UK Welfare Trap

Standing in line marking time
Waiting for the welfare dime
'Cause they can't by a job
--Bruce Hornsby

Prof John Cochrane shares more data on marginal taxes associated with welfare benefits (other recent posts here and here). On both carts the horizontal axis denotes gross (i.e., before tax) annual wage income from work and the vertical axis shows after tax annual income from both work and welfare benefits. At current conversion rates, 5000 pounds equals about $8000.

The first chart, representing single workers 25 yrs of age or younger, indicates virtually no reward for 7500/ pounds per yr of gross wages. Approximately 84% of the wages are lost in welfare benefit withdrawals. The way to think about this on the chart is that the flatter the line, the less additional after tax income is gained from more gross wage income.

The second chart, representing single parents with two kids, indicates virtually no reward for work below 5000 pounds/yr of gross wages. Then, after a work tax credit kicks in at about 5000, then a subsequent marginal tax rate of 70-95% for the remainder of the wage horizon. There is little point in taking on incrementally more work past 5000 pounds per yr.

As Cochrane notes, most UK benefits are not time sensitive. Thus, the poverty trap gets passed down thru generations.

Thought provoking example of how disincentives drive productivity (and standard of living) into the gutter.