Since 2016, the Georgia Center for Opportunity (GCO) has demonstrated the existence of welfare cliffs. Now a team of five economists has come to the same conclusion.

Welfare cliffs are an unfortunate feature of the American welfare system. They occur when a family’s breadwinner, or an individual, discovers that his or her family will become worse off economically by earning more money. It sounds paradoxical, but it happens whenever the loss in welfare benefits exceeds the additional take-home pay.

Exactly when the cliffs occur, and how bad they are, depends on many factors, including the characteristics of the family, how much they earn, and where they live. And because of the haphazard way the welfare system is constructed, it turns out that there isn’t a single cliff but multiple cliffs that a family can encounter over the range of potential earnings.

For more information on GCO’s work on the cliffs, check out this website that shows cliffs in eight states by common family types.

New Study

Authored by economists at the Federal Reserve Bank of Atlanta, Boston University, and the University of California, Berkeley, a newly published study takes a sophisticated approach to identify disincentives in the U.S. tax and welfare structure. Published as a working paper by the National Bureau of Economic Research (NBER), the authors fed the results of the most recent Survey of Consumer Finances through a fiscal analyzer.

The Economic Team

David Altig, Federal Reserve Bank of Atlanta

Alan J. Auerbach, University of California, Berkeley and NBER

Laurence J. Kotlikoff, Boston University and NBER

Elias Ilin, Federal Reserve Bank of Atlanta and Boston University

Victor Ye, Boston University

 

 

The Survey of Consumer Finances is a project of the Board of Governors of the Federal Reserve System. It is the most comprehensive survey examining the personal finances of American individuals and families. Thus, the input data for their study represent a statistical picture of how families are faring economically.

In other words, the financial situations of a representative cross-section of families in America was fed through a fiscal analyzer. This particular fiscal analyzer was based on a personal financial planning tool developed by the software company of Laurence Kotlikoff, one of the study’s authors.

The fiscal analyzer estimates the likely future financial path that individuals or families will take over their remaining lifetime, along with the future taxes and benefits they will pay or receive. The study uses standard mortality rates to predict lifespans and gives a unique calculation on the degree and magnitude that incentives or disincentives exist over that likely path.

The study defined the future fiscal burdens, consisting as taxes and benefits, as marginal tax rates. If a person’s remaining marginal tax rate increases, then so does the tax burden. The greater the magnitude of the marginal tax rate, the greater the disincentive.

Study Results

Given our own work, the conclusion of the authors was not surprising. To quote from their study:

“Our findings are striking. One in four low-wage workers face marginal net tax rates above 70 percent, effectively locking them into poverty.”

“… one in four bottom-quintile households, regardless of age, face marginal tax rates above 65 percent. Thus, a major share of poor households are effectively locked into poverty by America’s fiscal system.”

The authors were careful to point out that this study looks at the structure of America’s fiscal system, meaning these disincentives are hardwired into the laws and rules of the system. This corroborates exactly with our research. The very rules themselves are what create the disincentives and the cliffs. The silver lining here is that rules can be changed.

This study did not attempt to measure how people react to the disincentives. Some might bite the bullet, take the hit, and still advance their earnings anyway. On the other hand, others may take a defeatist tact, backing off from earning more to draw down more government assistance. This is a ripe area for future research, to determine the proportion of people who forge ahead anyway versus those who give up and retreat.

In the meantime, we shouldn’t wait for future research on how many people accept defeat and remain poor. It makes more sense to fix the rules now so the question becomes moot.

Erik Randolph is Director of Research at the Georgia Center for Opportunity. This blog reflects his opinion and not necessarily that of the Georgia Center for Opportunity.