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24 April 2008

Catch-22 Government programs intended to help people often have a way of backfiring badly. The reason for this, of course, goes to the inherent knowledge problem that elected politicians and government bureaucrats have when shaping and executing public policy. In a nutshell, they just aren't capable of knowing enough to truly solve problems in a way that makes everyone better off and worse, in their arrogance that they can, the ignorance they do not acknowledge, or in the pursuit of a particular interest group's support, they often create new problems or exacerbate other ones in the process of "helping".

Harvard's Jeff Frankel recently cited an example of this phenomenon provided by his colleague Jeff Liebman, an expert on how the federal government's welfare assistance programs intended to help those in need instead effectively trap people into dependence (we've added the links and inserted paragraph breaks for improved readability):

Despite the EITC and child credit, the poverty trap is still very much a reality in the U.S.

A woman called me out of the blue last week and told me her self-sufficiency counselor had suggested she get in touch with me. She had moved from a $25,000 a year job to a $35,000 a year job, and suddenly she couldn’t make ends meet any more. I told her I didn’t know what I could do for her, but agreed to meet with her.

She showed me all her pay stubs etc. She really did come out behind by several hundred dollars a month.

She lost free health insurance and instead had to pay $230 a month for her employer-provided health insurance.

Her rent associated with her section 8 voucher went up by 30% of the income gain (which is the rule).

She lost the ($280 a month) subsidized child care voucher she had for after-school care for her child.

She lost around $1600 a year of the EITC.

She paid payroll tax on the additional income.

Finally, the new job was in Boston, and she lived in a suburb. So now she has $300 a month of additional gas and parking charges. She asked me if she should go back to earning $25,000.

I told her that she should first try to find a $35k job closer to home. Also, she apparently can’t fully reverse her decision to take the higher paying job because she can’t get the child care voucher back (the waiting list is several years long she thinks).

She is really stuck. She tried taking an additional weekend job, but the combination of losing 30 percent in increased rent and paying for someone to take care of her child meant it didn’t help much either.

We now see that between all the phaseouts of welfare benefits she had been receiving and the higher taxes that resulted from her taking on a job paying a higher income, which would incidentally place her roughly at the U.S.' 50th percentile for household income (scroll to the bottom of our post from yesterday for confirmation!), this mother faced exorbitantly high and punitive marginal tax rates in taking on a job that paid just $10,000 more than she made before. In fact, Liebman estimates she faces an effective marginal tax rate increase of 130% for having traded up to that $35,000 per year job.

And it was all done by government programs designed and intended to help people with low incomes! Government programs all designed, implemented and executed by elected politicians and government bureaucrats, who never considered that what they were doing could make the people they were trying to "help" so much more worse off. And because of their inherently limited knowledge and focus, negative outcomes like this situation are virtually guaranteed to occur.

It's a recurring problem that begs a solution - one that can overcome the overreaching belief of politicians and elected bureaucrats in their own competence and ability to effect positive change. Econlog's Arnold Kling has provided a bit of a starting point in considering how to effectively resolve the problem:

The problem is that when a poor person starts earning income, he or she loses eligibility to a variety of in-kind benefits, especially Medicaid.

In my view, the key to changing this is to change the default measurement of income from "only count cash income" to "include in-kind benefits as income." A cynic could say that those who prefer to ignore in-kind benefits do so in order to overstate poverty.

But the consequences are real. Because so many subsidies and benefits are phased out or cut off on the basis of cash income, the effective marginal tax rates on poor people are enormous.

The sensible approach is to include in-kind benefits as income. Then, in order to avoid an across-the-board cut in benefits, you would raise the cut-off and phase-out points be several thousand dollars, to allow for the effect of including in-kind benefits in income.

Arnold's argument that the full dollar value of public assistance welfare benefits that an individual receives should be taken into account when determining how much that person is effectively taxed is compelling. As elected politicians and government bureaucrats have consistently proven incapable of coordinating the assistance programs they implement, the taxes they demand and the real needs of the people trapped in an ineffective system, it's an issue that we'll be exploring in the very near future.

We figure that someone had better. Otherwise, all we'll get is more poorly considered policies sold under the banner of hope and change that can never deliver on an ultimately empty promise.

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