Public policies designed to help unskilled workers sometimes have unintended consequences. For example, several public assistance programs intended to assist people with few marketable skills actually impose extremely high penalties when earnings rise. That is, as a family’s income increases beyond a certain point, most or all of their benefits from the support program are lost because program “marginal tax rates” are high. That is, for each additional (or marginal) dollar earned, program benefits fall by a substantial amount, sometimes by even more than the single dollar earned. This can discourage family members from working, or working full-time. An extreme example of this “earnings penalty” is the loss of Medicaid health insurance benefits. Prior to the 1987 expansions of Medicaid eligibility for children, a family would lose all its Medicaid benefits if its income increased beyond the welfare qualification threshold. Common sense tells us that such severe earnings penalties may deter unskilled individuals from entering the workforce or working their way up to higher paying jobs.
In this study, Dr. Aaron Yelowitz, an economist at UCLA, examines the effects of Medicaid reform on the work incentives and earnings of welfare recipients. Using ten years of Current Population Survey data, Dr. Yelowitz finds that the prospect of losing Medicaid benefits in fact discouraged labor force participation. In addition, he finds that the expansion of Medicaid eligibility for children in poverty helped to increase employment and to reduce welfare dependency by lowering extremely high marginal tax rates on poor families.
The results of Dr. Yelowitz’s research provide a beacon for policymakers to use in shaping current public policies in light of the massive changes in U.S. welfare law over the past four years. By passing the Personal Responsibility and Work Opportunity Reconciliation Act in 1996, Congress recognized the value of work for able-bodied citizens. As welfare law evolves, policymakers must keep a careful watch on program features that can discourage the poor from entering the workforce or undermine the financial assistance such programs are intended to provide.
The “Earnings Up/Income Not” Dilemma
Dr. Yelowitz explains the hurdles encountered when individuals move from welfare to work, focusing particularly on the high marginal tax rates that encourage welfare dependency. Policymakers attempting to help the poor have created various assistance programs without fully appreciating their ancillary effects.
Low-income families often collect cash, tax credit or in-kind benefits from Food Stamps, the Earned Income Tax Credit (“EITC”), Medicaid and other public programs. As Dr. Yelowitz’s new research shows, when a family increased its earnings from employment wages, EITC benefits first increased, then leveled off, and finally phased out. Increased earnings also triggered increased Social Security and other tax burdens along with reductions in government transfers from Food Stamps and AFDC.
Until 1987 the income eligibility limit (the maximum income allowable to receive benefits) for Aid to Families with Dependent Children (“AFDC”) was effectively the same as the income limit for Medicaid. This meant that at a predefined level of earnings, both AFDC and Medicaid benefits were lost. Losing Medicaid abruptly created a large and negative “notch” in income realized from work, totaling several thousand dollars. Because of this notch problem, a welfare recipient who increased her earnings above the income limit would actually make her family worse off than before. The notch contributed to keeping families dependent on welfare and discouraged the movement of welfare recipients into the workforce.
Without the benefit of Medicaid expansions, a family in 1996 increasing its earnings from $9,000 to $10,000 would lose their Medicaid benefits. Losing Medicaid and other benefits combined with increased tax liability would cause the family to lose $2,863 of income. Medicaid expansions effectively postponed the loss of $1,838 of income until earnings reach over $17,000 for families eligible for the expansions. Even with the expansions, however, both families stand to have a lower total income at $20,000 in earnings than they had at $9,000 in earnings.
Alleviating the Earnings Penalty — The Effects of Expansion
In 1996, the federal government reformed the AFDC program, requiring many welfare recipients to find and keep a job. Dr. Yelowitz studied those most likely to be affected by welfare reform, a sample consisting of working-age female household heads with at least one child present. A substantial fraction of working-age females (70%) participated in the labor force (as either employed or seeking employment). Among those who failed to finish high school, only 43% were in the labor force, far less than the 78% of high school graduates who were employed or seeking jobs. High school dropouts were also more than twice as likely to collect AFDC benefits compared to high school graduates. Considering that many welfare recipients are now “on the clock,” moving the least skilled among them into the workforce has become the primary challenge of welfare reform.
Medicaid eligibility expansions were some of the first steps taken to facilitate recipients working their way off welfare. The Medicaid notch and high earnings penalties in other programs led many welfare recipients to limit their work activities for fear that they would lose cash, in-kind or health insurance benefits. Dr. Yelowitz’ study assesses the success of these Medicaid reforms to promote work over welfare.
Dr. Yelowitz found that the Medicaid expansions led to more people working and fewer people receiving welfare. Specifically, he concluded that expansions of Medicaid led to a 1.58 percentage point increase in labor force participation. His research also found that eligibility expansions led to a 2.03 percentage point decline in the AFDC participation rate, a drop of 6.3%. The positive labor market effects of eligibility expansions led to a sizable decrease of 1.8 percentage points in the percentage of family income coming from cash public assistance.
Some families were helped more than others. Raising the Medicaid income limits led to a 10% drop in AFDC caseloads from 1987 to 1996 for those with more education. Among those with less education – 54% of whom were on AFDC – the decrease in welfare participation was much less striking, only 0.3 percentage points. These results suggest that policymakers must be particularly attentive to the challenges (and unintended consequences) facing the lowest-skilled individuals — the very ones most likely to remain on welfare today.
Welfare reform has led to millions of welfare recipients leaving public assistance rolls. Unfortunately, those that remain are generally thought to be the least skilled and hardest to employ. It is difficult to justify policies that erect any barrier to employment for this group, such as an arbitrary income cap to programs such as Medicaid. Dr. Yelowitz’s research addresses the severe earnings penalties created by one program, and shows how reducing or eliminating such penalties has a positive effect on workforce participation and welfare dependency.