Taxes and the poor

It’s probably been a year since I brought up whether the poor are doing well in America. I thought I would revisit this topic because of what Mitt Romney said. By the way, Romney supposedly wants to eliminate or reduce the Earned Income Tax Credit. What’s funny is that it was started during the Ford years and has been expanded by every President since. I think this alone is reason enough to not vote for Romney. However, that leaves us with the possibility that Obama gets another term which would be devastating to the poor. I am going to discuss one reason that is and it revolves around the Earned Income Tax Credit (EITC).

The EITC was enacted as a way to reduce the burden of taxes and eventually FICA on the poor. It helps lift millions out of poverty and can even keep workers off of other welfare programs. However, the program inherently discourages investment by the very poor. As a person who lives in a poor neighborhood, it is very discouraging when I walk into the convenience store and every person ahead of me wants a lottery ticket. The fact is, most poor people could do well to invest that money or just save it. The problem is that Americans, in general, are not educated in public schools about finance. But then again, if poor people knew to invest their money wisely, they would be hurting themselves because of they could forfeit the EITC. This is due to the fact that there is a limit on how much investment income a poor person can earn or risk losing the EITC, namely, $3150.

So why would the government want to discourage poor people from investing other than to use lotto money to build roads? I am not really sure, but John Kerry actually proposed to fix the EITC with his Strengthen the Earned Income Tax Credit Act of 2011 and eliminate the investment income provision. Although I would probably never vote for John Kerry, this is a good idea. So let’s imagine that the guy who cleans your toilets, at work after your overweight boss goes the bathroom following a burrito lunch, makes 20,000 dollars a year. Let’s also imagine that he has a wife who stays at home and two small children. Let’s say his wife stays at home because daycare is costly and because we all know women shouldn’t be in the work place anyway. With the EITC, this man would pay no taxes but instead receive ~$5100 with the EITC. If you add $2000 more for the Child Tax Credit, you get $7100 which is an effective tax rate of -35%.

I know what you’re thinking, this guy is getting a third of his salary in taxes back? I remind you, he just cleaned you’re Boss’s dump after a burrito. Give the guy a break. It’s likely that you don’t pay taxes either. Now, what if this guy happened to receive an inheritance from his Uncle that included a dividend stock that paid a qualified 5% dividend? Let’s say his Uncle had invested $63,020 which would provide his nephew $3151 per year. Well, it turns out that instead of earning $7100, he will only receive $2000 because he does not qualify for the EITC. Because of this provision, he now only has $25,151 instead of $27,100. To someone that poor, $2000 is a lot of money. Even better, if the investment provision never existed, he would have closer to $30,000.

If he is smart because his parents could afford to send him to a Catholic school that was not mandated to pay for birth control (so of course he could be born), he would sign up for a DRIP with that investment. In this case, let’s say that he is 25 years old. With a DRIP, assuming the stock price remains the same and the dividend is maintained (I’m thinking a Utility/Telecom stock), by the time he is 67, he will be receiving $26,692.78 per year in retirement income. That is more than he would receive from Social Security.

So why does this matter? It matters because it keeps one more person above the poverty line and out of Welfare which may help keep the federal debt down. You may think that giving someone $7100 a year because they are poor is stupid or unfair. But what is truly stupid and unfair is giving 500 million dollars to a solar panel company with a terrible business model. The point is that the $7100 in that poor man’s pocket is going to provide more stimulus than 787 billion of shovel ready projects that aren’t truly shovel ready. The fact is that the government should not be discouraging investments by poor people by punishing them financially. The upward mobility in this Country is broken and here is one way to improve it.