Welfare trap

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The welfare trap (aka the welfare cliff, unemployment trap, or poverty trap in British English) theory asserts that taxation and welfare systems can jointly contribute to keep people on social insurance because the withdrawal of means-tested benefits that comes with entering low-paid work causes there to be no significant increase in total income. According to this theory, an individual sees that the opportunity cost of getting a better paying job is too great for too little a financial return, and this can create a perverse incentive to not pursue a better paying job. [1]

Contents

Different definitions

The term used for this concept varies depending on country. In the United States, where government benefit payments are colloquially referred to as "welfare", the welfare trap often indicates that a person is completely dependent on benefits, with little or no hope of self-sufficiency. [2] The welfare trap is also known as the unemployment trap or the poverty trap, with both terms frequently being used interchangeably as they often go hand-in-hand, but there are subtle differences. [3] [4]

In other contexts, the terms "welfare trap" and "poverty trap" are clearly distinguished. For example, a Southern African Regional Poverty Network report on social protection clarifies that "poverty trap [means] a structural condition from which people cannot rescue themselves despite their best efforts. A welfare trap in this context, by contrast, refers to the barrier created by means-tested social grants that have in-built perverse incentives." [5] The South African definition is typically used with regard to developing countries.

This concept may include other adverse effects of welfare such as on the family structure: it may encourage the increase in the numbers of single-mother families and divorce rates, as individuals see a distinct benefit in such a lifestyle. [6]

In the UK, there is a distinction between two concepts within the welfare trap:[ citation needed ]

Causes of welfare traps

There are two predominant views which look to examine how recipients can become stuck in such traps. [7] The first view examines the behavioural traits of recipients and their inability to climb the socio-economic ladder. This view holds that recipients' lack of necessary traits is a result of their decision-making or individual psychology. [8]

The other view examines analyses of labour supply wherein individuals will act to maximise their utility. This utility acts as a function of the amount of goods and services they can enjoy (their real disposable income) and the amount of non-working time available to them. [9] For example, if a worker is free to choose the amount of hours they work, they will continue to offer more labour until an additional hour of leisure forgone is worth more than the goods and services attained through the additional work. Thus, people strive for a utility maximisation in which individuals may deliberately choose to continue receiving employment benefits, as the opportunity cost of employment is too high for the reduction in means-tested support they would otherwise receive. [10]

Example 1: If a person on welfare finds a part-time job that will pay the minimum wage of $5 per hour for eight hours per week (totaling $40), and, of the amount earned per week, $20 is deducted from welfare, there is a net gain of only $20. If the government imposes taxes on the $40, at say 15% ($6), and there may be extra child-care and commuting costs as well since that the person can no longer remain at home all day, the person is now worse off than before getting the job. This result occurs despite performing eight hours of work per week that is productive to society.

Example 2: Consider a hypothetical welfare program that guarantees a minimum income level to welfare recipients, so that an increase in earnings results in a dollar-for-dollar decrease in benefits up to the income threshold. As shown in the diagram below, this creates a "spiked" budget constraint OABC. Indifference curve analysis reveals that a welfare recipient's utility may be higher if they don't work and earn the guaranteed minimum income (curve U1) than if they do work and earn slightly more (curve U0).

Traditionalwelfare.JPG

Welfare traps in practice

Range of Marginal Tax Rates Between the 10th and 90th Percentiles for Low- and Moderate-Income Taxpayers, by Earnings Group, 2016 Marginal Tax Rates Between 10th and 90th Percentiles for Low- and Moderate-Income Taxpayers.png
Range of Marginal Tax Rates Between the 10th and 90th Percentiles for Low- and Moderate-Income Taxpayers, by Earnings Group, 2016

Many western countries have developed complex social safety nets that act to protect vulnerable families and individuals experiencing poverty and destitution. [11] As these individuals aim to move off of welfare, the complex labyrinth of programs and policies - such as the 80 federal anti-poverty programs currently available in the United States - create confusion in the process to understand effects of increased income to means-tested payments. [12]

