would increase labor force participation by 7.5% among men and 11.4% among women." These are far greater responses to tax incentives than have been found among younger workers. For the population as a whole, the Congressional Budget Office assumes a response about one-third this size. The effect on marginal tax rates of the means test proposed in the Heritage budget would be almost four times larger than the increase studied by Schmidt and Sevak — and in the wrong direction — and so would be likely to yield a powerful undesirable response. Similarly, a study by Eric French of the Federal Reserve and John Jones of the State University of New York found that labor-force "participation decisions are most sensitive to financial incentives when workers are old." Means tests would thus impose powerful negative incentives precisely when people are most responsive to them.

He makes a compelling case, Professor Caplan.  

Comments

[Adie Andrews]

I hope that this reform will really work as I think that we are missing one key part that people are not always acting logically especially in the time of crises.

Greets short let london