Pearson Edexcel · A-Level · Economics B

    Course version: 9EB0 · Version from Sept 2015

    Re-distribution of income and wealth: b) Incentives and the poverty trap

    Full specification wording

    Re-distribution of income and wealth: b) Incentives and the poverty trap

    The poverty trap occurs when individuals on low incomes face a disincentive to work longer hours or seek higher-paying jobs.

    Checked against the Pearson Edexcel 9EB0 specification (opens in a new tab) on .

    • Point 2 of 3
    • 4 key terms

    Study notes

    From the checked teaching notes for this specification point.

    The idea

    The poverty trap occurs when individuals on low incomes face a disincentive to work longer hours or seek higher-paying jobs. This happens because the combination of income tax and the withdrawal of means-tested benefits results in little or no increase in disposable income, creating a high marginal effective tax rate. For example, if a worker earns an extra £100 but loses £65 in benefits and pays £20 in tax, their net gain is only £15, severely reducing the incentive to earn more. This situation perpetuates relative poverty and limits labour market participation. Governments attempt to mitigate the poverty trap by adjusting benefit withdrawal taper rates, increasing the personal tax allowance, or reforming welfare systems.

    What earns the marks

    • Define the poverty trap as a situation where an increase in gross income leads to little or no increase in disposable income.
    • Explain that the poverty trap is caused by the simultaneous deduction of income tax and the withdrawal of means-tested benefits.
    • Calculate or identify the marginal effective tax rate to demonstrate the disincentive to work longer hours.
    • Evaluate government policies designed to reduce the poverty trap, such as altering the taper rate of universal credit or other benefits.

    Common mistakes and how to put them right

    • Confusing the poverty trap with the unemployment trap.

      Put it right: The poverty trap affects those already in low-paid work seeking to increase hours, whereas the unemployment trap affects those out of work deciding whether to accept a job.

    • Stating that individuals in the poverty trap lose all their income.

      Put it right: They lose a significant proportion of their additional income, not their total income.

    • Assuming that increasing the minimum wage automatically solves the poverty trap.

      Put it right: Higher wages may still be offset by benefit withdrawals and taxation unless the tax and benefit system is reformed.

    Exam tips

    • Use a numerical example to illustrate the poverty trap, showing the net effect of earning additional gross income on disposable income.
    • Clearly distinguish between means-tested benefits, which contribute to the poverty trap, and universal benefits, which do not.
    • Discuss the trade-off between providing an adequate safety net and maintaining incentives to work when evaluating welfare policies.

    Try the lesson

    The start of the Re-distribution of income and wealth: b) Incentives and the poverty trap lesson, made from checked teaching notes for this specification point.

    Have a go first

    Which of the following best defines the economic concept of the poverty trap?

    Listen

    The poverty trap occurs when individuals on low incomes face a disincentive to work longer hours or seek higher-paying jobs. This happens because the combination of income tax and the withdrawal of means-tested benefits results in little or no increase in disposable income, creating a high marginal effective tax rate. For example, if a worker earns an extra £100 but loses £65 in benefits and pays £20 in tax, their net gain is only £15, severely reducing the incentive to earn more. This situation perpetuates relative poverty and limits labour market participation. Governments attempt to mitigate the poverty trap by adjusting benefit withdrawal taper rates, increasing the personal tax allowance, or reforming welfare systems. A strong answer earns marks for these points. Define the poverty trap as a situation where an increase in gross income leads to little or no increase in disposable income. Explain that the poverty trap is caused by the simultaneous deduction of income tax and the withdrawal of means-tested benefits. Calculate or identify the marginal effective tax rate to demonstrate the disincentive to work longer hours. Evaluate government policies designed to reduce the poverty trap, such as altering the taper rate of universal credit or other benefits. A common slip: Confusing the poverty trap with the unemployment trap. Instead, the poverty trap affects those already in low-paid work seeking to increase hours, whereas the unemployment trap affects those out of work deciding whether to accept a job. Exam tip: Use a numerical example to illustrate the poverty trap, showing the net effect of earning additional gross income on disposable income.

    See it

    A top-down flowchart. A worker earning extra gross income leads to two parallel effects: income tax deducted and means-tested benefits withdrawn. Both feed into little or no increase in disposable income, which leads to a high marginal effective tax rate. That leads to a reduced incentive to work longer hours or seek higher pay, which leads to relative poverty being perpetuated and labour market participation limited. Finally, governments respond by adjusting taper rates, raising the personal tax allowance or reforming welfare.
    Shows how income tax and benefit withdrawal combine to leave little or no gain in disposable income, creating a high marginal effective tax rate and a disincentive to work, which governments try to mitigate.

    Key words

    Say what each word means before you turn the card.

    Incentives to work

    Try answering aloud or in your head before turning the card.

    Taxation and benefits

    Try answering aloud or in your head before turning the card.

    Labour market participation

    Try answering aloud or in your head before turning the card.

    Relative poverty

    Try answering aloud or in your head before turning the card.

    See every definition
    Incentives to work
    The motivation to work longer hours or seek higher-paying jobs, which is reduced when extra earnings bring little or no increase in disposable income.
    Taxation and benefits
    The simultaneous deduction of income tax and the withdrawal of means-tested benefits, which together can leave little or no increase in disposable income.
    Labour market participation
    Involvement in work, which the poverty trap limits because earning more brings little or no gain in disposable income.
    Relative poverty
    A situation perpetuated by the poverty trap, in which those on low incomes face a disincentive to earn more.

    Label the diagram

    Some boxes have lost their names. Pick the right name for each number.

    The diagram again, with 3 boxes numbered instead of named. A top-down flowchart. A worker earning extra gross income leads to two parallel effects: income tax deducted and means-tested benefits withdrawn. Both feed into little or no increase in disposable income, which leads to a high marginal effective tax rate. That leads to a reduced incentive to work longer hours or seek higher pay, which leads to relative poverty being perpetuated and labour market participation limited. Finally, governments respond by adjusting taper rates, raising the personal tax allowance or reforming welfare.

    • 1Box 1

    • 2Box 2

    • 3Box 3

    0 of 3 labelled

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