How public programs can penalize workers earning more

Aayush Goodpaty

Aayush Goodapaty is an intern with Illinois Policy Institute. He is a rising fourth-year at The University of Chicago where he is majoring in Economics and History.

Aayush Goodpaty
June 25, 2024

How public programs can penalize workers earning more

Families trying to escape poverty are sometimes worse off with greater incomes because of benefits cliffs hidden in public programs.

Chicago’s poverty rate stands at 17.2%, higher than before America launched a war on poverty in the 1960’s. Why? One key factor is the perverse incentives created by “benefits cliffs.”

What is a benefit cliff?

The Institute for Research on Poverty at the University of Wisconsin-Madison defines a benefits cliff as a situation in which even a small income increase triggers “a loss of public benefits equal to or greater than the dollar value of the income increase.” Even a 25 cent per-hour raise can cost vulnerable families thousands a month in lost financial resources.

A benefits cliff punishes working, low-income families by penalizing growth through higher wages. Navigating eligibility for multiple benefits programs can be challenging, creating uncertainty for families and discouraging them from advancing in their careers. Half of lower-income parents reported they turned down higher paying jobs for fear of falling off the cliff and 85% reported experiencing a benefits cliff according to a recent survey.

That has downstream economic effects as well. Benefits cliffs tax work itself for those in poverty. This makes it harder for local businesses to fill needed positions as workers cut back on their hours or reject job opportunities for fear of losing the subsidies they need to make ends meet. An analysis from the Federal Reserve Bank of Atlanta found the benefits cliff discourages many lower-income workers from pursuing a long-term, potentially lucrative career in nursing by financially penalizing individuals in the short-term. This can exacerbate an already precarious shortage of nurses in Illinois.

Benefits cliffs also raise effective marginal tax rates for lower income families. A report from the Institute for Research on Poverty found working families face effective marginal tax rates of, on average, 75% just as they are escaping poverty because of drastic cuts in Temporary Assistance for Needy Families or the Supplemental Nutrition Assistance Program and other programs. Put simply, for every dollar people escaping poverty make, they lose 75 cents on average in benefits. That deprives families of much needed and deserved opportunities.

The worst benefits cliff in Illinois is the Child Care Development Fund. An analysis from the University of Chicago’s Inclusive Economy Lab shows how a family of three, a single parent and two children, in Cook County making $54,000 a year would lose $25,000 in childcare subsidies if their income increased by $1,000. Interviews with low-income mothers and child care administrators reveal many low income families turn down increased wages and hours to avoid falling over this cliff and becoming suddenly unable to care for their children.

As families try and navigate out of poverty, they face benefits cliffs created by safety net programs. Taking a job, promotion, or raise that should be a milestone requires them to forfeit more in childcare, food assistance and subsidized housing than they stand to gain in the short-term.

What is the solution?

Policymakers at the federal, state and local levels must work together to turn well intentioned benefits programs into well designed policy. Local lawmakers can look at pilot programs in cities and counties across the country for inspiration on how to reshape incentives towards embracing opportunities for work rather than turning those away. Meanwhile, Illinois has broad leeway to change funding allocation for benefits programs.

Lawmakers in Springfield can reform its allocation of TANF funding to direct more dollars to families facing benefits cliffs and bring the state closer to the national average. The federal government should reform the Workforce Innovation and Opportunity Act to allow for states to fully implement innovative pilot programs. Together, these reforms to our safety net programs can turn a hand-out into a hand-up.

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