ncome Maintenance and work Incentives In the simplest possible case, a states welfare program can be characterized by two variables G-the basic grant the individual receives when not working t-the rate at which the grant is taken away when the recipient earns income the tax rate
11 Income Maintenance and Work Incentives • In the simplest possible case, a state’s welfare program can be characterized by two variables: • G – the basic grant the individual receives when not working. • t – the rate at which the grant is taken away when the recipient earns income; the tax rate
ncome Maintenance and work Incentives For example, suppose a state gives a grant of $300, but benefits are reduced by 25 cents for each dollar earned G=300andt=0.25 If the individual earns $500, her welfare benefit is reduced from$300to($300-0.25*500),or$175 Eventually, the person will earn too much money to qualify for any welfare benefit 12
12 Income Maintenance and Work Incentives • For example, suppose a state gives a grant of $300, but benefits are reduced by 25 cents for each dollar earned. – G=300 and t=0.25 – If the individual earns $500, her welfare benefit is reduced from $300 to ($300-0.25*500), or $175. • Eventually, the person will earn too much money to qualify for any welfare benefit
ncome Maintenance and work Incentives Algebraically, the actual benefit received(B)is related to the tax rate(t), welfare grant (G), and actual earnings(B B=g-tE 13
13 Income Maintenance and Work Incentives • Algebraically, the actual benefit received (B) is related to the tax rate (t), welfare grant (G), and actual earnings (E). B = G − tE
ncome Maintenance and work Incentives When benefits fall to zero(B=0), the person is no longer eligible for welfare. This implies E When a welfare system only has two features, G and t, the above equation tells the earnings level where welfare eligibility ends 14
14 Income Maintenance and Work Incentives • When benefits fall to zero (B=0), the person is no longer eligible for welfare. This implies: E G t = • When a welfare system only has two features, G and t, the above equation tells the earnings level where welfare eligibility ends
ncome Maintenance and work incentives · This formula is called the" break-even”|evel. It highlights the fundamental tradeoff in welfare program design Lower tax rates, t, provide better work incentives for welfare recipients, but make more people eligibl For example, with G=300 and t=0. 25, the income eligibility limit is $1200 With a much higher tax rate of 100%, the income eligibility limit is $300 Fewer people qualify with the 100% tax rate, but such a high tax could discourage work among welfare recipients 15
15 Income Maintenance and Work Incentives • This formula is called the “break-even” level. • It highlights the fundamental tradeoff in welfare program design: – Lower tax rates, t, provide better work incentives for welfare recipients, but make more people eligible. – For example, with G=300 and t=0.25, the income eligibility limit is $1200. – With a much higher tax rate of 100%, the income eligibility limit is $300. – Fewer people qualify with the 100% tax rate, but such a high tax could discourage work among welfare recipients