The Taxation of Transfer Income

In this paper we provide a model for evaluating the total marginal tax rate faced by households participating in several transfer programs and paying state and federal income taxes. Because the programs may not be administered according to statute and households may avoid taxation through income under-reporting, or both, we distinguish among statutory, as-administered, and effective taxation. We then estimate AFDC taxation for each member of the household, using AFDC data and data collected separately in the Seattle and Denver Income Maintenance Experiments. We find that the AFDC program is administered accurately, but that substantial income underreporting reduces the effective total marginal tax rate of female heads of household from 66 2/3 to about 50 percent and that the marginal tax rates of other household members are lower.