Title: Government spending on cash welfare is relatively modest 1'7% of the federal budget'
1Introduction
- Government spending on cash welfare is relatively
modest 1.7 of the federal budget. - Yet the programs generate controversy because it
is thought, by some, that welfare is responsible
for many social ills. - The welfare systems greatest cost is the human
cost to the poor. In the name of compassion we
have funded a system that is cruel and destroys
families. Newt Gingrich.
2Why redistribute income?
3Why Redistribute Income?
- The socially efficient outcome of a nations
economy does not necessarily maximize a nations
social welfare function. - Social returns if people are credit constrained
and unable to invest in themselves - Democracymoney buys influence, increases rent
seeking - May be easier to get efficient policies if can
compensate losers - Winner-takes-all may generate rent seeking
- More unequal countries have lower growthwhy?
4FACTS ON INCOME DISTRIBUTION IN THE UNITED
STATESRelative income inequality
- We can think about the distribution of income in
either a relative sense or an absolute sense. - Relative income inequality is the amount the poor
have relative to the rich. - This is illustrated in Table 1 for the United
States, over time.
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7Facts on income distribution in the United
StatesAbsolute deprivation and poverty rates
- The poverty line is the federal governments
standard for measuring absolute deprivation. - The poverty line was developed in 1964 by Molly
Orshansky, an employee of the Social Security
Administration. - She started with nutritional standards for a
minimally acceptable diet, and applied average
national food costs to price out the cost of
buying this bundle. - Then, using the fact that the average family
spent about one-third of their after-tax income
on food, she multiplied the food bundle by 3. - That is how the poverty line came to be. It has
been updated for inflation for the last 40 years.
8Facts on income distribution in the United
StatesAbsolute deprivation and poverty rates
- The poverty thresholds for 2004 are shown in
Table 3. - They increase with family size, but reflect the
economies of scale in home production.
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11Problems inpoverty line measurement
- Although the poverty line is a mainstay in U.S.
public policy, there are numerous criticisms
12Problems inpoverty line measurement
- Income definition incomplete.
- Uses cash income only.
- Ignores non-cash transfers like Medicaid, food
stamps, and public housing. - Ignores job related expenses like childcare.
- Ignores taxes.
- Bundle has changed.
- Cost of living differences are ignored
13WELFARE POLICY IN THE UNITED STATES
- The welfare reform law, known as the Personal
Responsibility and Work Opportunity
Reconciliation Act (PRWORA) was signed into law
in 1996. - It dramatically changed the delivery of welfare
in the United States.
14WELFARE POLICY IN THE UNITED STATES
- Instead of receiving matching grants, state
governments now received lump-sum block grants. - With this flat payment, states were given broad
latitude to redesign their welfare system. - In addition, work requirements and time limits
were imposed on welfare recipients. - The welfare caseloads declined dramatically, as
shown in Figure 1.
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16WELFARE POLICY IN THE UNITED STATES
- Two main ways to determine who is eligible
- Categorical welfare means welfare programs are
restricted by some demographic characteristic. - Single motherhood or disability are examples.
- Means-tested welfare are welfare programs that
are restricted only by income and asset levels. - For example, programs that restrict eligibility
to those under 100 of the poverty line.
17WELFARE POLICY IN THE UNITED STATES
- Two main ways redistribution is conducted
- Cash welfare are welfare programs that provide
cash benefits to recipients. - In-kind welfare are welfare programs that deliver
goods rather than cash to recipients. - Medical care, food, and housing are all examples.
18Welfare policy in the United StatesCash welfare
programs
- The two major cash welfare programs are Temporary
Assistance to Needy Families (TANF) and
Supplemental Security Income (SSI). - A third program, administered through the tax
code, is the Earned Income Tax Credit (EITC).
19Welfare policy in the United StatesCash welfare
programs
- Aid to Families with Dependent Children (AFDC)
was begun in 1935 to support widows and orphans.
As family structure changed, the program focused
largely on mothers who were either divorced or
never-married. - In 1996, TANF replaced AFDC.
- Expenditure on TANF, 25.5 billion, is about ten
times smaller than that on Medicare, and almost
twenty times smaller than that on Social Security.
20Welfare policy in the United StatesCash welfare
programs
- The benefit guarantee is the cash welfare benefit
for individuals with no other income. - This varies across states, from 170 per month in
Mississippi to 923 per month in Alaska. - Payments too low to move a family out of poverty.
