EconoMonitor

Ed Dolan's Econ Blog

Does the Social Safety Net Provide Enough Incentive to Work?

One of the most common criticisms of social safety net programs is that they discourage work. As House Speaker Paul Ryan has put it, they risk becoming a “hammock that lulls able-bodied people to lives of dependency and complacency,  that drains them of their will and their incentive to make the most of their lives.”

It is not hard to find examples in which the threat to work incentives is real. Not long ago, in a post on labor market adjustments to trade shocks, I cited a recent report from the Congressional Budget Office, according to which taxes and benefit reductions can claw back as much as 80 percent of each dollar of additional income earned by households whose income is just above the poverty level.

A few days later, however, a reader called my attention to a paper, “It Pays to Work: Work Incentives and the Safety Net,” by Isaac Schapiro and colleagues at the Center on Budget and Policy Priorities. The CBPP team uses the very same CBO data to support the opposite conclusion:

Some critics of various low-income assistance programs argue that the safety net discourages work.  In particular, they contend that people receiving assistance from these programs can receive more, or nearly as much, from not working — and receiving government aid — than from working. Or they argue that low-paid workers have little incentive to work more hours or seek higher wages because losses in government aid will cancel out the earnings gains.

Careful analysis of the data and research demonstrates, however, that such charges are largely incorrect and that it pays to work.

What is going on here? How can it be that the same data support both the view that the social safety net discourages work, and that it does not?

Half full vs. half empty

The debate over the safety net and work incentives centers on the issue of effective marginal tax rates (EMTRs). A household’s EMTR is the sum of the benefit reduction rates on all social programs for which it is eligible, plus the the marginal rates of any taxes paid. For example, consider a household that receives food stamps, subject to a benefit reduction rate of 24 percent; housing benefits, subject to a benefit reduction rate of 30 percent; and earns minimum wage income subject to a 7 percent payroll tax. The EMTR for that household would be 24+30+7=61 percent, meaning that the household’s net income, after benefit reductions and taxes, would rise by just $39 for each $100 earned.

As the following chart from the CBO report shows, EMTRs vary over a wide range, both between and within income groups. Which parts of the range you choose to emphasize depends, at least in part, on your political objectives. The data on which the chart is based include federal and state taxes paid, the Earned Income Tax Credit (EITC), food stamps (SNAP), cost sharing subsidies for health insurance, and the child tax credit. They do not include Temporary Assistance for Needy Families (TANF), Medicaid, or housing subsidies.

P160414-1

In their efforts to justify budget cuts, conservatives find it useful to select examples from the least favorable regions of the chart, found at the tops of the bars in an income range just above the poverty level. Such examples fit the “hammock” scenario, making make safety net programs look counterproductive.

In contrast, progressives, who would like to expand the safety net, prefer to emphasize cases where EMTRs are at a minimum. For example, Schapiro et al. lead off with an example of a single mother with two children who, starting from zero, takes a half-time job at the minimum wage, thereby doubling her income, including benefits. We can see that the example comes from the most favorable range on the CBO chart.

But if the half-full vs. half-empty distinction were all there were to this story, it would hardly be worth blogging about. It turns out there is much more than that. Read on.

The importance of coverage

The chart shows that the highest EMTRs occur in the range of 100 to 149 percent of the poverty level. In the middle of that range, between 120 and 125 percent of the poverty level, the EMTR for a single parent with one child can reach 80 percent, even without including programs like housing assistance and daycare subsidies. However, looking at all low- and moderate income families, the CBO calculates that the mean EMTR is only 31.3 percent. When only the employee’s share of payroll taxes is included (As Schapiro et al. argue should be the case), the mean EMTR is just 24.3 percent.

What accounts for the large difference between the peak and mean EMTRs? Schapiro et al. explain it this way:

The often-cited examples are generally atypical worst-case scenarios that apply only to a small fraction of families with children — namely, families that: a) have income in certain fairly narrow ranges, typically just above the poverty line; and b) receive an unusual combination of government benefits, all or most of which phase down in the same income range.  We estimate that only about 3 percent of single mothers with two children and earnings below 150 percent of the poverty line (below about $29,000) receive the EITC, SNAP, and either TANF or housing aid (or both) and are in the earnings range where these benefits all phase down simultaneously—and consequently face marginal tax rates above 80 percent.  The proportion is even smaller for other family configurations.

This is a curious defense of the social safety net to hear from a progressive source. Yes, work incentives are intact for most low-income households, but it pays to work, not because the safety net is  well designed, but because its coverage is so limited.

Consider, for example, this version of the typical conservative complaint, from George Mason University’s Garret Jones, via John Stossel of Fox News:

The question is not whether people start out life in homogeneous circumstances, [Jones] adds. “The question is whether government policies that try to fix this actually make things better or worse.”