In the United States, the Congressional Budget Office estimates that median marginal tax rates will rise sharply for taxpayers in the lowest quartile who earn less than 150 percent of the federal poverty level (FPL). For a taxpayer earning less than 50 percent of the FPL, the median marginal tax rate would increase from 14 percent to 34 percent when they find work that places their earnings at just above the poverty line (100-149 percent of the FPL). [13] Following the second view on welfare traps posited earlier, recipients are rational actors and would likely experience material losses in access to goods and services when taxes, loss of leisure time, and support for dependents is factored in. [14]

High "effective marginal tax rates" (EMTRs) can identify welfare traps or poverty traps. EMTRs are affected by the combination of the increments of an individual's gross income and disposable income. The phenomenon of welfare traps or poverty traps appears when individuals lack encouragement to seek new jobs in the labour market due to the net growth in disposable incomes being too low. This low increasing disposable income is related to the interaction of social security and income taxation systems. The strength of poverty traps rises as the length of non-transfer-income ranges is subject to high EMTRs growth. So, understanding which factors lead to high EMTR can help people understand more about how to reform tax and welfare policy. In Australia, welfare traps have been improved by the Social Security (Poverty Trap Reduction) Act of 1985, for example, reforming pension policy, which does not charge tax to people with full-rate pensions, and integrating child family payments to welfare receipts. Another tax policy reform was conducted by the Coalition Parties that increased the annual threshold for income taxes and reduced the minimum percentage rate. After the Howard government introduced goods and services taxation (GST), welfare payments increased to respond to these taxes. All these political initiatives indirectly ameliorated welfare traps—however, they did not inhibit high EMTR. [15]

Another measure called RRs (replacement rates) compares income from a person when he does not work and income from this person when he does work. RTR is the third measure which means the Participation Tax Rate. It means the proportion between the net influence of working with gross salary. [16] RRs and RTR are used to compare the incentive between work and not work. In reality, it is difficult for people to choose how many hours more to work (no active option), and it is easy for people to choose between working or not working. So, compared with EMTRs, RRs and PTRs are more appropriate for measuring welfare traps. [17]

Avoiding welfare traps

An incentive to get out of the welfare trap is that the return to the labour market gives a person chances of moving up the career ladder, improving old and acquiring new job skills, etc., thus eventually improving standard of living. [18] Policies that allow for the continued receipt of benefit payments for a period of time after entering work or up to a specific earnings ceiling may also eliminate the welfare trap. For example, for UK claimants of Incapacity Benefit or Employment Support Allowance, "permitted work" arrangements allow for paid work up to either 16 hours or £95 per week without the withdrawal of the disability benefit payments, leading to a net overall increase in income. [19] However, any earnings over £20 may be taxed, and additional earnings may affect receipt of Housing Benefit and Council Tax Benefit, which is an example of the welfare trap remaining potentially in effect. To eliminate the welfare trap entirely would require a policy that permanently continues benefit payments regardless of any conditions, with no income from paid work being withdrawn. One example of this would be unconditional basic income. [20] Addressing the affordability of education and healthcare is a way to escape the welfare trap. In the US, for some families on welfare, the high cost of healthcare and higher education drives them to remain in the welfare trap, even though being in the welfare trap reduces their health status and access to credit. Without welfare support, they would have difficulty affording the high cost of healthcare. If the provision of healthcare and education could be improved, this could encourage some welfare families to find work and escape the welfare trap. [21]

In the UK, where single-parent families' reliance on benefits has been on the rise, welfare reformers argue that if the unemployed who are stuck in the benefit trap are taught skills that match their job prospects, then they will be more likely to seek work rather than remain in the benefit trap. They believe that there should be reciprocal obligations between the government and the individual, and that this will encourage welfare recipients to be more active in acquiring job skills and finding work, in order to prepare them for employment. In the United States, the government believes that the unemployed are not motivated to work, so they have taken steps to support work, such as raising the minimum wage, reducing taxes on low-income groups, and providing more health care to working families. However, the main measure that proved effective was the compulsory work scheme, wherein people could only receive benefits if they worked. This has led to a significant increase in the number of people employed and a reduction in the number of unemployed people caught in the welfare trap. In Australia, the government saw low work motivation as a barrier to the unemployed finding new jobs and moved away from helping the unemployed with skills training to motivating the unemployed to find work. The ultimate aim of these reforms is to reduce the number of unemployed people caught in the welfare trap. [22] [23]

See also

Related Research Articles

<span class="mw-page-title-main">Welfare state in the United Kingdom</span> Welfare Programs in the United Kingdom

The welfare state of the United Kingdom began to evolve in the 1900s and early 1910s, and comprises expenditures by the government of the United Kingdom of Great Britain and Northern Ireland intended to improve health, education, employment and social security. The British system has been classified as a liberal welfare state system.

