April 1, 2017

When the Right Surrenders, Part 2

I do not like criticizing fellow conservative/libertarian/free market proponents. There is enough work to be done to counter the egalitarian onslaught aiming for continuous expansion of the American welfare state. However, sometimes it is necessary to set the record straight within our own ranks, especially when a fellow traveler wanders off to the left side of the political field and comes back enamored with one of their economically most destructive ideas.

A good example is the incomprehensible interest in Paid Family Leave programs among people at the American Enterprise Institute and the American Action Forum. One of the key publications from these organizations, seeking to advance the Paid Family Leave agenda, is a report from August 15, 2016 by Ben Gitis, Director of Labor Market Policy at the American Action Forum. 

Under the title The Earned Income Leave Benefit: Rethinking Paid Family Leave for Low-Income Workers, Mr. Gitis suggests a version of the paid-family leave program that meets all the criteria of a classic egalitarian amendment to the American welfare state: it is redistributive, it is aimed exclusively at low-income earners and it creates growth-hampering taxes and worker disincentives.

Modeled after the Earned Income Tax Credit (EITC), the Earned Income Leave Benefit (EILB) would only be eligible to a group of citizens defined as "low income". In a nutshell, the EILB would:
  • offer 12 weeks of paid family leave;
  • tie benefits to family income at a rate of 34 cents to the dollar earned; and
  • cap eligibility at a total of $27,990 of family income.
Based on these parameters, and in the absence of any funding model for the EILB, Mr. Gitis then estimates the cost of the entitlement program. He uses two methods for the estimate, one based on official statistics over how much family leave people took under the Family Medical Leave Act and the other based on the maximum entitlement value of the program. The latter method, which Mr. Gitis referred to in a  memo on January 26, 2016, and I applied to a different type of Paid Family Leave program in my July 2016 article, would cap out the cost of the EILB at $31.6 billion per year. 

Compared to my estimate from July 2016, which placed the maximum entitlement value at just over $1 trillion per year, the EILB sounds palatable, even doable. There are, however, three problems with his entitlement program that Mr. Gitis does not address. 

The income replacement rate

The most important cost-capping variable in the EILB is not the income threshold, but the income replacement rate. Currently set at 34 cents to the dollar, it is low enough to discourage most workers from frivolously using the program to get an extra week off from work. Thereby, it restrains the costs of the program without having to employ an intrusive bureaucracy to scrutinize applications for EILB benefits. 

At the same time, the choice of a low replacement rate indicates that the real purpose behind the program is not to provide a benefit, but to restrain its costs. The eligible population - low income workers within an income bracket narrower than even for the EITC - is hardly helped by a replacement rate of 34 cents for every dollar they lose by being home from work. The households that qualify for the program, as Mr. Gitis suggests it be designed, have a propensity to consume that is almost equal to 100 percent of their disposable income. 

With a pauperish replacement ratio, the EILB looks more like an attempt to have it both ways than a serious paid family leave program. Assuming that the primary goal with the program is to actually provide what its intended purpose is, namely income replacement in the event of family-related leave from work, it would be more reasonable to apply the income replacement rates included in the paid family leave program introduced in Washington, DC: for the first $1,000 of monthly income, the entitled person receives 100 percent of his income in benefit; for every dollar there above the replacement rate is 50 percent. 

Interestingly, if we use the Washington, DC replacement-rate model, and then convert the numbers that Mr. Gitis uses to reach his $31.6-billion maximum entitlement value, we find that individual beneficiaries of the EILB would receive, on average, 100 percent of their income. This raises the maximum entitlement value of the EILB to $112.9 billion, three and a half times more than Mr. Gitis suggests. 

A "compromise" replacement rate could be the 67 percent that will go into effect when the New York state paid family leave program goes into full effect in 2021. Now the cost of the EILB "only" doubles to $62.7 billion per year. 


The problem with using an unrealistically low replacement rate in the presentation of a new entitlement program is that the program, if it goes into effect, is going to be under-funded from the start. If the EILB became the law of the land as Mr.Gitis envisions it, very soon Congress would radically increase the replacement rate, with reference to "decency" and "sustainable benefits". After all, as designed, the EILB offers to keep people on a standard of living - albeit temporarily - that is below even what the federal government deems tolerable in their definition of poverty. 

