Social assistance and the cycle of poverty

A question from Yahoo! Answers:

Why do social programs such as welfare, keep citizens in a cycle of poverty?

In and of themselves, they don’t. The circle of poverty is perpetuated by the combination of welfare and tax penalties for people who try to get off it.

About 10 years ago, German economist Christian Thimann wrote a very informative article about how German social assistance system operates. Here’s a lengthy quote:

Social assistance benefits are adjusted with changes in net monthly earned income (gross income less social security contributions, taxes, and an allowance for employment expenses equivalent to around 10 percent of gross income), as follows:

  • Less than DM 130: workers are entitled to receive full benefits.
  • Between DM 130 and DM 1,000: social assistance payments are reduced by 85 percent of additional net income. In other words, a DM 100 increase in net earnings raises disposable income by only DM 15 — an implicit tax rate of 85 percent.
  • Between DM 1,000 and DM 1,150: social assistance payments are reduced by the full amount of the increase in net income, and the implicit marginal tax rate is 100 percent.
  • More than DM 1,150: workers are no longer eligible for social assistance.

In other words, getting off welfare in Germany carries a substantial tax penalty. Similar penalties exist in other developed nations. In the U.S., a mildly successful attempt was made to lessen (although not to get rid of) this penalty through introduction of Earned Income Credit…

Source:

Christian Thimann, “Germany’s Social Assistance Program: The Dilemma of Reform”, Finance and Development, Volume 33, Number 3 (September 1996):
http://www.worldbank.org/fandd/english/0…

Added on December 8, 2007:

Effective marginal tax rates for at least some people getting off welfare may be much higher than 100% in the U.S., as getting off welfare may mean losing health coverage for dependent children…

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