21Welfare policy in the United StatesCash welfare
programs
- The actual benefit is reduced as income
increases. - The benefit reduction rate is the rate at which
benefits are reduced per dollar of other income
earned. - This is essentially a tax rate on earnings.
- The tax rate tends to be very high, in the
neighborhood of 50-100.
22Welfare policy in the United StatesCash welfare
programs
- The federal government provides block grants to
states to finance the program. - The federal government also imposes
- Time limits Lifetime limit of 60 months on
welfare - Work requirements Individuals must work after
receiving, at most, 24 months of TANF benefits. - Federal government requires that half of states
TANF caseload must be working at any point in
time (but there are some loopholes).
23Welfare policy in the United StatesCash welfare
programs
- SSI provides welfare to the aged, blind, and
disabled. Expenditure was 31.6 billion in 2002. - It essentially fills in some of the holes created
by Social Security and Disability Insurance, by
allowing those who have insufficient work
experience to smooth consumption. - Both adults and children can qualify.
- Most of the growth in SSI has been because of the
disabled population, especially disabled children.
24Welfare policy in the United StatesIn-kind
programs
- There are also numerous programs that provide
in-kind assistance, including - Food Stamps (24.1 billion 2002)
- Nutritional programs (WIC, School lunch) (12.8
billion) - Public Housing Projects/Section 8 vouchers (32
billion) - Medicaidlargest 250 billion (10x TANF)
25THE MORAL HAZARD COSTS OF WELFARE POLICY
- Prominent economist Authur Okun once compared the
process of income redistribution to a leaky
bucket we are carrying money from the rich to
the poor, but some money leaks out along the way. - Redistribution comes with potentially large moral
hazard costs. The social welfare function
quantifies the efficiency-equity tradeoff between
less redistribution and more social efficiency,
and more redistribution and less social
efficiency.
26THE MORAL HAZARD COSTS OF WELFARE POLICY
- The leakage from transfers comes from
- Administrative costs.
- Taxation on higher income individuals may affect
their labor supply and savings. - By insuring against being poor, the programs
create an incentive for individuals to become
poor in order to qualify for the transfers.
27The moral hazard costs of welfare policyMoral
hazard effects of a means-tested transfer system
- Actual welfare benefits are related to program
parameters through the following equation - Where B stands for actual benefits received, G is
a benefit guarantee level, ? is the benefit
reduction rate, w is the hourly wage rate, and h
is hours worked.
28The moral hazard costs of welfare policyMoral
hazard effects of a means-tested transfer system
- Setting actual benefits equal to zero results in
the break-even formula the income level where
welfare eligibility ends - Thus, with a guarantee of 300 and tax rate of
75, earnings of 400 reduces the welfare benefit
to zero and removes the person from welfare.
29The moral hazard costs of welfare policyMoral
hazard effects of a means-tested transfer system
- In principle, setting G equal to the poverty line
(with, say, J1.00) would eliminate poverty. - The Current Population Survey suggests that such
a policy would cost 98 billion, a concept known
as the poverty gap. - Yet such an exercise does not account for the
moral hazard effects of such a policy.
30Solutions to the Moral Hazard Problem
- Lower the benefit reduction rate.
31Solutions to Moral HazardLowering the benefit
reduction rate
- Although such a policy ameliorates the work
disincentives relative to higher tax rates for
some people, it potentially exacerbates the work
disincentives for others. - This is because the breakeven level to qualify
for welfare goes up when the tax rate is lowered. - The net impact depends on the relative sizes and
preferences of the different consumers.
32The moral hazard costs of welfare policyThe
iron triangle of redistributive programs
- The iron triangle there is no way to
simultaneously encourage work, redistribute more
income, and lower costs. - If the tax rate is lowered, work could be
discouraged for some and costs could go up. - If the guarantee is lowered, work increases and
costs fall, but redistribution falls.
33REDUCING THE MORAL HAZARD OF WELFARE
- Main problem of moral hazard is redistribution
based on voluntary characteristics - Government cannot observe an individuals
earnings capacity - Any other policy design that can overcome moral
hazard problems?
34REDUCING THE MORAL HAZARD OF WELFARE
- Other policy instruments
- Moving to categorical welfare payments
- Using ordeal mechanisms
- Increasing outside options
35Reducing the moral hazard of welfareMoving to
categorical welfare payments
- There are some characteristics that are easy to
verify, hard to change, and related to low
earnings. - For example, being blind limits a persons job
opportunities and individuals are unlikely to
change their behavior to qualify. - This type of targeting categorical welfare
payments can overcome the iron triangle.
