Incentivizing poor and low-income persons to work and save more

Vijay K. Mathur

Published in Standard-Examiner, October 28, 2012, Ogden, Utah

Means-tested anti-poverty programs determine eligibility based on income and assets. If benefits to able-bodied low income and poor persons are cut in larger proportions of their increasing earnings and assets, it provides a disincentive to earn and save more. Benefit cuts are like a tax on work earnings.

The study by John Karl Scholz, Robert Moffitt and Benjamin Cowan (SMC), Discussion Paper no. 1350-08, September 2008 (www.irp.wisc.edu), cites a study of low-wage single-parent families in New York where benefit cuts were such that their extra dollar earnings, from working between 8 to 35 hours per week, would increase their take home by only 15 cents per dollar earned (a 85 percent cut in income). However, there is also an upside of anti-poverty programs. SMC study investigates the role of social insurance programs and means-tested transfers, including entitlements, in reducing poverty. Assuming no behavioral response, they show these programs do reduce percentage of poor across different family types between 35 percent to 86 percent. The investigators did not want to confound the effect of anti-poverty programs on poverty rates by including behavioral responses. Even though anti-poverty programs have substantially reduced poverty rates, there is still a significant fraction of poor people in the country.

It appears that a large proportion of post transfers residual poverty rates must be due to behavioral responses to programs’ benefit policies. Program benefit cuts are an increasingly larger proportion of increasing earnings and assets, as the above study for New York shows. In addition, more benefits are guided to single parent as opposed to two parent families, thus encouraging formation of single parent families and/or encouraging divorces. The data show that single parent families headed by females have a much higher poverty rate than two parent families.

Since benefits and Earned Income Tax Credit (EITC) increase with family size, they tend to encourage more children in a single-parent family. Large family size is another source of hardship for poor families. However EITC, one of the fastest growing means tested program after Medicaid, is a pro-work program. Mr. Romney once remarked that the 47 percent of Americans who do not pay federal income taxes claim victimhood and expect the government to provide these transfers. It includes all those low-income people and poor who receive EITC. The credit provides incentive to work. Therefore, if the credit is taken away, poverty roles will further increase. In fact all means tested poverty programs for able-bodied persons, including food stamps, TANF (Temporary Assistance to Needy Families), housing subsidies and supplemental nutrition program (WIC), should be tailored around the theme of work incentives.

If we are serious about reducing poverty, benefits should increase when able-bodied poor and low-income families earn and save more, until income reaches a threshold level equal to "Basic Needs Budget" (BNB) proposed by National Center for Children in Poverty (NCCP) at Columbia University (www. Nccp.org). NCCP’s budget based income thresholds are higher than the poverty income thresholds defined by the Census Bureau, and vary from high-cost to low-cost cities and types of families. For example, Kinsey Dinan of NCCP (March, 2009) proposed annual income need of $41,000 for a single-parent family with two children in moderate-cost city, Des Moines, Iowa. It is 233 percent of the federal poverty level.

There is another beneficial side effect of pro-work EITC. The study by Gordon Dahl and Lance Lochner (DL), American Economic Review, August 2012, investigates scholastic achievement of children five years old and over due to EITC. They use a data set of 4,500 children from the National Longitudinal Survey of Youth and sample period (1987-2000) and measure family income as total net income, including EITC net of federal and state taxes and transfers. Test scores on PIAT (Peabody Individual Achievement Tests) measure scholastic performance of children. These standardized scores measure ability in mathematics, oral reading, reading comprehension and ability to derive meaning from printed words.

They find that increase in current income due to EITC significantly increases a child’s math and reading scores. Increase in scores is larger for younger children growing up in poor disadvantaged families, such as unmarried households, minority families, families with low-educated mothers. The effects are also more pronounced for boys. These findings are predictive of a better future for poor children and economic well-being of poor families.

Evidence indicates that means tested anti-poverty programs would provide incentives for work if a smaller proportion of benefits were reduced with increase in earned income. Census Bureau’s measures of poverty income are inadequate and hence should be modified along the lines of BNB. Also, benefits should promote education and skills and asset accumulation to put poor families on a sustainable path to economic self-sufficiency and replace programs that subsidize employers such as Work Opportunity Tax Credit. These subsidies do not help fill the skill gap emerging in the labor market due to the changing structure of the economy.

This is the second part of a two-column series by Mathur, who wrote on Oct. 21 about a renewed focus on poverty and entitlements. Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also writes blogs for the Standard-Examiner at http://blogs.standard.net/economics,etc.