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Kansas or California?

BERKELEY – US President Donald Trump and congressional Republicans have made large tax cuts for top earners a high priority, arguing that such cuts will stimulate economic growth, create jobs, and pay for themselves through increased revenues.

But these claims are baseless. Countless international, national, and state comparisons have demonstrated overwhelmingly that trickle-down economics is a regressive fantasy. The latest evidence of this comes from Kansas, where tax cuts signed by Governor Sam Brownback in 2012 have utterly failed to deliver growth.

Before making the same costly mistake, Trump should take a lesson from California – a progressive state that he loves to hate. California raised taxes for top earners in 2012 and has since enjoyed one of the strongest growth rates in the country. And now, California is significantly expanding its earned income tax credit, CalEITC, building on the proven record of the federal earned income tax credit (EITC).

The federal EITC is a refundable tax credit available to low-income workers based on hours worked and how many children they have. The EITC was originally based on the negative income tax proposed by Nobel laureate economist Milton Friedman. The EITC has bipartisan support; it was enacted under President Gerald Ford, and has been expanded under Republican and Democratic presidents alike: Ronald Reagan, Bill Clinton, George W. Bush, and Barack Obama.

Helping low-income families is clearly not high on Trump’s agenda, given that around 60% of the budget cuts he has proposed hit programs that help low- and middle-income families. But he might support Speaker of the House Paul Ryan’s proposal to make the EITC more generous for childless workers, and to enlarge the child tax credit to help low-income families.

In fact, expanding the EITC could be one area of bipartisan agreement in tax-reform negotiations. Whereas supply-side tax cuts have failed spectacularly, bipartisan support for the EITC reflects its proven record of success in achieving its goals: encouraging work, raising poor and near-poor families’ incomes, reducing poverty, stimulating growth, and improving maternal and infant health. Moreover, the EITC increases educational attainment for children raised in low-income households, which translates into higher earnings when they reach adulthood.

Around 28 million low-income working Americans currently receive an average annual credit of $2,500 from the EITC. In 2013 alone, the EITC lifted an estimated 6.5 million people – including 3.3 million children – out of poverty, and mitigated the circumstances of poverty for an additional 21 million people. Without it, the number of children living in poverty in 2013 would have been about 25% larger.

There is a compelling case for expanding the EITC even further. In 2015, approximately 21% of all American children lived in poor households, compared to less than 10% in Germany and the United Kingdom. Beyond being a moral travesty, childhood poverty costs the US an estimated $500 billion per year (nearly 4% of GDP) in terms of forgone future earnings, higher crime rates, and increased health-care costs for these children.

The EITC has also been effective in encouraging single parents, particularly women, to seek employment. According to one recent study, a $1,000 increase in the EITC led to an estimated 7.3-percentage-point increase in employment and a 9.4-percentage-point drop in the share of families below the poverty line.

EITC programs have been introduced in the District of Columbia and 26 states, including even Kansas and several other states that Trump won in the 2016 election. Under the budget that California Governor Jerry Brown recently signed, the number of families eligible for CalEITC will nearly triple, from 600,000 to 1.7 million, and the income eligibility threshold will increase from $14,000 to $23,000.

California’s poverty line for a family of three currently is $20,000 per year. So, with this increase, any family with a full-time minimum-wage worker will qualify for the tax credit, keeping them above the poverty line.

Moreover, CalEITC will now apply to freelancing and self-reported income, which account for almost all of California’s income growth today. These forms of income are earned disproportionately by people of color and women, with women now accounting for three fifths of eligible tax filers, and seven out of ten eligible tax filers with children.

California is also one of 21 states that raised its minimum wage this year. By 2022, its statewide minimum wage will be $15 per hour – the highest in the country. Kansas, by contrast, is one of a handful of states that still adheres to the federal minimum wage of $7.25 per hour. In inflation-adjusted terms, that is 20% lower than it was during the Reagan presidency. Still, Trump and the Republican congressional leadership oppose any increase to the federal minimum wage, which puts them at odds with a majority of Americans.

The EITC and the minimum wage are complementary policies that bring about better outcomes when used in tandem. Because the EITC expands the supply of low-income workers, it can exert downward pressure on wages. But with a higher minimum wage, that “leakage” effect is mitigated. Accordingly, California plans to increase its CalEITC income-eligibility threshold as it phases in its higher minimum wage.

Opponents of a higher minimum wage argue that such policies reduce employment for low-wage workers, or in lower-wage regions within a particular state. Yet research consistently finds that minimum-wage increases have no discernible impact on employment. And, according to Michael Reich of the University of California, Berkeley, any employment loss from California’s minimum-wage increase will likely be offset by low-income workers’ greater purchasing power, which will create demand for goods and services, and thus jobs.

As Trump turns to tax reform, he should take a lesson from progressive states like California, which have been successfully using the EITC and the minimum wage to combat poverty, reduce inequality, and stimulate demand. These states, unlike the supply-side embarrassment that Kansas has become, are clearly doing something right.

Laura Tyson, a former chair of the US President’s Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley, and a senior adviser at the Rock Creek Group. Lenny Mendonca, Senior Fellow at the Presidio Institute, is a former director of McKinsey & Company.

By Laura Tyson and Lenny Mendonca


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