36Reducing the moral hazard of welfareMoving to
categorical welfare payments
- What characteristics make a good targeting
mechanism? - Characteristics that are unchangeable.
- Characteristics that target those with low
earnings capacity. - In reality, welfare programs target
characteristics like blindness, age, disability,
and single motherhood.
37Reducing the moral hazard of welfareMoving to
categorical welfare payments
- Does single motherhood meet these two criteria?
- Low earnings capacity poverty rates for single
parent families exceed 33. - Is single motherhood is unchangeable? Does it
respond to welfare payments? - Figure 5 shows the time-series correlations.
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39Reducing the moral hazard of welfareMoving to
categorical welfare payments
- Although single motherhood and welfare generosity
rose together during the 1960s, welfare benefits
fell thereafter while single motherhood continued
to rise. - This appears true for within-state comparisons
over time. - The consensus from existing research is that this
effect is, at most, very small.
40Reducing the moral hazard of welfareUsing
ordeal mechanisms
- An alternative approach is to try get individuals
to reveal themselves as less able through ordeal
mechanisms. - Ordeal mechanisms are features of welfare
programs that make them unattractive, leading to
self-selection of only the most needy recipients. - If the system was set up such that high-ability,
lazy individuals find the system unattractive,
they self-select out of welfare.
41Reducing the moral hazard of welfareUsing
ordeal mechanisms
- Work or training requirements of TANF
- In kind benefits
- Stigmatizing welfare programs
- Food stamps that are redeemed in public at a
supermarket. - Waiting in lines at public welfare offices.
42Reducing the moral hazard of welfareIncreasing
outside options
- The third approach to reducing moral hazard is to
increase the outside options available so that it
is no longer as attractive to be on welfare.
43Reducing the moral hazard of welfareIncreasing
outside options
- There are five different approaches the
government can take to increase outside
opportunities for welfare recipients - Training
- Labor market subsidies
- Child care
- Child support
- Removing welfare lock
44Reducing the moral hazard of welfareIncreasing
outside options
- Another approach is to directly subsidize wages.
- One fairly expensive, broad approach is the
Earned Income Tax Credit. - An alternative is targeted wage subsidies to
those on welfare. This runs into the problem
that it does not help those who are reluctant to
go on welfare, and could also have entry
effects for those who did not intend to go on
welfare.
45Reducing the moral hazard of welfareIncreasing
outside optionswelfare lock
- Cash welfare is often linked with other programs.
- Until the mid-1980s, Medicaid was restricted to
those on AFDC cash welfare. Leaving welfare
entailed the entire loss of the health insurance. - Medicaid notch marginal tax rate on earnings
is far in excess of 100. - Uncoupling health insurance from cash welfare
could therefore lead to exits from cash welfare. - Empirical evidence is mixed on the actual
effects.
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46WELFARE REFORMChanges due to welfare reform
- The 1996 legislation, PRWORA, made many changes
to the welfare system. These include - Block grants to states rather than open ended
entitlements. - Greater freedom for states to experiment with
program rules. - Time limited benefits.
- Work requirements.
- New efforts to limit unwed motherhood.
47Welfare reformEffects of the 1996 welfare reform
- As illustrated earlier, welfare caseloads fell
dramatically - On a national basis, caseloads fell more than
50. - Some states experienced reductions of more than
80. - Empirical evidence suggests one-third of the
decline was from welfare reform, but other
factors, like the growing economy, also played an
important role.
48Welfare reformEffects of the 1996 welfare reform
- Welfare reform was a windfall to the states,
because their block grant was based on welfare
expenditure in 1994, when caseloads were very
high. - Some states used the windfall to subsidize
pro-work policies, like subsidized childcare.
49Welfare reformEffects of the 1996 welfare reform
- A key question about welfare reform is how it
affected the income and well being of single
mothers. - Most single mothers have not seen a drop in their
consumption there was a large increase in labor
supply at the same time that caseloads were
declining. - Some subgroups, mainly low skilled single
mothers, have suffered a decline, however.
50Welfare reformEffects of the 1996 welfare reform
- Was welfare reform a success?
- They have reduced the welfare rolls without
lowering incomes of single mothers. - Yet, success in the long run also depends on
- The distribution of income, not just the average.
- The reduction in utility from reduced leisure.
- Whether the block grants will work well during
recessions. - The long run effects on children in these
families.