Worse, in most cases. Government “help” encourages poor people to be dependent and passive. Dependent people stay poor.

As I understand it, Shapiro et al. do more to confirm this contention than to refute it. What they say is that most poor people do have an incentive to better themselves, but only because they do not qualify for most safety net programs. Meanwhile, those few who do get enough help to lift themselves  above the poverty level do face incentives to remain dependent and passive. It is hard to see what there is for progressives to boast about here.

Improving program design

As new programs have been added on top of old ones, policymakers have paid insufficient attention to the way the disincentives of multiple programs interact. Progressives should be putting their energies into fixing this problem, so that it would become possible to broaden coverage without destroying work incentives. Yet Schapiro et al. take a very limited view of the alternatives for program redesign:

There are really only two options to lowering marginal tax rates.  One is to phase out benefits more slowly as earnings rise; this reduces marginal tax rates for those currently in the phase-out range.  But it also extends benefits farther up the income scale and increases costs considerably, a tradeoff that many policymakers may not want to make.  The second option is to shrink (or even eliminate) benefits for people in poverty so they have less of a benefit to phase out, and thus lose less as benefits are phased down.  This reduces marginal tax rates, but it pushes the poor families into — or deeper into — poverty and increases hardship, and thus may harm children in these families.  In effect, the second option would “help” the poor by making them worse off.

That is too pessimistic, in my view. It implicitly accepts the conservative claim that any safety net that offers the breadth of support that progressives would like to see must either strain the federal budget or destroy work incentives. Fortunately, there are options that escape that dilemma.

One idea, far from new, would be to replace the current tangle of overlapping programs with a single negative income tax that would phase out more gradually as incomes rise. The following chart shows how an NIT would compare to existing programs, based on the CBO’s example of a single parent with one child, living in Pennsylvania in 2015.

P160418-1

The red line shows the family’s earned income. The blue line shows net income (earned income plus benefits minus taxes paid) under existing programs. The effective marginal tax rate is one minus the slope of the blue line. At its flattest, around 120 to 125 percent of the poverty line, the EMTR for the blue schedule reaches 80 percent. What is more, there are numerous notches, where the benefits of some program are completely lost as the household passes some income threshold.

The green dotted line shows a hypothetical NIT schedule. In this case, NIT benefits start at $18,000 a year, which is the average benefit provided to zero-income households under existing programs. It is then phased out smoothly at an EMTR of 45 percent until benefits fall to zero at an earned income of $40,000, or about two-and-one-half times the poverty line.

If there were no change in work behavior, the total cost of the NIT for families receiving benefits under the NIT would be approximately the same as the cost for families receiving positive net benefits from existing programs. If the lower EMTR resulted in more paid work by families now receiving benefits, the NIT would cost proportionately less. After adjusting for changes in work behavior, it would also make sense to revise the schedule of income and payroll taxes paid by moderate-income workers just beyond the breakeven point (not shown here) in order to maintain work incentives in that range and make the whole program revenue neutral.

A more radical design change would replace most or all existing safety net programs with a universal basic income (UBI), a subject on which I have written in detail elsewhere. By a UBI, I mean any program that provides a fixed cash grant to everyone (in my version, all resident citizens) without regard to income or labor force status.

In outline, here is how a UBI would affect work incentives:

  • UBI benefits are not reduced as income rises. Because there is no phase out, they have no effect on effective marginal tax rates. As a result, EMTRs would decrease for any household currently receiving means tested benefits under any program replaced by the UBI.
  • Work incentives of any safety net program include an income effect (work effort tends to decrease as income rises, other things being equal) and a substitution effect (work effort tends to increase as the EMTR decreases, other things being equal). For households who receive benefits equal to or greater than the UBI under existing programs, replacing those programs with a UBI would have no income effect, so it would unambiguously increase incentives. For those who previously received smaller benefits or none, the positive impact of the substitution effect would outweigh the reduced incentive of the income effect. (See here for details and sources.)
  • A UBI would be affordable so long as it replaced existing transfer programs rather than adding to them. For low-income households, the UBI would replace means tested programs such as EITC, TANF, SNAP, and housing assistance. For middle- and upper-income households, the UBI would replace “middle class welfare” such as deductibility of mortgage interest and interest on retirement savings. The UBI would not need to replace all transfer programs so long as “double dipping” was not allowed. For example, a retired person could choose between Social Security benefits or UBI benefits, whichever was greater, but could not take both.

In this way, a UBI would entirely circumvent the dilemma of means-tested programs that Schapiro et al. describe. It could provide needed resources to households with low earned income, or none, without imposing high effective marginal tax rates. At the same time, it would not increase net tax burdens on middle- and upper income households.