<span class="mw-page-title-main">Welfare spending</span> Means-oriented social benefit

Welfare spending is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifically to social insurance programs which provide support only to those who have previously contributed, as opposed to social assistance programs which provide support on the basis of need alone. The International Labour Organization defines social security as covering support for those in old age, support for the maintenance of children, medical treatment, parental and sick leave, unemployment and disability benefits, and support for sufferers of occupational injury.

<span class="mw-page-title-main">Unemployment benefits</span> Payments made by authorized bodies to unemployed people

Unemployment benefits, also called unemployment insurance, unemployment payment, unemployment compensation, or simply unemployment, are payments made by governmental bodies to unemployed people. Depending on the country and the status of the person, those sums may be small, covering only basic needs, or may compensate the lost time proportionally to the previous earned salary.

Welfare reforms are changes in the operation of a given welfare system aimed at improving the efficiency, equity and administration of government assistance programs. Reform programs may have a various aims, sometimes the focus is on reducing the number of individuals receiving government assistance and welfare system expenditure, at other times reforms may aim to ensure greater fairness, effectiveness and allocation of welfare for those in need. Classical liberals, libertarians, and conservatives generally argue that welfare and other tax-funded services reduce incentives to work, exacerbate the free-rider problem, and intensify poverty. On the other hand social democrats and socialists generally criticize welfare reforms that minimize the public safety net and strengthens the capitalist economic system. Welfare reform is constantly debated because of the varying opinions on a government's need to balance providing guaranteed welfare benefits and promoting self-sufficiency.

<span class="mw-page-title-main">Social insurance</span> Government-sponsored social program

Social insurance is a form of social welfare that provides insurance against economic risks. The insurance may be provided publicly or through the subsidizing of private insurance. In contrast to other forms of social assistance, individuals' claims are partly dependent on their contributions, which can be considered insurance premiums to create a common fund out of which the individuals are then paid benefits in the future.

Workfare is a governmental plan under which welfare recipients are required to accept public-service jobs or to participate in job training. Many countries around the world have adopted workfare to reduce poverty among able-bodied adults; however, their approaches to execution vary. The United States and United Kingdom are two countries utilizing workfare, albeit with different backgrounds.

<span class="mw-page-title-main">Temporary Assistance for Needy Families</span> U.S. federal aid program

Temporary Assistance for Needy Families is a federal assistance program of the United States. It began on July 1, 1997, and succeeded the Aid to Families with Dependent Children (AFDC) program, providing cash assistance to indigent American families through the United States Department of Health and Human Services. TANF is often regarded as just "welfare", but some argue this is a misnomer. Unlike AFDC, which provided a guaranteed cash benefit to eligible families, TANF is a block grant to states that creates no federal entitlement to welfare and is used by states to provide non-welfare services, including educational services, to employed people.

Active labour market policies (ALMPs) are government programmes that intervene in the labour market to help the unemployed find work, but also for the underemployed and employees looking for better jobs. In contrast, passive labour market policies involve expenditures on unemployment benefits and early retirement. Historically, labour market policies have developed in response to both market failures and socially/politically unacceptable outcomes within the labor market. Labour market issues include, for instance, the imbalance between labour supply and demand, inadequate income support, shortages of skilled workers, or discrimination against disadvantaged workers.

<span class="mw-page-title-main">Welfare in New Zealand</span> Overview of welfare in New Zealand

Social welfare has long been an important part of New Zealand society and a significant political issue. It is concerned with the provision by the state of benefits and services. Together with fiscal welfare and occupational welfare, it makes up the social policy of New Zealand. Social welfare is mostly funded through general taxation. Since the 1980s welfare has been provided on the basis of need; the exception is universal superannuation.

Social security, in Australia, refers to a system of social welfare payments provided by Australian Government to eligible Australian citizens, permanent residents, and limited international visitors. These payments are almost always administered by Centrelink, a program of Services Australia. In Australia, most payments are means tested.

