Anti-poverty programs are said to be ill-conceived because they make the choice of not-working more lucrative than employment. The poor are thereby ‘trapped’ in aid programs, against their own best interest. Rep. Ryan means to free them from this cage by eliminating such programs and providing the money to state governments in one lump sum. In my previous post I explained why this is a formula for diminishing the funds available, but put that aside for now. This week we will deconstruct the poverty trap claim. The unsubtle implication of this claim is that the current design of anti-poverty programs is at the root of poverty itself. Anti-poverty programs induce people to choose welfare over work and content themselves with poverty-level standards of living.
To start we need a basic, number-light picture of how the alleged ‘trap’ operates. Every anti-poverty aid program can be described as some maximum or standard benefit at zero income, and some “take-away rate” as income increases (an exception is the Earned Income Tax Credit, about which more later). The take-away rate is also known as a benefit reduction rate (BRR) or an implicit marginal tax rate (MTR). If the BRR is zero, it’s not an anti-poverty program; it’s for everybody. If the BRR is negative (benefits increase with income), it’s socialism for the rich. A number of provisions of the individual income tax actually fit the latter description.
Suppose a person receiving aid faces a minimum combined effective ‘tax’ on earnings of the benefit reduction rate plus the payroll tax (7.65%). Suppose the aid is $10K at zero income. Under the current minimum wage of $7.25, a full-time job gets you $14,500 a year, before tax. Suppose the BRR is 25 percent. Then after-tax/after-BRR income for 2000 hours of work is $9,765 — less if you include any costs of working (child care, transportation, work clothes). Less still if you owe any income tax. So work doesn’t appear to pay; you are ‘trapped’ in the aid program. How to fix this?
One resort is to free you from dependency by eliminating the aid program. Now it’s either work or starve. Are you better off? Maybe no, but maybe yes. Your income is certainly reduced, perhaps a great deal. But once you are working, you might be fortunate enough to enjoy wage increases that eventually put you over $10K, after-tax and after-BRR. In that event, being deprived of the benefit could make you better off, eventually.
The force of this argument depends on the individual being too stupid to see the longer-term benefits of work. She has to be shoved into the workforce. She needs tough love.
But suppose jobs are not available, or they do not provide an upward wage path? In that case, the individual’s choice of welfare over work is the smart decision. Whether the poor are smart or dumb in conservative commentary tends to vary depending on the argument. Since a commitment to work is assumed to pay off eventually, the default assumption about the poor is that they are stupid and myopic. If it is conceded that work doesn’t pay, the grounds shift to that of moral condemnation.
If work doesn’t pay, however, we have bigger problems. The sad trends in stagnant wages have been well-documented. Capitalism isn’t working so well for a lot of folks. The irrationality argument has less currency. Moral condemnation then comes to the fore, mixed in with race prejudice and crank social science alleging pervasive pathologies of the underclass.
There is another option to fix the trap. The BRR could be reduced. This slows down the phase-out of aid as earnings grow. But the inevitable consequence is that the program costs more. Under a lower BRR, more benefits are available for any given income level covered by the program, and a wider range of income expands eligibility for benefits.
The only way to hold spending down with a lower BRR is to reduce the starting point for benefits at income zero. The fundamental trade-off is you can attenuate the effect of the poverty trap with a lower BRR and no reduction in benefits at increased budget expense, or you can reduce both benefits and the BRR in budget-neutral fashion. But you cannot reduce the BRR without either increasing costs or reducing benefits. A lower BRR either costs some aid recipients or it costs the government. The Ryan report is explicit that reducing the maximum benefits available is not a good idea:
But lowering the effective marginal tax rate at the bottom of the income scale by reducing the amount of aid would mean deep cuts for the most vulnerable. (Page 10)
This problem, however, is not solved with a block grant. The same trade-off presents itself if you send any program to state governments, social workers, Catholic Charities, or Santa Claus. There is no avoiding it. A commitment to budget neutrality, much less spending cuts, means that fixing the ‘trap’ with a lower BRR must reduce benefits for those who are stuck, for one reason or another, at the lowest income levels. If we are in the business of providing cash assistance to those with low or no income, there is still a decision to make about how much aid goes with what level of income.
The Ryan remedy for this dilemma is to “customize” assistance to the individual. How exactly this solves the problem is left to the imagination. A work requirement is irrelevant — if you are suffering from the effects of the BRR, you are already working, since for the poor the BRR is triggered by labor earnings. Only if the customization puts you on a wage path that transcends benefit phase-outs is the problem solved. But if such a wage path is available (see ‘capitalism isn’t working,’ above), the BRR is irrelevant in the first place.
With the benefit of this basic arithmetic, we can better evaluate claims about the poverty trap and relevant reforms. About which more tomorrow.