Taxes & Spending’s impact on Poverty

The phrase “government safety net” covers a broad variety of policies and government programs. Some nations spend much more than others on ensuring that the poor don’t starve and can live a decent life. Some have policies that are effective at keeping people productive, happy, and mostly out of poverty; others have programs that can’t even keep the people they’re designed to help from going hungry. It’s easy to think of the correlation between money spent and effectiveness of the programs as being relatively straightforward, but there’s a lot of variance between the effectiveness of each dollar (or euro, or yuan, or pound; whatever) spent in the safety-nets of different nations.

In the case of America’s anti-poverty programs, you can’t say that they haven’t been effective: “A major study by Christopher Wimer and Liana Fox, researchers at Columbia University’s Population Research Center, and three collaborators, found that if there were no tax and transfer programs, the poverty rate would have increased from 27 percent of the population in 1967 to 29 percent in 2012. With government anti-poverty programs, the poverty rate had actually fallen to 16 percent by 2012.” [source]

But while things may not be as bad as they could be, it’s painfully obvious that our safety-net systems aren’t working as well as we’d like. The Economist may have put it most succinctly when it said that America’s safety net “manages to be both stingy and to discourage work,” which is a sadly accurate description.

Our welfare system is also expensive – ruinously so, in the long run, when compared to how much we take in in taxes – but we still don’t spend enough to broadly eliminate poverty in the manner of some other nations. More importantly though, while welfare payments have helped the poor in many respects, the way we’ve structured our tax and subsidy systems have actually imposed new costs on the poor, over and above their lack of financial resources.

There’s always a catch

The classic example of this is the massive marginal tax rate that minimum-wage workers face when they increase their income. The Congressional Budget Office calculates that the marginal tax rate for some low-income households can spike to 95% of each new dollar in some instances, and averages around 30%. This isn’t because of high tax rates, of course; rather, it’s because as their income rises they lose access to government subsidy programs.

Among other effects, this complicates the incentive structure of welfare programs. Let’s take a very specific example, because the rules vary somewhat by state: In 2012, a single mother in Pennsylvania who was making around $17,000/year could work an additional 500 hours a year and net less than 35 cents/hour for her additional work. If she is paying as little as $1/hour for babysitting or childcare, she would actually be losing money by working more. Even in cases where the effective tax rate is “only” 50%, child care, transportation, and other work-related expenses can easily reduce the gains to zero or actually create a situation in which welfare recipients would lose money by working more. (Numbers in this example are from the CBO paper linked above.

The actual impact of the high effective marginal tax rates on low-income household labor decisions is still subject to debate. We don’t know, for instance, how many households could be earning more money but choose not to because it’s too much effort for too little gain. What we do know, however, is that these extremely high disincentives for work create a barrier that many people fail to cross, effectively keeping them in poverty and on government welfare.

Navigating a Labyrinth

It would be one thing if it were clear to people that they’d be facing a marginal tax rate as their income increased, and what that marginal tax would be. Unfortunately, it’s rather the opposite. The myriad anti-poverty programs (92 alone on the federal level, and many more on the state and local levels) create a maze of requirements, restrictions, income thresholds, and provisions that low-income families must deal with in order to gain access to government benefits. Exactly when and how you should expect to lose a particular benefit or set of benefits can frequently be as clear as mud, and so families can end up running into high marginal tax rates unintentionally, with painful consequences.

There are a variety of forms that these programs and their corresponding restrictions can take. Tax refunds are the most obvious and commonplace method by which low-income households receive benefits. Filing a tax return is anything but simple in the US, so a multi-billion dollar industry has grown up around this demand for clear answers and reliable management of the tax refund process; the problem is that the dire circumstances and need of its customers have also created serious incentives for fraud and predatory behavior.

Complying with other parts of the welfare system requirements is even more complicated, requiring applicants to navigate many obstacles and frequently turning being jobless and on welfare into a job in and of itself. The complexity of the system effectively imposes an extra tax on those who depend on it – a tax in added stress, a tax on their time, and sometimes even a tax on their already-strained financial resources.

Pinned in Place

Another way in which the complexity of the welfare system harms those who depend on it is by keeping them rooted in place, unwilling – or unable – to move elsewhere in pursuit of a better life for fear of losing access to their benefits. As an article by the libertarian think tank R Street put it, “[e]very program requires its own enrollment and qualification process, so every new program created, even if it is effective on its own terms, presents an additional barrier to geographic mobility.” Most subsidies are linked to an address, with considerable time and red tape needed to change it; many vary by which state you reside in, making inter-state relocation risky for those dependent on, say, Medicaid; and the simple fact that local (city or county) welfare systems each require a new registration means that moving even short distances can become a serious endeavor if you’re dependent on welfare for survival.

There is, unfortunately, little hard data on how much “in-place” or “place-dependent” welfare systems in the US reduce the geographic mobility of those who depend on them. One can point to the significant correlation between the increase in inequality in the US and the decrease in the geographic mobility of Americans, but this does not prove causality. Nevertheless, there is sufficient anecdotal evidence that this could be a very real component of why poor families remain poor: they cannot afford the risk of moving to greener pastures in pursuit of good jobs, because by doing so they would risk losing access to welfare and falling even further behind financially.

Wheat or Chaff?

America’s maze of welfare programs wasn’t built all at once, obviously. Each piece was originally intended to serve an individual, worthy purpose. Every program had a subsidy and method of delivering that subsidy, and most had some form of check – some way to ensure that the recipient of that subsidy deserved it and wasn’t simply defrauding the government. Those measures are important – the sheer scale of fraud in Medicare, Medicaid, Social Security, and other forms of welfare is evidence of the need for safeguards – but taken together they form a mass that adds an incredible amount of complexity to the lives of the people who can least afford added complications.

This is a distinction that’s often made when talking about welfare programs, that there are two kinds of poor people: those who deserve help, and those who don’t. This grows out of American culture: we have a national image of self-reliance and a cultural distaste for asking others for help. We have both a high rate of charitable giving and a strong negative reaction toward those who manipulate the rules to receive charity they don’t need or deserve.

Any proposal in America of giving government-funded charity to those in need has historically been greeted by a certain amount of resistance. For example, in order to get Social Security included as part of his New Deal, FDR had to dress it up as an “insurance plan” rather than a welfare scheme in order to get the American public to accept it – and that was for a universal welfare program, not one focused on the poor. Things get stickier when you mix in questions of class and race (and, let’s face it, the over-representation of African Americans and Latinos in the lower-income brackets means that poverty is a racially-charged issue).

Combine all this with the drop in social capital over the last half-century, particularly the drop in trust between Americans and their government, and you end up with a view of the unemployed poor as shiftless and lazy, undeserving of any charity. This creates a strong desire to somehow separate them from those who do deserve government support, and to keep people in general from becoming dependent on the government.

These impulses aren’t as misguided as progressives like to paint them. A culture of dependency is a burden on society, and something to be avoided, and it’s absolutely critical to incentivize people to work instead of avoiding work. However, the manner in which the government has gone about trying to identify those who “deserve” welfare, and stop funding from going to those who don’t deserve it, has created a mess of perverse incentives surrounding America’s welfare system. The government may be spending a lot of money supporting the poorest Americans, but much of the money is wasted or spent inefficiently, and what does get to the poor gets there in a way that makes their lives worse and makes it harder for them to escape poverty.


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