The Welfare Trap

Establishing an appropriate social safety net to provide for those who are in need is a complex problem. The issue is also affected by societal attitudes. If a nation believes that most people wish to work and few would take advantage of a welfare system then the problem can be simplified by providing everyone with a guarantee of an income sufficient for survival. If a nation believes that choosing to live on welfare is a moral affront that must not be allowed, then complex means tests and conditions must be imposed in order to make sure that everyone is at least trying to work and not taking advantage of the system. In both cases the level of benefits available can disincentivize seeking a job on the part of the welfare recipient if the benefits are sufficiently generous.

An interesting article in The Economist addresses some of these issues as they apply to the United States, a country determined to avoid excess generosity. In fact, conservatives are once again attacking the current system as being too comfortable for the nonworking. The author of the article points out that it is difficult to either support or dispute this claim because the system is so complex.

"Measuring the benefits that flesh-and-blood Americans actually receive is difficult because the system is unbelievably complex. Cato [Institute] counts 126 separate federal anti-poverty programmes, including 72 that provide "cash or in-kind benefits to individuals". The states have many more."

It seems some sort of counseling must be required for a poor person to navigate such a system. It is conceivable that there are ways to game the system, but probably more ways to miss out on potential benefits with so many programs available.

One characteristic of welfare benefits in this type of system is that they are means tested on the basis of income. As a recipient’s income rises, benefits are withdrawn. This is a crucial part of any functional approach. If benefits are too lavish as income rises, there might be little incentive to take a low paying job instead of continuing to live off of welfare payments. If the benefits are withdrawn too quickly, a person could see little benefit to accepting work and might even be worse off, considering the new costs associated with working outside the home.

The Congressional Budget Office (CBO) found an excellent means of illustrating this issue. It tracked the manner in which benefits would change for a single mother with one child in a typical state (Pennsylvania) as her income increased. The CBO chose to represent this progression as an equivalent marginal tax rate.

The mother is, in effect, treading water economically as her income rises because the withdrawal of benefits consumes most of the increase in income as the equivalent marginal tax rates go as high as 95%. A welfare recipient who only has work available at or near the minimum wage of $7.25 will see little if any benefit from working.

"If the prospect of keeping only five cents of each extra dollar earned does not discourage work, it is hard to imagine what might. And the CBO’s calculation does not include Medicaid and several other means-tested benefits."

One should recall all the arguments about multimillionaires being disincentivized by that "outrageous" 40% marginal tax rate.

The real issue for both conservatives and liberals is having a path whereby people receiving benefits can obtain paying work that will allow them to survive without government benefits. The current system does not do that well. How might this approach be improved?

Given the existing complexity, and the difficulty in getting even common sense laws passed, it is not clear that there is a path forward from within the welfare system itself. Arguments over program details and benefit levels could go on indefinitely.

A more fundamental issue seems to be the mismatch between the income required to escape poverty, and the income available from minimum wage jobs. The best way to create an incentive for people to seek work as an alternative to welfare is by making work financially advantageous.

If the major path for exiting welfare is to assume a job at or near the minimum wage of $7.25, it feels to a welfare recipient as if they are working for free. The problem is not that benefits might be too high; it is that wages are too low.

Those who argue that the minimum wage should be raised are correct. A value in the $12-15 range could produce a much better economy, a much more stable workforce, and eliminate a lot of welfare expenses.

Let’s go for it!