Speaking of funding: at no point does Mr. Gitis explain how the EILB is to be funded. Conventional wisdom - and experience from New York - suggests a payroll tax. It is unclear who would pay the payroll tax; if the EILB benefits are restricted to only those who make, say, up to 200 percent of the federal poverty limit, then will the tax also be restricted to that group? If not; if the tax applied to all income earners; then by definition it is a program for the redistribution of income between individual citizens. 

In other words, an egalitarian expansion of the welfare state. We will have to return to that point some other time; for now, it is worth noting that the American Action Forum lends itself to egalitarian purposes.

The funding side of the EILB is more problematic than simply lack of specifics. The main issue is the calibration of the tax vs. expected cost of benefits. If we use the first method that Mr. Gitis applies, namely base the entitlement cost estimate on statistics of family leave days under the Family and Medical Leave Act, then we are very likely to under-estimate the cost. Even if we stick to the 34-percent income replacement rate, it is very likely that more people will use the program than if the replacement rate was zero. (This does not mean that the 34-percent rate is no longer pauperish; this is just an observation of human responses to incentives.) If the tax then is set after the rate of family-leave days under the FMLA, the EILB will be under-funded and add to the federal deficit. 

If, on the other hand, we calibrate the tax to fund EILB at its maximum entitlement value, it adds notably to the payroll taxes that fund what is officially known as Social Insurance and Retirement. These taxes currently deliver just over $1 trillion annually into the federal government's coffers; even if we assume that the EILB income replacement rate would only be 67 percent, the federal payroll tax rate would have to increase by 0.83 percentage points. This would take the OASDI tax rate from 12.4 to 13.23 percent. 

To many small businesses, that will be a painful increase in the cost of labor. Given how businesses have responded to the taxes added on by the Affordable Care Act, it is likely that they will scale back employee hours in response, thus neutralizing some of the expected revenue. 

Negative worker incentives

Since the EILB is designed with the EITC as its template, it also suffers from the same worker disincentives toward self determination. The EITC steeply reduces its benefits as the beneficiary's income rises, creating marginal income taxes that are only surpassed by incomes in excess of $418,000.

The EILB has a similar effect. If we stick to the original, 34-percent replacement rate, the EILB offers a maximum of $3,359 in benefits per year to a family with no more than $27,990 in annual income. Assuming that the family would have to go without any income replacement in lieu of the EILB, the EILB benefit represents a 12-percent increase in their disposable income. Suppose, then, that the main income earner in this family gets a ten-percent raise, taking their family income up to $30,789. 

Federal income taxes take 15 percent of the $2,799 raise, leaving the family with a net increase of $2,379. However, since they now passed the threshold for qualifying as low income, they lose the EILB, deducting $3,359 from their disposable income. This leaves them with a net loss of $980 per year. 

Just to break even, this family would have to get a pre-tax raise of $3,952, or 41 percent - and we have not even mentioned the loss of or reductions in other benefits, such as EITC, SNAP, TANF...

Needless to say, the EILB is a classic redistributive entitlement program aimed at advancing the same egalitarian agenda that underpins the American welfare state ever since the War on Poverty.


The EILB is a particularly bad idea, probably even more harmful in the long run than generalized models covering the entire population. Its limitation to low-income workers, and a replacement rate of only 34 percent, seem to be lifted straight out of a have-it-both-ways political playbook. The problem is that when entitlements are designed this way, the legislative body that has jurisdiction over them - Congress in this case - eventually has to make up its mind: is the program there for its beneficiaries, or is its design primarily for cost containment purposes? 

When that happens, the consequences are massive. Mr. Gitis would be aware of this, had he added a section to his report on the experience with these programs, and the aforementioned design conflict, in European welfare states. Yet Mr. Gitis makes no effort whatsoever to account for the international experience. This is highly unfortunate: had he acquainted himself with the ample literature on the subject, he would have avoided making the list of mistakes I have accounted for in this article.

I am left wondering what makes an otherwise apparent fellow economic-freedom traveler veer so sharply off to the left. He is not alone: as mentioned, there are plenty of examples of people over at the American Enterprise Institute who have run into the egalitarian woods and gotten lost.

Why does this happen?

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