Can Tax Policy Live Up to Its New Role in the Fight Against Poverty?

Last, week, the Urban-Brookings Tax Policy Center hosted a half-day event on the role tax policy has played in efforts to fight poverty since the declaration of the War on Poverty. The panelists agreed that the role of tax policy has changed drastically since the 1960s. The trend is clear: tax policy is making up a greater share of anti-poverty programs compared to direct spending programs. The Low-Income Housing Tax Credit and the Earned Income Tax Credit, for example, are now among the biggest anti-poverty programs in terms of cost to the federal government.

If direct-spending and tax-policy programs were equally cost effective at fighting poverty, this change wouldn’t matter much. But they are not perfect substitutes. Transitioning from direct spending to tax policy tends to target the working poor (a group often cynically considered to be the “deserving poor”) while excluding others in poverty. While this shift has arguably created a more politically secure system for helping the poor, it is problematic when there are few jobs, as in a recession, and when the share of the working poor declines in proportion to the total population in poverty. In other words, a shift from direct spending to tax policy comes at the expense of helping the unemployed – or “unemployable” – and makes it harder for those people to reenter the larger economy. At the same time as we have witnessed the expansion of costly tax provisions of questionable merit intended to help the poor (like the Low-Income Housing Tax Credit), we have seen the stagnation of budget allocations for direct-spending programs like TANF. Operating as a block grant and receiving flat funding since 1996, TANF was unable to provide needed additional financial assistance as the numbers of the poor and unemployed swelled in the recession.

Another consequence of the shift in anti-poverty policy from direct spending to the tax code is that program evaluation and cost-benefit analyses have become much more difficult. Especially in the case of supply-side tax credits that are intended to help low-income families, such as the Low Income Housing Tax Credit, the New Markets Tax Credit, and Empowerment Zones, it is nearly impossible to determine success or failure of the program. Even if evaluators could get past the problem of isolating a counterfactual, that is, how low-income families would have fared in the absence of the program, the programs lack a clear metric for success. As Brett Theodos of the Urban Institute noted on the panel last week, the programs have so many goals that there is no way to nail down measures of success.

We see similar problems with tax-policy solutions in other areas of policy related to asset-building. The same problems of limited scope and the lack of measurable goals that afflict the tax-code’s income-supporting anti-poverty programs also make the tax code’s saving incentives less effective. As we have discussed before, tax provisions that are widely considered to be pro-saving like the incentives associated with 401(K)s, IRAs, 529 College Savings Plans, and the mortgage interest deduction actually fail to cost-effectively promote net new savings and tend to benefit only the highest-earning households.

There are ways to reform anti-poverty and asset-building programs to more effectively provide income supports and promote savings for everyone – even through the tax code. A system of progressive refundable credits to replace or augment the existing system of tax deferral and exclusion, as in the Financial Security Credit proposal, would be one such solution. Advancing social policy through the tax code has its merits, but it needs to be done right. If tax-based solutions to the most pressing social problems like poverty and low savings are here to stay, we need to find ways to make them at least as effective and at least as broadly targeted as the direct-spending programs they’re replacing.