Benefits Cliffs in the Aggregate: Consequences for Welfare and Business Cycles
Benefits cliffs – sudden decreases in public benefits that may occur with a small increase in earnings – may inhibit upward mobility. I study the effect of a multitude of cliffs across the universe of benefit programs in nine southern US states on intensive-margin labor supply and the implications for aggregate fluctuations. Using the American Community Survey and proprietary data from the Georgia Center for Opportunity covering nine southern US states, I leverage geographic and household-structure variation to find that, in aggregate, individuals in households approaching benefits cliffs reduce their working hours by about 40 hours annually. I then build a dynamic stochastic general equilibrium model that matches this result, where a key assumption of inframarginal households allows me to accurately capture the benefits cliffs of the US tax and transfer system. I find the aggregate implications of benefits cliffs on output are small, but welfare gains from their elimination are large and concentrated. In a counterfactual model that smooths over benefit cliffs, output increases about 1.6% more on impact in response to an aggregate productivity shock compared to the baseline model with benefits cliffs, but the welfare gain to formally-constrained households doubles.