Monday, March 3, 2008

The Poverty Trap and how to Overcome It

The poverty trap occurs when people have little or no incentive to get a better paid job or work longer hours. (not to be confused with unemployment trap where there is no incentive to get a job at all.)

In the UK, there are a wide range of benefits. It is estimate that 5 million people receive some kind of government benefits and these benefits may create a disincentive to get better paid jobs

The poverty trap occurs due to benefits such as income support, housing benefit, single parent allowance and family tax credit. If somebody got a better paid job they would lose benefits and pay more tax (income tax and NI. Therefore, their take home pay may be the same as before.

Policies to reduce poverty trap

1. Reduce benefits.

If benefits are reduced or abolished, such as income support there is a greater incentive to get a better paid job. However,
This may increase relative poverty as the low paid will get lower incomes compared to the rest of the population.
It may cause the unemployment trap. It will reduce the gap between unemployment benefits and low paid work.

2. Have a Graded system of Benefits.

This means that if your income increases you still get some benefits. There isn't an immediate cut off point, but, there is still an incentive to work longer hours and get a better paid job.

3. Increase the Income Tax Threshold.

This means that you increase the amount of income that you can earn before you start paying any tax. At the moment, it is around £5,000. Increasing this limit gives a greater incentive to work and earn more.

4. Increased Minimum Wages.
A higher minimum wage helps to make work more attractive. However, if it is too high it might cause a rise in unemployment. However, the increase in the UK minimimum wages since '97 has not caused unemployment

5. Family Tax Credits - graded benefits for those in work. It leads to lower tax bills and is graded to avoid any disincentives of working harder.

6. Make it harder to get sickness and disability to benefits.

It is argued that many people who are on sickness and disability benefits would be able to do some types of jobs. In some cases, sickness benefit has been seen as an alternative to being on unemployment benefit. But, because it is attractive to remain on sickness benefit there is a disincentive to work.

It is a difficult situation, with a conflict between the need to give workers the proper incentives and the importance of avoiding unfair treatment of the low paid.

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