Policy Analysis No. 41

The Tightening Grip of the Poverty Trap

By Arthur Laffer
August 30, 1984

Executive Summary

Over the past 16 years, a “safety net” has been created for the disadvantaged and unemployed in our society. Food stamps, rent subsidies, medical care, and direct income supplements in the form of Aid to Families with Dependent Children (AFDC) are available to alleviate the worst hardships of poverty. Since 1968 transfer payments to persons have increased more than sevenfold, to $403 billion; even after adjusting for inflation, transfer payments have more than doubled in this period. Although much of this increase has occurred in Social Security and other government-funded retirement programs, the growth in transfer-payment programs aimed specifically at the poor and disadvantaged tells much the same story. In 1983 expenditures for AFDC, food stamps, and the like [1] totaled $105.6 billion — nearly three times the amount in constant dollars spent in 1968 (figure 1).

Nonetheless, in the government’s persistent effort to achieve parsimony in conjunction with fairness and equity, each of these programs has stringent criteria for its recipients. For people who receive AFDC, for example, there is an income test that, after four months, reduces this benefit, dollar for dollar, on any earned income above $75 per month. AFDC benefits can be sheltered from this 100 percent tax by expending the same amount in earned income on child care. Similar means test and income test strictures apply to recipients of food stamps, housing subsidies, unemployment compensation, and the like. These criteria of eligibility are designed to ensure that only the truly needy receive the help they so desperately lack. Excluding people in progressively higher income groups means that funds are not squandered on those who are less in need.

Although these means, retirement, income, unemployment, and other needs tests may be rationalized on both moral and budgetary grounds, they have marked adverse effects on the economic incentives of the poor. When combined with payroll and income taxes, the phased reduction of welfare benefits means that spendable income actually rose very little as gross wages increased to $1,600 per month (at least in our Los Angeles case study). With the tightening of eligibility requirements for food stamps and AFDC by the Reagan Administration spendable income (total spending power) actually declines as gross wages rise to $1,300 per month.

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Arthur B. Laffer is Charles B. Thornton Professor of Business Economics at the University of Southern California.