The bottom line

Conservatives are right to emphasize the need to maintain strong work incentives for beneficiaries of the social safety net. With only a few exceptions, though, they have shown little interest in reforming or replacing existing programs. Instead, they have seized disincentives as a weapon in their campaign to reduce government spending, taxes, and deficits. They have been partially successful in doing so. For example, the share of poor families receiving cash assistance from TANF has fallen steadily as states have narrowed eligibility requirements and even added petty restrictions like listing the types of entertainment permitted for TANF beneficiaries.

Eligibility limits have, on average, reduced the disincentives to which low-income households are exposed, but it makes little sense for progressives to cite that fact as a defense of existing programs. Quite the opposite. If progressives ever managed to roll back the restrictions on eligibility that conservatives have imposed, work disincentives would reemerge in full force. Progressives should instead support fundamental redesign that would simultaneously broaden coverage and encourage low-income families to become more active in the labor market.

Related posts:

Voters are Angry About Free Trade: What is the Right Policy Response?

The Economic Case for a Universal Basic Income

A Universal Basic Income and Work Incentives

 

11 Responses to “Does the Social Safety Net Provide Enough Incentive to Work?”

windrivenApril 28th, 2016 at 11:21 am

"Conservatives are right to emphasize the need to maintain strong work incentives for beneficiaries of the social safety net."

Why?

Intuitively, there are a lot of easy answers to that 'why?' but how do they hold up to the economic realities of the 21st century? Labor inputs to producing the food we eat today employ only a tiny fraction of the population. Similarly, labor inputs to manufacturing are now falling sharply as automation and offshoring bite. The best growth is in the 'routine low wage service' sector.

Looking down the road to a point where human labor is a minor input in the generation of food, clothing, housing, and manufactured goods, what do we do with the excess labor? Some, of course, will be soaked up by technical or creative activities. But the reality is that these require highly developed skills and talents that are unlikely to be within reach of large chunks of the population. So do we return to a time of elevator operators and doormen?

Our notions of 'contributing' are going to need to evolve beyond classical conceptions of work. People do need to contribute both for the betterment of the community and to establish their personal relationship with the community; this seems to be a central component of how we see ourselves. But for work incentives to be meaningful there has to be meaningful work to be had – or we need to rethink what work means.

Ed Dolan EdDolanApril 28th, 2016 at 1:41 pm

I pretty much agree with you, so take what I say here in the spirit of "Devil's advocate."

My impressions, from many conversations I have had with conservatives and some liberals, is that it all boils down to the idea of "deserving" vs. "undeserving" poor. The question is, how do you know who is deserving? In a few cases, it is obvious, for example, people with physical or mental disabilities that disqualify them from any realistic job. Short of that, if you are poor and want help from a conservative, you have to put out some kind of signal that indicates that you are in the "deserving" category. The best way to do that is to show you are willing and able to work. However, just saying you are willing and able is not enough of a signal for some conservatives, who sincerely believe that anyone willing to work could find a job of some kind if they really tried. As a result, the only acceptable signal of being "deserving" is actually to work. Once you are working, conservatives are much more comfortable with programs like EITC that subsidize wages. In this context, it is completely irrelevant whether the work is "meaningful" or not in the normal sense of producing something of economic value. The bottom line is that yes, we might actually be headed back to a regime of elevator operators and door . . . doorpeople? door openers? Many good conservatives would be much more willing to pay a wage subsidy to someone who was willing to stand in an elevator 8 hours a day doing something useless than to someone who wanted to spend that same time caring for their children or mowing their own lawn. In fact, given that world view, it would be perfectly fine to give the elevator operator enough of a wage subsidy to cover the costs of child care and lawn service.

BryanWillmanApril 28th, 2016 at 1:50 pm

Invert that – given that we live in an era where "social capital" support from the group receiving safety net payments back to the taxpayer is effectively zero, we could ask why does society offer a social safety net at all?

One presumes that the answer is to assure current taxpayers that if they fall on hard times they won't starve. Hence, social security probably has more support than any other federal program, and is payments tested (you are only eligible if you or your spouse paid taxes.) Various forms of welfare have the least support, and if we come to era where taxpayers believe they'll never benefit from such programs, we might also come to an era where the programs end because taxpayers simply refuse to pay for them.

Historically, a bigger population was generally an advantage to a society, because it meant more total output, more people to engage in warfare, and so on.

In a world were all material needs are fulfilled by robots and a handful of human watchers, why is there a need for any other people? Indeed, why would the robots bother feeding us at all?

Ed Dolan EdDolanApril 28th, 2016 at 1:59 pm

I'm not sure whether the robots would bother feeding us. I'll have to think about that.

