15.2 The Poverty Trap

3 min readLast Updated on June 24, 2024

Government assistance programs aim to help those in need, but they can create unintended consequences. These programs sometimes discourage work by reducing benefits as income rises, leading to poverty traps where earning more results in a net loss of resources.

Antipoverty initiatives face challenges like cliff effects and high benefit reduction rates. These issues can create disincentives to work or advance in careers. Understanding how these programs affect budget constraints helps explain why some people might rationally choose to remain in poverty.

Government Assistance, Poverty Traps, and Welfare

Work Incentives

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  • Government assistance programs can create disincentives to work
    • Means-tested programs reduce benefits as income rises discouraging employment (Medicaid, SNAP)
    • High marginal tax rates on earned income for low-income households effectively penalizes work
  • Poverty traps occur when the structure of assistance programs makes it difficult for recipients to escape poverty
    • Earning additional income may result in a net loss due to reduced benefits and increased taxes creating a financial disincentive to work
    • This creates a rational choice to remain in poverty to maximize overall resources such as housing subsidies and cash assistance
  • Work incentives are diminished when the marginal benefit of working is low or negative
    • Effective marginal tax rates can exceed 100% in some cases meaning each additional dollar earned results in a net loss of income
    • This discourages labor force participation and advancement trapping individuals in low-wage jobs or unemployment

Antipoverty Initiatives

  • Eligibility thresholds can create cliff effects
    • Sudden loss of benefits at certain income levels (TANF, EITC) creates a disincentive to earn above the threshold
    • Discourages earning income above the threshold to avoid losing critical support
  • Benefit reduction rates may be too high
    • Rapid phaseout of benefits as income rises (SNAP, housing assistance) can result in net income loss for each additional dollar earned
    • Creates high effective marginal tax rates discouraging work and advancement
  • Lack of coordination among programs
    • Multiple programs with different eligibility criteria and benefit structures (Medicaid, TANF, SNAP) can lead to confusion and difficulty navigating the system
    • Can lead to unintended interactions and perverse incentives such as discouraging marriage or asset accumulation
  • Insufficient support for transitioning to self-sufficiency
    • Limited resources for job training, education, and childcare make it difficult for recipients to acquire skills and advance in the workforce
    • Makes it difficult for recipients to acquire skills and advance in the workforce perpetuating dependence on assistance

Budget Constraints

  • Budget constraint shows the tradeoff between leisure and consumption
    • Leisure on the horizontal axis, consumption on the vertical axis representing the combination of goods and services an individual can afford
    • Slope of the budget constraint represents the effective wage rate or the opportunity cost of leisure
  • Welfare programs shift the budget constraint
    • Means-tested benefits increase consumption at low levels of work effectively raising the intercept of the budget constraint (TANF, SNAP)
    • Benefits phase out as earned income rises, leading to kinks in the budget constraint and a flatter slope at higher income levels
  • High effective marginal tax rates flatten the budget constraint
    • Reduces the slope, making the tradeoff between leisure and consumption less favorable as each additional hour of work results in a smaller increase in consumption
    • Can create a rational choice to reduce work effort when the marginal benefit of work is low
  • Illustrative examples:
    • Scenario 1: No welfare benefits
      • Budget constraint has a constant slope equal to the wage rate
    • Scenario 2: Means-tested welfare benefits with high phaseout rates
      • Budget constraint has a steep slope at low levels of work, then flattens sharply (TANF, SNAP)
    • Scenario 3: Welfare benefits with gradual phaseout and work incentives
      • Budget constraint has a more gradual kink, maintaining a positive slope over a wider range of work hours (EITC)

Term 1 of 18

Budget Constraint Line
See definition

The budget constraint line represents the maximum combination of goods and services that an individual or household can afford to purchase given their income and the prices of those goods and services. It is a fundamental concept in microeconomics that helps analyze consumer behavior and decision-making.

Key Terms to Review (18)

Term 1 of 18

Budget Constraint Line
See definition

The budget constraint line represents the maximum combination of goods and services that an individual or household can afford to purchase given their income and the prices of those goods and services. It is a fundamental concept in microeconomics that helps analyze consumer behavior and decision-making.

© 2025 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.

Term 1 of 18

Budget Constraint Line
See definition

The budget constraint line represents the maximum combination of goods and services that an individual or household can afford to purchase given their income and the prices of those goods and services. It is a fundamental concept in microeconomics that helps analyze consumer behavior and decision-making.



© 2025 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.

© 2025 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.
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