Poverty’s impact on Taxes & Spending

MK:  Previously, we had described the link between Taxes & Spending and Poverty as being a bi-directional one, with each direction being merely the opposite of the other – essentially, welfare programs put stress on government coffers, and (vice-versa) tightening of government budgets cuts spending on welfare programs.  Having refined the problem-set of the Taxes & Spending section, though, we’ve decided that this was too simplistic, that the two links are decidedly different, and so we will be replacing the current stub of Taxes & Spending <—> Poverty with two new articles.


Poverty’s impact on Taxes & Spending

Governments in the US spend a lot on the poor and elderly.  Vast pension and healthcare obligations for the elderly have broken the budgets of some cities, are placing incredible stress on some state governments, and have consistently wrecked attempts to balance the federal government’s budget.  Welfare spending on the non-elderly isn’t quite as high, but is still a huge chunk of money that needs to be accounted for by those who want to balance our government’s books.

This category of spending is above all else complicated – politically, economically, and morally.  Deciding who deserves to get government support, and how to verify that they actually do deserve it, adds many layers of complexity to bills that modify subsidy/pension programs or the tax code.  Politicians fear powerful lobbies like the AARP so much that even a suggestion of modifying Social Security or Medicare to make them more sustainable is enough to bring discussions of reform to a halt.  Suggestions to cut welfare for the poor spark nasty and partisan fights between progressive and conservative policy makers and opinion makers.  We have to do something about welfare spending in order to get our fiscal house in order, but the current deadlock in Washington is so severe that it’s almost impossible to deal with such a complex issue.

How much for a safety net?

Government pensions and welfare spending from all levels of government in the US amounted to $2.67 trillion in 2013, 44% of the total spending on government budgets.  Once you take into account total tax expenditures, and their disproportionate subsidy of the wealthy, welfare spending comes out at “only” somewhere between 35% and 40% of total government spending.

Welfare for the elderly in blue; welfare for the poor in green.  Data from usgovernmentspending.com

Spending for the elderly in blue, for the non-elderly poor in green. Data from usgovernmentspending.com

A lot of this is geared directly towards the elderly, with Medicare spending at around $500 billion, Social Security’s Old Age Survivor Insurance spending at around $670 billion, and government employee pensions at around $370 billion.  This money is being spent on them whether they’re poor or not, so it isn’t all about addressing poverty – but, then again, keeping the elderly from becoming destitute after they could no longer work was what these programs were originally about, and they are lifelines to the more than 40% of the elderly who truly depend on them.

Beyond the $1.5 trillion being spent on the elderly, though, there’s $1.1 trillion going to those who are of working age but still unable to make ends meet.  One can think of all of this as just generic “welfare,” but there’s such a variety of different programs that fall under that header that it’s somewhat misleading to lump them all together.  If you break that $1.1 trillion down, you end up with six big categories of spending, plus a grab-bag of odds and ends:

  1. Medicaid ($433 billion)
  2. Income supplements (totaling $171 billion) like the Earned Income Tax Credit ($58 billion) and the Supplemental Security Income Program ($53 billion)
  3. Unemployment insurance ($161 billion)
  4. Disability insurance ($143 billion)
  5. Food subsidies ($110 billion)
  6. Housing assistance ($86 billion)
  7. Plus an assortment of other programs that total $27.2 billion.

Some tax expenditures (EITC, child tax credit) are included in the stats on spending.  Somewhere around 9% of all other tax expenditures also go to the poor, but they have been excluded here because they are not intended as “welfare” and are not means tested.

Opportunity Costs

The other effect of poverty on government budgets is that of lost income – the poor don’t pay much in taxes.  This isn’t to say that they don’t pay taxes at all, of course: “[w]hen all federal, state, and local taxes are taken into account, the bottom fifth of households pays about 16 percent of their incomes in taxes, on average.  The second-poorest fifth pays about 21 percent.”

Although the taxes gathered from the poor probably feel excessive to them, considering how little money they have to spare, the bottom 40% of households only pay around 10% of the total taxes collected in the US.  There just isn’t much of a cash base for taxes to come from.

