17.5 Welfare Reform

1. Income Distribution and Welfare Programs Chapter 17 On August 22, 1996, President Bill Clinton signed into law the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (PRWORA), more commonly known as the welfare reform law. Before this law, cash welfare in the United States was a system in which states received matching grants to provide time-unlimited benefits to low-income single mothers. After the law, states received a lump-sum block grant, a flat amount, independent of state spending on welfare, earmarked to provide time-limited benefits to a broader range of low-income families. 17.1 Facts on Income Distribution in the United States 17.2 Welfare Policy in the United States 17.3 The Moral Hazard Costs of Welfare Policy 17.4 Reducing the Moral Hazardof Welfare 17.5 Welfare Reform 17.6 Conclusion

2. Income Distribution and Welfare Programs

3. Facts on Income Distribution in the United States 17 . 1 Relative Income Inequality relative income inequalityThe amount of income the poor have relative to the rich.

4. Facts on Income Distribution in the United States 17 . 1 Relative Income Inequality

5. Facts on Income Distribution in the United States 17 . 1 Absolute Deprivation and Poverty Rates absolute deprivation The amount of income the poor have relative to some measure of “minimally acceptable” income. poverty line The federal government’s standard for measuring absolute deprivation.

6. Facts on Income Distribution in the United States 17 . 1 Absolute Deprivation and Poverty Rates

7. Facts on Income Distribution in the United States 17 . 1 Absolute Deprivation and Poverty Rates

8. Problems in Poverty Line Measurement The poverty line has remained a mainstay of U.S. public policy, with its exact placement influencing billions of dollars of government spending each year. There have been three types of criticisms: Bundle Has Changed: The share of food in family consumption has fallen over time relative to clothing, shelter, medical care, and other goods. As a result, using the cost of food times three is no longer an appropriate way to compute a minimum standard of living. Differences in Cost of Living Across Areas Are Ignored: In 2005, the median single-family home in the Boston–Cambridge–Quincy area of Massachusetts cost $413,000. The median single-family home in St. Louis, Missouri, cost only $141,000. Yet the same poverty line applies to both locations. Income Definition Is Incomplete: If two individuals have the same cash income but only one of them has Medicaid coverage, then the individual with Medicaid is effectively richer because he or she doesn’t have to pay for medical costs.

9. Facts on Income Distribution in the United States 17 . 1 What Matters—Relative or Absolute Deprivation? Once the poor can reach an acceptable level of consumption, why does it matter how much money the rich have? There are two reasons why relative income inequality measures may matter: • The “minimal” standard of living for a society may be best defined relative to the standard of living of others. • The level of inequality in society is itself negatively related to measures of well-being. A recent study by Luttmer (2004) also finds that individuals’ self-reported well-being rises as their own income rises, but falls as their neighbors’ incomes rise, suggesting that it is relative income, and not absolute income, that determines well-being.

10. Welfare Policy in the United States 17 . 2 In discussing welfare policy, it is important to understand two characteristics of each policy: 1. Categorical and Means-Tested Programs: categorical welfare Welfare programs restricted by some demographic characteristic, such as single motherhood or disability. means-tested welfare Welfare programs restricted only by income and asset levels.

11. Welfare Policy in the United States 17 . 2 2. Cash and In-Kind Programs: cash welfare Welfare programs that provide cash benefits to recipients. in-kind welfare Welfare programs that deliver goods, such as medical care or housing, to recipients.

12. Welfare Policy in the United States 17 . 2 Cash Welfare Programs Temporary Assistance for Needy Families (TANF) The TANF program provides support to low-income families with children in which one biological parent is absent. benefit guarantee The cash welfare benefit for individuals with no other income, which may be reduced as income increases. benefit reduction rate The rate at which welfare benefits are reduced per dollar of other income earned. Supplemental Security Income (SSI) SSI is a program that provides cash welfare to the aged, blind, and disabled.

13. Welfare Policy in the United States 17 . 2 In-Kind Programs Food Stamps Individuals are issued a card for a certain value of food, which is drawn down as they make purchases. Households without elderly or disabled members must have income below 130% of the poverty line to receive food stamps. Medicaid This is by far the largest categorical welfare program in the United States, with expenditures of $292 billion in 2004.

14. Welfare Policy in the United States 17 . 2 In-Kind Programs Public Housing The public housing system in the United States consists of two separate programs: • Public housing projects, typically large apartment buildings. • “Section 8 vouchers,” which individuals can use to subsidize private rentals from participating landlords. Benefits are restricted to low-income families, typically those with incomes below 50% of the median income in a metropolitan area. Other Nutritional Programs Special Supplemental Nutrition Program for Women, Infants, and Children (WIC), which provides funds for nutritious food purchases. Women who are pregnant or recent mothers, as well as children under five years old, are eligible if they are on cash welfare, are on Medicaid, or have incomes below 185% of the poverty line.

15. The Moral Hazard Costs of Welfare Policy 17 . 3 Moral Hazard Effects of a Means-Tested Transfer System • This system is a simplified version of TANF or other redistributive programs, but it allows us to clearly show the effects of moral hazard that come with redistribution. • The benefit to any individual would be equal to:

16. The Moral Hazard Costs of Welfare Policy 17 . 3 Moral Hazard Effects of a Means-Tested Transfer System

17. The Moral Hazard Costs of Welfare Policy 17 . 3 Solving Moral Hazard by Lowering the Benefit Reduction Rate

18. The Moral Hazard Costs of Welfare Policy 17 . 3 The “Iron Triangle” of Redistributive Programs iron triangle There is no way to change either the benefit reduction rate or the benefit guarantee to simultaneously encourage work, redistribute more income, and lower costs.

