Incentives matter: the government is here to help file

From Greg Mankiw's blog we get a sad story told by economist Jeff Liebman about the incentive effects of government programs aimed at helping the poor:

... the poverty trap is still very much a reality in the U.S. A woman called me out of the blue last week and told me her self-sufficiency counselor had suggested she get in touch with me. She had moved from a $25,000 a year job to a $35,000 a year job, and suddenly she couldn’t make ends meet any more. I told her I didn’t know what I could do for her, but agreed to meet with her. She showed me all her pay stubs etc. She really did come out behind by several hundred dollars a month. She lost free health insurance and instead had to pay $230 a month for her employer-provided health insurance. Her rent associated with her section 8 voucher went up by 30% of the income gain (which is the rule). She lost the ($280 a month) subsidized child care voucher she had for after-school care for her child. She lost around $1600 a year of the EITC. She paid payroll tax on the additional income. Finally, the new job was in Boston, and she lived in a suburb. So now she has $300 a month of additional gas and parking charges. She asked me if she should go back to earning $25,000.

Like so many government programmes the incentives are not what were intended. This woman is trapped by the very schemes set up to help her. The real question is do you do about it? Means-tested benefits have to be phased out at some point and at some time, so how and when? As long as you keep the benefit system in place, its not clear that there is anyway to remove benefits from people and keep the correct incentives in place. Jeff Liebman makes three recommendations, for the US case at least:

First, make child-related tax benefits equal for all families (now they are high at the bottom because of the EITC and high at the top because the dependent exemption is more valuable the higher the tax bracket you are in, and the dip in the middle raises marginal tax rates by 21 percent for a family with two kids — so eliminating the dip would get rid of this 21 percent portion of the effective marginal tax rate). [...] Second, in designing universal health insurance, we need to be very careful not to phase out income-related premium subsidies over the same income range where all of these other benefits are being phased out. Third, implement a delay between income increases and rent increases in section 8 — allow people to save up a bit before they are hit with the rent increase (I believe I read that some states have been trying out something like this recently, but I am not up to date on these policies).

Would these ideas really help? They could mitigate some of the worst aspects of the current system, but the main problem remains, the very system provides strong incentives for people to remain in it.