The important thing to think about when you look at a chart like the one above is that economics does not have to be a zero-sum game.  40% of the population will always be in the bottom two quintiles – that’s basic math.  But what would happen if we worked to change how well-off the bottom quintiles were?

Here’s a thought experiment:  Imagine we could dramatically improve skills and employability for half of the people in the bottom 40%.  Let’s say we succeed in improving the lot of half of those in the bottom quintile (average income in 2013: $13,500) and half of those in the second-lowest quintile (average income in 2013: $27,200), somehow giving them the jobs and support structure to match that of the people in the middle quintile (average income in 2013: $43,600). [source]

What would that do for government budgets?  Every working adult who moves up from a bare poverty existence to a middle-class income adds (roughly) $9,000/year to government tax revenues; every working adult moving from a 2nd quintile income level to the middle adds $5,000.  There would also be a notable savings in government spending on welfare and other expenses related to the poor.

Obviously, moving that many people (~29 million) out of poverty and into the middle class would be a tremendous feat, but the payoff would also be huge.  It would directly generate around $200 billion in new tax revenue under the current system, but that would be its smallest effect.  It would also create a substantial economic boom, boosting GDP growth by several percentage points, increasing the profitability of companies that sell to the middle class, making the whole society much richer, and generating a great deal of additional tax revenue.

The point of this thought experiment is more than just to say “wouldn’t it be nice if we could do X.”  Moving 29 million people into the middle class overnight may be a pipe-dream – but what about 1 million?  2 million?  5 million?  Any improvement would reduce stress on government budgets and reduce the indirect costs that poverty is exacting from America.

Indirect Costs

Those indirect costs come in a variety of forms.  People without easy or affordable access to healthcare often end up in emergency rooms, using public funds for their (frequently expensive) treatment.  Poverty also correlates with more illegal activity and higher law-enforcement costs, increased need for educational assistance, and more.  Studies have estimated that every homeless person costs the local and state governments upwards of $30,000 per year in medical treatment and law enforcement resources.  These cost estimates vary by study and by locality, and focus only on the poorest in the community, but they illustrate the point – these indirect costs add up.  They aren’t quite on the same scale as direct welfare spending, but they’re close.

The importance of opportunity

Poverty can be defined in either relative or absolute terms.  In relative terms, someone is always going to be poorer than others.  Throughout this discussion, however, we have been using the term in its absolute sense, in terms of an income above an amorphous, hard to define “poverty line” that corresponds to a level at which people have the resources to live frugal, but healthy lives, and to raise children to be productive, contributing members of society.  And that leads to a third definition of poverty:  lacking the skills, health, and personal resources to be productive, to do valued work.

As many on the right point out, large-scale poverty of the last sort creates a net loss for society as a whole, soaking up government resources while creating relatively little of value in return.  It is, in many ways, like having a Third World country inside our borders.  This should not be used as a blanket condemnation of those living in poverty, though; rather, it needs to be understood as a statement about the state of poverty itself – a state in which too many Americans have become trapped through little or no fault of their own.

Poverty will always be a sink for resources in any society that cares enough to keep its poorest from starving in the streets.  The question shouldn’t be how we can scrimp and save on supporting those who are least fortunate – it must be what level of support is appropriate, how to distribute that support most efficiently, and how best to create an environment that will lead more of them to become net contributors to society.

Any thoughtful analyst would conclude that there is a great deal that we can do to improve on that front.  The US has many inefficient, ineffective, contradictory, and counter-productive policies and programs relating to poverty and a variety of other issues that only serve to make the lot of the poor even worse.  Fixing these problems is necessary, not just for the sake of Americans suffering the effects of poverty, but for the benefit of all of us.

Moreover, it’s worth remembering that poverty is not the biggest drain on the public purse. That role goes to government pensions and healthcare for the elderly, which are set to explode government budgets over the coming decades. Too many on the right are content to condemn the poor for needing support; too many on the left are content to encourage dependency on government. If we want to be able to pay for our social safety net for another fifty years, as well as all of the needed investments in the future, we must do more than simply blame or sustain those who are least fortunate among us. We need to turn far more of them and their children into productive workers who can help support the waves of people getting ready to retire.


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