Problems with Means Testing
By David Henderson
Bryan posted earlier this week on why means testing is “awesome.” While I do think that future budget deficits will push us towards some version of means testing, I can’t agree that it’s awesome. It just may be less bad than what he accurately characterizes as “taking from Peter to pay Peter.”
Specifically, I see three problems with means testing. None of these problems necessarily means that means testing is worse than what we have now, but they are big negatives.
1. The phase-out issue.
Bryan recognizes that you wouldn’t want to give benefits below income threshold x and then zero benefits to people above that threshold. It’s important to say why. The reason is that when you earn the first dollar that puts you at $x+1, your implicit marginal tax rate on that $ could be hundreds of thousands of percent. I made that point earlier in discussing a proposal by Megan McArdle. So what’s the alternative? Phase out the benefit over some income range, recognizing, as one of the commenters on Bryan’s post pointed out, that the implicit marginal tax rate over that income range could be quite high. Take Bryan’s proposal of giving a benefit to the bottom decile and then phasing it out over the next decile. Let’s say the benefit is a $5,000 government check. Just eye-balling the data, I estimate that the bottom decile (about 8 million families) in 2008 had income between $0 and $17,500 and the second from the bottom decile had income from $17,500 to about $28,500. So that’s $11,000 of income over which to phase out a $5,000 benefit. The implicit marginal tax rate from that phase-out alone is, therefore, $5,000/$11,000 or 45%. That’s on top of other tax rates.
2. What are means?
Without exception, every time I’ve seen someone advocate means testing, he uses income as his measure of means. This completely ignores wealth. Although income and wealth are highly positively correlated, the correlation is not close to 1.0. Therefore means testing would discriminate in favor of wealthy people with low income. Because the most expensive programs for which means testing is advocated tend to be for the elderly, this is an even bigger problem. Among the retired population, the correlation between income and wealth is even weaker, I believe, than among the population in general.
3. The fairness issue.
Again, because the programs at issue tend to be for the elderly, there can be huge differences in income because one family saved a large percent over the years, and is earning interest and dividends on that income, and the other family saved 0 and relies on Social Security. This could be so even though the two families had a similar age-earnings profile. It’s unfair. I know that the program per se is unfair, with or without means testing, but this one seems particularly unfair.