As the welfare state expands while policymakers struggle to contain its costs, an unintended result is the creation of significant profit cliffs. A little-noticed September 2023 report written by Elias Ilin and Alvaro Sanchez of the Federal Reserve Bank of Atlanta (Mitigating Benefits Cliffs for Low-Income Families: District of Columbia Career Mobility Action Plan as a Case Study) explains the dynamics in the job:
The structure of the US social safety net includes the phase-out of public assistance as household incomes rise, which can function as an effective marginal tax on wage earnings, commonly known as a cliff -mowing profits. These so-called benefits cliffs create a disincentive for low-income workers, especially those with children, to accept higher-paying jobs or promotions.
The report cites research suggesting that benefit cliffs (sometimes called poverty traps) can effectively lock low-income workers into poverty:
Surprisingly, Altig et al. (2023) find that a quarter of low-income workers face lifetime effective marginal tax rates (EMTRs) or the percentage of resources, defined as net wealth plus human wealth, that workers lose in due to the gradual elimination of public assistance and an increase in taxes. after a $1,000 increase in income above 50 percent. These results suggest that high EMTRs effectively lock low-income workers into poverty.
Earnings plateaus, in which household financial resources do not increase over a wide range of earnings, also hurt the prospects of those looking for higher or higher paying jobs:
In some cases, losing eligibility for public assistance or tax credits can even leave families worse off (a benefits cliff) or no better off (a benefits plan) than before an increase in income. When this happens, workers may be motivated to forgo higher-paying job opportunities or turn down promotions to maintain eligibility.
These dynamics are especially pronounced in Washington, DC, where public welfare spending per capita exceeds that of any state. Ilin and Sanchez count more than two dozen important local and federal assistance programs available in DC, including TANF welfare checks, SSI and Social Security disability payments, EITC and CTC payments, food stamps, WIC and school meal benefits, nine local and federal housing and public service programs, and six child care and health care programs. They add that the list is not comprehensive and does not include local public assistance programs and smaller, more targeted tax credits. In summary, they find that the social safety net in DC is one of the most generous in the country and provides a good illustration of how benefit cliffs and high EMTRs, along with a high cost of living, can affect families financially.
How generous is the safety net in DC, exactly? As shown below, a representative family of a single parent and a three-year-old child can receive government benefits in excess of $70,000 per year, as long as the parent has low income from work. However, if that parent works and earns more, the phase-outs of benefits and rising payroll and income taxes combine to wipe out any improvement in their finances. The shocking result is this
due to benefit cliffs and the phasing out of various transfer programs, the hypothetical family has $11,000 both financially and $65,000 in earned income. In other words, because of the structure of DC’s combined federal and local social safety net, a $54,000 increase in labor income results in no net financial resource gain for this family.
Figure 1 below is copied from the report.
Ilin and Sanchez perform a similar analysis for a single parent with two children, ages three and five, finding that on low incomes their benefits can be as high as $90,000. It is very difficult for appeals to the dignity of work to compete with this. The authors highlight a new policy solution adopted by DC and some states to provide additional benefits as revenues rise to offset current benefit phase-outs, reducing EMTRs but imposing additional costs on taxpayers.
More attention should be paid to simpler solutions started a generation ago, such as ensuring that low-income benefit programs are temporary, which would reduce the incidence of benefit cliffs. For example, when TANF was created, it included a five-year lifetime limit on receiving benefits and allowed states to set shorter limits. But, as the report points out, DC offers one of the highest TANF benefits in the country and has lifted time limits entirely, providing welfare checks in perpetuity. These policy choices increase the degree to which DC’s safety net often discourages the kind of consistent work needed to lift families out of poverty for good.
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Image Source : www.aei.org