Government attempts to assist household with low incomes face an inevitable practical problem. As income for a household rises, it will be necessary to phase out the government assistance. But what happens if–at least over a certain range of incomes–a previously low-income household that increases its earnings discovers that its government benefits are being decreased by the same amount? In effect, this household faces an effective tax rate of 100%, because any increase in earnings from a job is being 100% offset by a decline in the value of government assistance.
Maybe this scenario sounds hypothetical and extreme, but Elias Ilin and Alvaro Sanchez of the Federal Reserve Bank of Atlanta point out that it holds true for low-income households in Washington, DC. (“Mitigating Benefits Cliffs for Low-Income Families: District of Columbia Career Mobility Action Plan as a Case Study,” NO. 23–1, September 2023, Community and Economic Development Discussion Paper).
This table looks at the situation of a single parent with two children. If the household earns $11,000, it is eligible for the benefits shown in the first column. If the household earns $65,000, then its eligibility for most of these benefits is phased out, as shown in the second column, and the taxes owed by the family rise as well. For those who don’t live and breathe these acronyms: TANF is Temporary Assistance for Needy Families (commonly called “welfare”), EITC is Earned Income Tax Credit, CTC is Child Tax Credit, SNAP is Supplemental Nutrition Assistance Program (often called “food stamps”), WIC is Special Supplemental Nutrition Program for Women, Infants, and Children, FRSP is Family Re-Housing Stabilization Program, LIHEAP is Low Income Home Energy Assistance Program, CCDF is Child Care and Development Fund, CHIP is Children’s Health Insurance Program, and ACA Premium Subsidy refers to the Affordable Care Act passed in 2010.
In passing, it seems appropriate to note that the administrative burden that this group of programs places on low-income households is quite real. Of course, as income levels or life circumstances change, support from these programs shifts as well.
But the main point here is that as household earnings for this D.C. household rises from $11,000 to $65,000, the decline in benefits and rise in taxes almost completely offsets the higher earnings. As the authors write:
[B]etween $11,000 and $65,000 our hypothetical family experiences no overall financial gain from an increase in earnings. … [A]n increase in income from $11,000 to $65,000 results in a complete or partial loss of most of the public assistance programs and tax credits. Paired with an increase in tax liability, these losses fully offset income gains. … We observe that at certain levels of employment income within the $11,000 to $65,000 range the family’s net resources dip. It means that the combined loss of public assistance programs outweighs the gain in income, meaning the family faces benefits cliffs. The first dip occurs at $22,000 when the family loses access to SNAP. A second benefits cliff occurs at $27,000, where the family loses TANF. That is followed by several small benefits cliffs that occur due to the loss of school meals, WIC, federal and state EITCs, Medicaid for Adults, and Medicaid for Children/CHIP. Finally, at $61,000 the last and the largest benefits cliff occurs, which entails a loss of the CCDF childcare subsidy.
The authors call this a “benefit cliff.” I have sometimes called it a “poverty trap” (for example, here and here), because of the work disincentives it provides to poor and near-poor households. There’s no simple way to address this situation. Cutting benefits to low-income households has an obvious downside for those families. Phasing out the benefits more slowly, as income rises, will mean providing benefits to more households and will cost substantially more. Ultimately, I think our society ends up relying on the fact that many low-income households would actually like to be self-supporting, to work, and to avoid or minimize their use of government assistance. But for other low-income households, the work disincentives of the poverty trap will bite.
