Government spending on cash welfare is relatively modest 1'7% of the federal budget'

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Introduction

• 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.

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Why redistribute income?
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Why 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?

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FACTS 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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Facts 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.

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Facts 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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Problems inpoverty line measurement

• Although the poverty line is a mainstay in U.S.
  public policy, there are numerous criticisms

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Problems 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

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WELFARE 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.

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WELFARE 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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WELFARE 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.

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WELFARE 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.

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Welfare 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).

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Welfare 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.

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Welfare 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.

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Welfare 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.

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Welfare 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).

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Welfare 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.

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Welfare 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)

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THE 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.

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THE 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.

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The 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.

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The 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.

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The 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.

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Solutions to the Moral Hazard Problem

• Lower the benefit reduction rate.

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Solutions 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.

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The 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.

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REDUCING 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?

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REDUCING THE MORAL HAZARD OF WELFARE

• Other policy instruments
• Moving to categorical welfare payments
• Using ordeal mechanisms
• Increasing outside options

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Reducing 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.

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Reducing 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.

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Reducing 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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Reducing 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.

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Reducing 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.

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Reducing 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.

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Reducing 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.

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Reducing 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

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Reducing 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.

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Reducing 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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WELFARE 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.

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Welfare 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.

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Welfare 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.

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Welfare 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.

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Welfare 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.