<span class="mw-page-title-main">Effective marginal tax rate</span>

The effective marginal tax rate (EMTR) is the percentage of additional income that a recipient of government welfare pays in taxes or loses in welfare benefits and tax credits. The EMTR is a measure of the benefits cliff, the point where the welfare recipients experience an increase in income, thus crossing the means test threshold and becoming ineligible for welfare, but their additional income is not enough to cover the expenses resulting from loss of the welfare benefits.

<span class="mw-page-title-main">Social programs in the United States</span>

The United States spends approximately $2.3 trillion on federal and state social programs including cash assistance, health insurance, food assistance, housing subsidies, energy and utilities subsidies, and education and childcare assistance. Similar benefits are sometimes provided by the private sector either through policy mandates or on a voluntary basis. Employer-sponsored health insurance is an example of this.

<span class="mw-page-title-main">Welfare's effect on poverty</span>

The effects of social welfare on poverty have been the subject of various studies.

<span class="mw-page-title-main">Welfare in Finland</span> Overview of welfare in Finland

Social security or welfare in Finland is very comprehensive compared to what almost all other countries provide. In the late 1980s, Finland had one of the world's most advanced welfare systems, which guaranteed decent living conditions to all Finns. Created almost entirely during the first three decades after World War II, the social security system was an outgrowth of the traditional Nordic belief that the state is not inherently hostile to the well-being of its citizens and can intervene benevolently on their behalf. According to some social historians, the basis of this belief was a relatively benign history that had allowed the gradual emergence of a free and independent peasantry in the Nordic countries and had curtailed the dominance of the nobility and the subsequent formation of a powerful right wing. Finland's history was harsher than the histories of the other Nordic countries but didn't prevent the country from following their path of social development.

Welfare dependency is the state in which a person or household is reliant on government welfare benefits for their income for a prolonged period of time, and without which they would not be able to meet the expenses of daily living. The United States Department of Health and Human Services defines welfare dependency as the proportion of all individuals in families which receive more than 50 percent of their total annual income from Temporary Assistance for Needy Families (TANF), food stamps, and/or Supplemental Security Income (SSI) benefits. Typically viewed as a social problem, it has been the subject of major welfare reform efforts since the mid-20th century, primarily focused on trying to make recipients self-sufficient through paid work. While the term "welfare dependency" can be used pejoratively, for the purposes of this article it shall be used to indicate a particular situation of persistent poverty.

The California Work Opportunities and Responsibility to Kids (CalWORKs) program is the California welfare implementation of the federal welfare-to-work Temporary Assistance for Needy Families (TANF) program that provides cash aid and services to eligible needy California families.

As the unemployed according to the art. 2 of the Ukrainian Law on Employment of Population are qualified citizens capable of work and of employable age, who, due to lack of a job, do not have any income or other earnings laid down by the law and are registered in the State Employment Center as looking for work, ready and able to start working. This definition also includes persons with disabilities who have not attained retirement age and are registered as seeking employment.

<span class="mw-page-title-main">Unemployment insurance in the United States</span> Overview of unemployment insurance in the United States

Unemployment insurance in the United States, colloquially referred to as unemployment benefits, refers to social insurance programs which replace a portion of wages for individuals during unemployment. The first unemployment insurance program in the U.S. was created in Wisconsin in 1932, and the federal Social Security Act of 1935 created programs nationwide that are administered by state governments. The constitutionality of the program was upheld by the Supreme Court in 1937.

Poverty in Norway had been declining from World War II until the Great Recession. It is now increasing slowly, and is significantly higher among immigrants from the Middle East and Africa. Before an analysis of poverty can be undertaken, the definition of poverty must first be established, because it is a subjective term. The measurement of poverty in Norway deviates from the measurement used by the OECD. Norway traditionally has been a global model and leader in maintaining low levels on poverty and providing a basic standard of living for even its poorest citizens. Norway combines a free market economy with the welfare model to ensure both high levels of income and wealth creation and equal distribution of this wealth. It has achieved unprecedented levels of economic development, equality and prosperity.

A wage subsidy is a payment to workers by the state, made either directly or through their employers. Its purposes are to redistribute income and to obviate the welfare trap attributed to other forms of relief, thereby reducing unemployment. It is most naturally implemented as a modification to the income tax system.