19. Reducing the Moral Hazard of Welfare 17 . 4 Moving to Categorical Welfare Payments By targeting welfare payments to observed earnings, the government introduces incentives for individuals to work less hard in order to qualify for larger welfare payments. This problem could be eliminated if the welfare program could target those who are truly less capable of earning, to ensure that benefits go to those who really need them, not just to those who are working less hard in order to qualify for benefits. What Makes a Good Targeting Mechanism? • Individuals have no way to change behavior in order to qualify. • The best mechanisms target those with low earning capacity.

20. Reducing the Moral Hazard of Welfare 17 . 4 Moving to Categorical Welfare Payments Targeting by Single Motherhood

21. Reducing the Moral Hazard of Welfare 17 . 4 Using “Ordeal Mechanisms” ordeal mechanisms Features of welfare programs that make them unattractive, leading to the self-selection of only the most needy recipients. The Paradox of Ordeal Mechanisms If the government provides a benefit that is not attractive to the non-needy but helps out the truly needy, then targeting will be more efficient. The paradox of ordeal mechanisms is therefore that apparently making the less able worse off can actually make them better off.

22. An Example of Ordeal Mechanisms The government wants to set up a soup kitchen for low-ability individuals who are poor, but the government cannot tell whether individuals are truly low-ability, or high-ability and just lazy. The government can: • Hire a large number of workers for this soup kitchen, so that no one has to wait very long for a bowl of soup. • Hire a small number, so that there is always a line outside. The long line might prevent the more able from using resources that they don’t need and are not really intended for them. Through the use of ordeal mechanisms, such as waiting in line, welfare programs can use the fact that the low-ability want the good more, and have a lower disutility from this ordeal, to more effectively target the redistribution of scarce resources.

23. Reducing the Moral Hazard of Welfare 17 . 4 Increasing Outside Options

24. Reducing the Moral Hazard of Welfare 17 . 4 Increasing Outside Options Training Training programs lead to modest declines in welfare receipt and increase the earnings for welfare recipients. Labor Market Subsidies Subsidizing work increases employment and reduces the number of people on welfare, and this impact rises with the size of the subsidy.

25. E M P I R I C A L E V I D E N C E THE CANADIAN SELF-SUFFICIENCY PROJECT • This program randomly offered wage subsidies to a treatment group of Canadian welfare recipients who had been on welfare for more than one year. • If these individuals found a full-time job within one year of leaving welfare, the program would, on average, double their earnings over the first three years they held the job. • This treatment group was compared to a control group of long-term welfare recipients randomly selected to not receive this wage subsidy. • The employment rates of those offered the subsidy rose by 43% relative to those who were not offered the subsidy. • The rate of welfare enrollment fell by roughly the same amount. • After five years, the treatment and control groups appeared similar in terms of work and welfare utilization.

26. Reducing the Moral Hazard of Welfare 17 . 4 Increasing Outside Options Child Care Subsidizing child care has been shown to raise female labor supply: recent estimates suggest that for each 10% rise in child care subsidies, female labor supply increases by about 2%. Child Support child support Court-ordered payments from an absent parent to support the upbringing of offspring. The major advantage of stronger enforcement of child support is that it potentially reduces the incidence of single motherhood by making it financially costly for fathers to abandon their families.

27. Reducing the Moral Hazard of Welfare 17 . 4 Increasing Outside Options Remove “Welfare Lock”

28. Welfare Reform 17 . 5 Changes Due to Welfare Reform 1. Cash welfare was changed from an entitlement to a block grant. 2. States were allowed, and encouraged, to experiment with alternative structures of cash welfare payments. 3. Time limits were imposed on welfare recipients. 4. Work requirements were imposed on welfare recipients. 5. New efforts to limit unwed motherhood were introduced.

29. Welfare Reform 17 . 5 Effects of the 1996 Welfare Reform • Led to a large financial windfall for the states. • Most studies find that single mothers as a group have not seen a drop in their income or their consumption. • There has been no noticeable effect of welfare reform on fertility rates.

30. E M P I R I C A L E V I D E N C E ESTIMATING THE IMPACT OF WELFARE REFORM • The time series evidence for the effects of welfare reform is not entirely convincing for two reasons: • The caseload decline began in 1994, well before welfare reform began taking effect. • This period saw one of the largest economic booms in the history of the United States, and better labor markets have always been associated with reductions in welfare rolls. • So many different aspects of the welfare laws changed that it is hard to assign a causal impact to any one of the changes. • Analysts of the 1996 welfare reform have proposed two solutions to this problem: • Compare the outcomes of single mothers to other control groups, such as married mothers, who were subject to similar economic shocks but were not much affected by welfare reform. • Use the fact that some states received waivers from the federal government to experiment with particular aspects of welfare reform before the national law was in place.

31. Welfare Reform 17 . 5 Effects of the 1996 Welfare Reform Was Welfare Reform a Success? • Whether these reforms were ultimately “successful,” depends on four additional factors: • Costs for a small share of women may exceed the gains from reduced government welfare spending. • Although incomes for single mothers were not down on average, they did not rise much either, and leisure clearly fell. • This reform was passed in the midst of one of the largest economic expansions in U.S. history. • The most important long-run effects of welfare reform are likely to be on the children in welfare-eligible families.

32. Conclusion 17 . 6 Welfare programs have been a source of contentious debate for many years, and the past decade has witnessed the most radical reform of cash welfare since the program’s inception. Despite the apparent success of the 1996 welfare reform, welfare debates will no doubt continue in the future.