The Distribution of Income: The Welfare Trap An Illustration

The Welfare Trap An Illustration Imagine you're the head of a household receiving welfare benefits. If you're a typical recipient, you're a single mother with three dependent children, you don't work, and you receive a cash benefit of $421 per month in 1990 dollars, or $5,052 per year. This sum is approximately equal to the average annual cash payment received in 1990 by families of four eligible for Aid to Families with Dependent Children. You'd also be eligible for food stamps that would buy about $2,000 worth of food in 1990, assuming you had zero earnings and thus received the maximum dollar amount of food stamps. Medicaid benefits, which have an estimated cash value of $2,000 per year, would raise the sum of your cash income and the estimated value of in-kind benefits to $9,059 per year. You might also be eligible for other government programs, such as free school lunches or subsidized housing, which would push your total income over $10,000. Note, however, that if you were eligible only for Aid to Families with Dependent Children, medicaid, and food stamps, your annual income, assuming no work, would still be below the poverty threshold. These benefits vary from state to state. However, on average welfare recipients don't receive enough government assistance to push them over the poverty threshold. The data just given assume you don't work. What happens if you begin working parttime? Keep in mind that if you're the typical welfare recipient, you lack the education, skills, and experience to qualify for high-paying jobs. The most you can hope for is a job paying a minimum wage of, say, $4.25 per hour. Most states will allow you to earn about $150 per month before they start reducing your welfare benefits. After you earn the permissible maximum, your AFDC payments decline by 67 cents per dollar of earnings for the first four months of employment. You'll also have to pay some taxes on your wages. The dollar amount of food stamps you receive also eventually declines as your income increases. Finally, after you earn about $10,000 per year, your medicaid benefits will be cut off! This means your real income declines by the $2,000 value of medical benefits as soon as you hit the medicaid cutoff point. There is some good news for you amid this mass of reductions in your transfer payments and in-kind benefits. After you start your job you'll be eligible for the Earned Income Tax Credit (BITC). The EITC is a special payment from the federal government to the working poor. Workers with low incomes receive the EITC when they file their income tax returns. The EITC varies with an eligible recipient's income and had a maximum value of $953 per year in 1990. The maximum level was reached at $8,000 of earnings in 1990 and reduced after the worker earned more than $10,000 per year. After you reach a certain level of income, your total welfare benefits fall to zero and you're on your own. How well off will you be compared to not working? The answer is: not very. The table in Box 6 shows how you would fare as your earnings increased to various levels assuming that you work more than four consecutive months for the year. If you obtained part-time work during the year to earn $4,000, your cash payments from government would be only $3,852. You'd also have the privilege of paying taxes. Because there are generous deductions and exclusions under the income tax, the only actual tax you'd pay would be payroll taxes of $306. The food stamps you received would decline modestly to about $1,815 worth, and you'd still retain your medicaid benefits. Your total income including the value of in-kind benefits after taxes would be $11,361. Your $4,000 annual earnings increase your actual income by only $2,302 when compared with the $9,059 you would enjoy with no work! This means that you really keep only a bit more than one half of your earnings. How much incentive would you have to voluntarily accept part-time work under these circumstances? Suppose you obtain a full-time job. Given your skills, you can't hope to earn more than $4.25 per hour. Let's say you earn $10,000 per year. That's enough income to make you ineligible for AFDC welfare payments. At the end of the tax year you'll still get from the government a modest EITC payment of $953. You'd have about $975 in taxes deducted from your pay. You'd still be eligible for $1,723 worth of food stamps, but your medicaid benefits would be terminated! If you didn't receive employer-provided health insurance, you'd now be responsible for your own medical bills. Assuming you don't have health insurance, your income (including the value of food stamps) after taxes is now $11,701. The situation is worse if we figure in work expenses you incur such as transportation, meals at work, clothing, and other items you must buy to perform your job. As a welfare mother you will also incur some childcare costs. The next to last column shows estimated work expenses at various levels of earnings. Once these expenses are deducted from your total income your net income for $10,000 of earnings is $8,701 which is $358 less than the $9,059 income you had when you did not work at all! The table in Box 6 shows how you would fare with earned income of up to $15,000 per year under programs existing in 1990. As you can see, it's hard to get ahead by working. Recipients therefore are reluctant to accept jobs voluntarily. Some new policies adopted in the late 1980s require able-bodied welfare recipients to accept jobs in order to offset this lack of incentive to work. Of course, the incentive to work could be increased if the welfare benefits weren't reduced as much as the poor began to work. However, this would greatly increase the number of welfare recipients and therefore increase the burden of taxes needed to pay for welfare programs.