“In Defence of Poverty Traps” by Bruce Bradbury
Social Policy Research Centre Conference. Social Policy for the 21st Century
Peter Larose
Senior Economic Advisor
Ministry of Social Policy
In his paper on poverty traps, Bruce Bradbury discussed the difficulties of trying to alleviate unemployment by manipulating the tax/transfer system. Although he offered no firm conclusions, he clearly indicated that policy analysts should be wary of looking for solutions to the failures of the labour market in the tax/transfer system.
Poverty traps occur when an increase in private income leads to a reduction in disposable income. They are generally measured by "Effective Marginal Tax Rates" (EMTRs), which show the loss of income (through taxation and benefit reduction) that occurs for every dollar of additional private income. For people receiving substantial income support payments the "poverty trap" can be particularly severe. Historically this was justified on the grounds that high EMTRS were confined to income regions where there were few people. However, with increased diversity in labour markets (less standard working, more part-time) this assumption is less tenable. In fact, in many cases high EMTRs now extend into income levels where people are working for low wages.
Bradbury suggests that these might better be called "low-wage traps". John Jensen has suggested the term "dependency traps". In Australia (and other countries) policy reforms have attempted to decrease the severity of these "traps". But the reality is that they have simply "re-arranged" the problem. With the introduction of programmes such as Family Allowance (Australia) and Earned Income Tax Credit (USA), EMTRs are lowered for those with very low income, but raised for those with low-medium income. (When the Government provides people with income-tested benefits, eventually they have to abate away.) On the other hand, disposable income is higher for the "working poor" as they have both earnings and benefit income.
Bradbury concludes, "there are no easy solutions to the dilemmas illustrated by these examples". Reductions in dependency traps at one point must be associated with higher EMTRs elsewhere. The question is: Is it best to spread the burden around or keep it confined? The literature is mixed, Bradbury believes it comes down to balancing equity/efficiency arguments:
- If we are most concerned with the incomes of the poorest, the higher benefit level associated with high EMTRs is optimal. The poverty traps imposed upon these beneficiaries "ensures a targeting of scarce resources on the poorest and permits a reduction of EMTRs for low-wage workers".
- If we are most concerned with efficiency and work incentives, then we will want to keep EMTRs as low as feasible for as many as possible and spread the benefits across a wider income range.
Interestingly, Bradbury also argues that since most beneficiaries are compelled to search for work (while low-wage workers do not face this compulsion) the labour supply distortions are minimised. I would question the political ramifications of forcing people to work while imposing EMTRs of 100%.
The bottom line is that there is no silver bullet, only a need to balance equity/efficiency concerns. But he hints that Australia may have gone too far (and over-promised).
