That’s a question that anyone who benefits from any government assistance program has to answer whenever they reach a key income threshold that is tied to the value of benefits they receive, where they risk losing the benefits they have been getting even if they earn as little as one dollar more than that threshold.
This situation is called the “welfare trap” because it effectively traps people on welfare programs once they become dependent upon them for a significant portion of their income. Here, people who work to increase their income will face a marginal tax rate of much more than 100% because the value of the benefits they lose is much greater than the extra income they earn above the amount that triggers the loss of benefits.
Today’s example of the welfare trap in action is provided by ValuePenguin, a consumer finance web site that develops data-based analysis to help its readers make sound decisions for themselves. Here, they’ve considered the incentives that people whose incomes threaten to rise above the levels at which the U.S. government will provide subsidies to buy health insurance on their state’s exchange as part of the ObamaCare law:
Since the subsidies are only available to those purchasing insurance through the state exchange, the issues with the cliff will apply only to that same group. Within this group, it will take effect for households with incomes near 400% of FPL.
If your income is at or below the above 400% FPL figure for your household size, the government will subsidize your healthcare so that you spend no more than 9.5% of your income. Earn a dollar above the 400% FPL threshold and the subsidies disappear completely. This obviously creates a problem! If insurance costs substantially more than the capped premium for your family, that extra dollar may actually cost your household a huge amount in actual dollars.
CNBC summarizes ValuePenguin’s analysis of what the impact would be for a family of three who are unfortunate enough to go from earning $78,120 to $78,121:
In New York, a family of three whose annual income totals $78,120, would pay $12,784 for the second-lower-priced silver plan on that state’s insurance exchange. After getting a $5,363 tax credit, the family’s net cost for the insurance would be $7,421.
But if the family earned even slightly more than $78,120, they would have to pay the entire $12,784 for the insurance because they then wouldn’t qualify for the subsidy.
That extra $1 then effectively costs a family in this situation $12,784. If they decide to buy health insurance.
The other incredibly perverse incentive in the ObamaCare law is that the penalty for not having health insurance in 2014 is only $95, and they could still get health insurance within just 90 days after applying for it if they actually decide they need it. If you were this family, and you believe your family members won’t need much medical care in the next year, what would you choose to do?
Office of the Attorney General, State of Kentucky