"There are some excellent papers that carefully model how the cumulative effects of the welfare system create a poverty trap. But I don’t think either of these papers includes all of the factors facing the woman above — so they would probably indicate that she faced a 60 percent marginal tax rate rather than the 130% (or whatever it really is) rate that she actually faces.”
The problem is that when a poor person starts earning income, he or she loses eligibility to a variety of in-kind benefits, especially Medicaid.
In my view, the key to changing this is to change the default measurement of income from "only count cash income" to "include in-kind benefits as income." A cynic could say that those who prefer to ignore in-kind benefits do so in order to overstate poverty.
But the consequences are real. Because so many subsidies and benefits are phased out or cut off on the basis of cash income, the effective marginal tax rates on poor people are enormous.
The sensible approach is to include in-kind benefits as income. Then, in order to avoid an across-the-board cut in benefits, you would raise the cut-off and phase-out points be several thousand dollars, to allow for the effect of including in-kind benefits in income.
Jeff Frankel is my oldest friend in the economics profession, and it looks like he has a great new blog.