In the present time, I think that there are some ethical systems that would motivate supporting welfare even if you were sure you would never need it. The main one would be the "veil of ignorance" idea that you should support any policies that would seem good to you if you could vote on them in a trance of temporary ignorance, where you could evaluate the policy without knowing whether, when you woke from the trance, you would find yourself rich or poor, employed or jobless, able or disabled, etc. There are also religious based systems that impose a moral obligation to help others as a way of serving God. Probably others that don't come to mind just now. Not to mention the self-interested motive of just keeping the masses from rioting and burning down your house (or your robot factory).

BryanWillmanApril 28th, 2016 at 1:59 pm

Responding more directly to Ed Dolan's observations and suggestions – a true UBI that truly mostly replaced other safety net structures (and brought order to the patchwork quilt) might get and hold support on the "everybody gets this and benefits from it, so I support it" mindset.

But I doubt it, because I think that in reality some large part of the political/taxpayer support for welfare is "don't allow these particular bad things" and "make this particular issue go away" – and so if food stamps, housing support, etc., are replaced with general cash which can be mismanaged from the perspective of the taxpayer (they bought booze and videogames and didn't pay the rent or take the kids to the dentist) UBI is an ANTI feature. Because (I think) taxpayers as a whole don't care if poor people have money, rather, they don't want to see them living on the street (see current drama in Seattle and San Francisco) and don't want to see children maimed by lack of food, medical treatment, etc. So in some sense, UBI as a replacement for in-kind supports is non-starter – it's actually NOT the thing the distilled desire of taxpayers wants.

windrivenApril 28th, 2016 at 5:11 pm

"Indeed, why would the robots bother feeding us at all?"

Without wandering off into the philosophical weeds, why indeed?

Presuming they do, the opportunity for humanity to embrace a new paradigm, to refashion and repurpose society is a tantalizing possibility. The cynic in me insists that the probable reality will be rather more dystopic.

"[W]e could ask why does society offer a social safety net at all?"

We could. But reflection on a Western history of serfs and peasants suggests that the concomitant social ills and depressed aggregate demand may be a steeper price than the safety net. Whether those factors are true – and if they are if they will remain true – in a changing economic landscape, is a discussion beyond the scope of this forum.

Patrick R. SullivanApril 28th, 2016 at 6:28 pm

We've seen this play out before, in the late 1960s in the Nixon administration. Daniel Patrick Moynihan wrote a book about it; The Politics of the Guaranteed Income. Here's the NY Times review of it;
https://www.nytimes.com/books/98/10/04/specials/m

—————quote—————
No one expected the work requirement to work, least of all the President. "I don't care a damn about the work requirement," he told Moynihan, "This is the price of getting $1,600." Again, as McGovern belatedly found out, the only way to promote welfare changes was to call them workfare.

But the price Nixon paid for a vague and unstructured work requirement was to exacerbate liberal fears. Mothers of small children, it was argued, might be ordered to work regardless of the adequacy of day-care facilities or the appropriateness of the job. To make matters worse, hard-won rights of judicial review for welfare recipients would have been curtailed by the Nixon bill.

Evaluating these fears is a problematic task, which Moynihan does not systematically attempt. In a thick, complicated book he finds little space for the detailed arguments raised by the liberal opposition. His focus, instead, is on motives. The liberals, he charges, could not permit fundamental change in the welfare system for they were too beholden to their constituencies of social workers, self-seeking spokesmen for the underprivileged and existing welfare recipients in high-payment states.

A more sympathetic phrasing could be constructed on the same evidence. F.A.P. offered epochal gains for the Southern poor at the price of a change in the rules with uncertain consequences for the mothers and children on welfare in the North. Liberals chose to be strategically conservative.
————–endquote—————

Ed Dolan EdDolanApril 28th, 2016 at 6:38 pm

Thanks for the nice citation. To make it clear, Nixon's Family Assistance Program (FAP) was not what I call a Universal Basic Income. It was conditional in three ways: Only families with children qualified; it had a work requirement (for those deemed able bodied); and it was phased out as income rose at a rate of about 50 percent. It could better be described as a negative income tax for families with children. Still, it is relevant to the discussion. As I point out in the post, even a NIT would be better, in many ways, than the current welfare system, and that may have been true at the time.

TAX INCOME CHART 2017April 28th, 2016 at 7:00 pm

[…] TAX INCOME CHART Does the Social Safety Net Provide Enough Incentive to Work? The knowledge on which the chart is predicated embrace federal and state taxes paid, the Earned Income Tax Credit (EITC), meals stamps (SNAP), value sharing subsidies for medical insurance, and the kid tax credit score. They don’t embrace Temporary Assistance for …. Continue on EconoMonitor […]