References

  1. ↑ Baetjer, Howard (August 24, 2016). "The Welfare Cliff and Why Many Low-Income Workers Will Never Overcome Poverty". Learn Liberty.
  2. ↑ An example of the use of "welfare" as shorthand for public assistance in an academic publication.
  3. ↑ "The Unemployment Trap", CentrePiece Spring 2008. Barbara Petrongolo, London School of Economics.
  4. ↑ Kay, Lawrence (August 18, 2009). "Escaping the Poverty Trap: How to help people on benefits into work". Policy Exchange .
  5. ↑ pdf, webpage, a SARPN (Southern African Regional Poverty Network) report
  6. ↑ "The state of working America, 1996-97". Lawrence Mishel, Jared Bernstein, John Schmitt, section "Government Benefits and Family structure: Is there a Welfare Trap?"
  7. ↑ Fraser, Gordon, Nancy, Linda (1994). "A Genealogy of Dependency: Tracing A Keyword of the U.S. Welfare State". Signs. 19, 2 (2): 309–336. doi:10.1086/494886. S2CID   144939838.{{cite journal}}: CS1 maint: multiple names: authors list (link)
  8. ↑ "Welfare Regimes and Perceived Causes of Poverty", The Institutional Logic of Welfare Attitudes, Routledge, pp. 79–112, 2016-02-24, doi:10.4324/9781315556727-9, ISBN   9781315556727 , retrieved 2022-05-01
  9. ↑ M., Dockery, Alfred (2008). Welfare traps in Australia : do they bite?. the Centre for Labour Market Research. OCLC   836911417.{{cite book}}: CS1 maint: multiple names: authors list (link)
  10. ↑ Kraay, Aart; McKenzie, David (2014-08-01). "Do Poverty Traps Exist? Assessing the Evidence". Journal of Economic Perspectives. 28 (3): 127–148. doi: 10.1257/jep.28.3.127 . hdl: 10986/20540 . ISSN   0895-3309.
  11. ↑ "Social safety net", Wikipedia, 2021-11-19, retrieved 2022-05-01
  12. ↑ "Human Resources Subcommittee Discusses Need to Better Coordinate Dozens of Anti-Poverty Programs". Ways and Means Republicans. 2015-11-03. Retrieved 2022-05-01.
  13. ↑ "Effective Marginal Tax Rates for Low- and Moderate-Income Workers in 2016 | Congressional Budget Office". www.cbo.gov. 2015-11-19. Retrieved 2022-05-01.
  14. ↑ "Human Resources Subcommittee Discusses Need to Better Coordinate Dozens of Anti-Poverty Programs". Ways and Means Republicans. 2015-11-03. Retrieved 2022-05-01.
  15. ↑ Cashel, M.; McGavin, P. A. (December 1992). "Removing Poverty Traps: Taxation and Welfare Reform in Australia". The Economic and Labour Relations Review. 3 (2): 98–114. doi:10.1177/103530469200300205.
  16. ↑ Ingles, David; Plunkett, David. "Effective marginal tax rates: TTPI – Policy Brief 1/2016 August 2016" (PDF). Tax and Transfer Policy Institute.
  17. ↑ Dockery, Alfred M.; Ong, Rachel; Wood, Gavin. "WELFARE TRAPS IN AUSTRALIA: DO THEY BITE?" (PDF). ISSN   1329-2676.{{cite journal}}: Cite journal requires |journal= (help)
  18. ↑ Brian Lee Crowley (June 8, 2005). "Equalization:Welfare Trap or Helping Hand, a Brian Lee Crowley speech". Archived from the original on September 29, 2011.
  19. ↑ DirectGov
  20. ↑ "Basic Income and Labor Supply: The German Case" by B. Michael Gilroy & Mark Schopf & Anastasia Semenova, 2012.
  21. ↑ Necati Celik(2015).A DIFFERENT LOOK AT THE WELFARE TRAP: INSTITUTIONAL CAUSES AND REMEDIES
  22. ↑ "Reforming the Australian welfare state". aifs.gov.au. Retrieved 2023-04-23.
  23. ↑ "Welfare reform in America". aifs.gov.au. Retrieved 2023-04-23.
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