Friday, December 15, 2006

Tax Cuts Are Best Anti-Poverty Policy

Social welfare policy is my last lecture topic of the semester. We cover the evolution of U.S. anti-poverty efforts from the early-20th century to the present, focusing on both social insurance and means-tested programs. I conclude with a discussion of (and occasional debate on) and the 1996 welfare reform legislation.

It turns out that today's Christian Science Monitor ran an interesting article from Matthew Ladner at the Goldwater Institute on
the role of fiscal policy in fighting poverty:

When the US government ended "welfare as we know it" in 1996, it handed responsibility for reform to the states. In so doing, it also created a real-world test of two competing economic strategies used to fight poverty. The results are in and the lessons are clear: Low tax rates lift up the lives of America's poor.

Many people argue that government can reduce poverty by "redistributing" wealth through progressive taxation - imposing higher tax rates on higher income brackets - and through more government spending.

Most economists, however, say the best way to reduce poverty is through stronger economic growth. Growth means more jobs, a surefire antipoverty plan. Building a strong economy means keeping taxes and government spending low.

A study published last month by the Goldwater Institute, "How to Win the War on Poverty: An Analysis of State Poverty Trends," tests these different theories by examining state poverty rates from 1990 to 2000.

Nationwide, states took great strides in reducing both general and childhood poverty. Poverty fell by 5.3 percent and childhood poverty by 9.4 percent. Some states, however, reduced poverty much more than others, while some states suffered large increases.

Take Colorado. It reduced its childhood poverty rate by almost 27 percent. Meanwhile, Rhode Island's childhood poverty rate increased by almost the same amount. What accounts for those differences?

Using data from the Census Bureau, the report found that states with the lowest tax rates enjoyed sizable decreases in poverty. For example, the 10 states with the lowest total state and local tax burdens saw an average poverty reduction of 13 percent - two times better than the national average. The 10 highest-tax states, meanwhile, suffered an average increase in poverty of 3 percent.

Some high-tax states, such as California, Hawaii, and New York, suffered catastrophic increases in poverty. As California began to reject the low-tax legacy of the Reagan governorship, the state's poverty rate jumped 13 percent in the 1990s.

Some will be quick to dismiss this as a consequence of illegal immigration. But lower-tax border states such as Arizona and Texas had substantial declines in poverty while also experiencing large increases in immigration.

In fact, California's high taxation has been so damaging to the economy that another increase like the one in the 1990s would result in poverty exceeding Mississippi's by 2010.

When a state has a low tax burden, economic growth is stronger. Economic growth delivers more job creation and higher per capita and median family incomes. Economic growth is a powerful means to pull people out of poverty.

Although some policymakers justify high taxes for the sake of the poor, the data show that higher taxes and related spending do little to reduce poverty rates. Rather, states with healthy economic climates have much more success in lifting people out of poverty.

The causes of, and solutions to, poverty are complex, but one policy is clear: Low tax rates are a significant factor in achieving the universal goal of poverty reduction.
This is an intriguing analysis, but one would need a more detailed multivariate study to really sort out the causal factors explaining poverty reduction across states. A good first cut explanation, though, might very well be the impact of low tax rates on state economies, and the residual reduction in poverty rates.

I stress in my classes that robust economic growth is the best poverty-fighter around, as Ladner suggests. In fact, the 1996 welfare reform legislation -- the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) -- was passed just when the economy kicked into its late-decade high gear. Analysts will say that if there was ever a good time to pass a get-tough, work-based welfare reform bill, the late-1990s was it.

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