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Chapter 7. Government Subsidies and Income Support for the Poor. Discuss the extent of poverty in the US Understand the basis for government assistance to the poor – US
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Chapter 7 Government Subsidies and Income Support for the Poor
Discuss the extent of poverty in the US • Understand the basis for government assistance to the poor – US • Explain the difference between cash assistance, price distorting subsidies, and in-kind allotment of benefits and discuss their effects on incentives and resource allocation • Analyze the impact of transfer payments to the poor on work incentives • Examine the negative income tax, wage rate subsidies, and the earned income tax credit as alternative programs to aid the poor
Poverty in 2001 • 33 million people in U.S. affected • 12% of the population classified as poor
Family Structure Threshold ($ income annually) Single $9,214 One Adult-Two Children $14,269 Two Adults-Two Children $17,960 Poverty in the United StatesPoverty threshold or poverty line in 2001
Poverty line • Poor : who live in households having annual income below the established poverty level • Poverty Line: originally created by the Social Security Administration as three times the cost of a nutritionally adequate diet
Method of measuring poverty assumes: a poor family does not have enough income to purchase a low-cost diet and twice that amount to spend on other goods and services • The official poverty level varies with size of the family-a head of household solder than 65
Changing the Poverty Line • New definition proposed during Clinton Administration would have included child care and other expenses and would have raised the threshold to almost $20,000. • Such a change would have increased the poverty line in 1998 from 12.7% to 17%. • Politics are involved in setting poverty thresholds because many government means-tested programs are tied to the definition of poverty.
Why We Have Government Programs to Aid the Poor • Concern about equity-efficiency trade-offs. • Creates the positive externality of social stability.
Equity-Efficiency Trade-offs • Transfers to low-income persons can: • decrease incentives to work. • distort consumption patterns. • This approach recognizes that the way the “pie ” is divided can ultimately affect its size.
The Positive Externality: Social Stability Charity has characteristics of a public-good. • It creates social stability that benefits everyone. • Because of the free-rider problem, voluntary donations to the poor are likely to result in an undersupply of income redistribution to low-income groups relative to the efficient amount. • Government action to redistribute income can establish uniform standards of eligibility for aid that reflect political compromise.
Entitlement Programs: Government programs that guarantee recipients benefits as long as they meet eligibility tests . • Means Tests: typically income and wealth criteria that must be met for an individual or family to be eligible for a program • Status Tests: typically disability, children, and age criteria that must be met for an individual or family to be eligible for a program.
Cash Programs TANF: Temporary Aid to Needy Families • Program most identified with a welfare check; may provide for child-care expenses or job retraining SSI: Supplemental Security Income • Program provides cash payments to the widowed, orphaned and disabled. EITC: Earned Income Tax Credit • A program that increases the take-home pay of the working poor by as much as $3888 in 2000 for a family with two children.
In-Kind Programs • Food Stamps: vouchers that enable a broad class of poor people to purchase a wide variety of food products • WIC vouchers: enable poor, pregnant, and post-natal women to purchase a narrow variety of food products. • Medicaid: federal and state funded program that provides health care services to the poor • The Children’s Health Insurance Program: federal program that subsidizes health insurance coverage for the working poor.
Program Federal Spending Dollars (Billions) Percentage of Federal Spending SSI $32 1.52 TANF $26 1.23 EITC $35 1.66 Subtotal of Cash Programs $93 4.41 Medicaid $155 7.36 Food Stamps $24 1.14 Child Protection and Social Services $4 0.52 Child Nutrition $11 9.21 Subtotal of In-Kind Programs $287 13.62 Major Federal Government Expenditures To Aid the Poor, 2003
Price Distorting Subsidies Price Distorting Subsidies lower the price of a particular (subsidized) good relative to other goods for eligible people.
Figure 7.1 A Price Distorting Subsidy L I E3 N3 E1 N1 E2 Expenditure on Other Goods per Month (Dollars) N2 U3 U1 U2 Subsidy S H1 H2 H3 A L' 0 B Housing Services per Month
Dead Weight Loss or Excess Burden Dead Weight Loss (sometimes called Excess Burden ) measures the dollar value of the distortion that exceeds the amount transferred to the recipient.
Figure 7.2 Excess Burden of a Subsidy Excess Burden of Subsidy B E A 400 S = MSC Rent (Dollars per Month) C F E’ S’ 200 D = MSB 0 Q1 Q2 Number of Apartments Rented
Figure 7.3 Full Subsidization of Medical Services E1 A 25 = P* Price (Dollars per Month) Excess Burden MBL E2 Q* QG 0 Medical Office Visits per Year B
Additional Effects of Subsidies: The Case of Increasing Costs Taxpayers face a double burden: not only must they pay Medicaid costs through taxes,the program also increases the amount non-eligible patients pay for medical services by increasing demand for those services.
Figure 7.4 The Impact of The Medicaid Program on Price: The Case of Increasing Cost S = MSC E2 35 Price (Dollars) E1 25 DM' DM = MSB DO DL QL QO' QO QI Q2 0 Medical Office Visits per Year QG
Medicaid and State Governments • Medicaid allotments make up more than 20 percent of state government budgets. • State Medicaid budgets have grown at 12% per year (overall budgets have grown at 6%). • In 2002: • Medicaid payments per person were about $3,500 • Medicaid costs for the 11% of aged participants were nearly $10,000 per person.
Subsidized Housing Providing Apartments: allocates standard apartments to eligible recipients. With this type of subsidy,recipients cannot supplement the subsidy with their own cash. It is a “take it or leave it” option. Housing Vouchers: allows recipients particular allotments of vouchers to rent housing, but recipients may supplement the subsidy with their own cash. Cash: not restricted to spending on housing.
Figure 7.5 Eligibility for Public Housing and the Effect on Housing Consumption I' 800 = I 210 90 G M 210 E2 Expenditure on Other Goods per Month (Dollars) H J 400= F E1 U3 U1 U2 A B 0 1 2 3 4 5 6 7 Housing per Month (Number of Rooms Rented)
Figure 7.6 Refusing a Public-Housing Subsidy I G M E1 J U2 U3 Expenditure on Other Goods per Month (Dollars) 0 1 2 3 4 5 6 7 A Housing per Month (Number of Rooms Rented)
Subsidizing Food Food Stamps: subsidies that allow recipients particular allotments of vouchers to buy food, but recipients may supplement the subsidy with their own cash. It is illegal to sell food stamps, though it may be in the recipients’ interests to do so.
Figure 7.7 The Impact of an In-Kind Transfer: Food Stamps A B B B E2 F L I I C C U3 Expenditure on Other Goods per Month (Dollars) M1 E2 U2 M2 E1 E1 U1 M1 U2 U1 QF 0 QF QF1 QF2 A A' 0 QF2 QF3 A A' QF* Food per Month
The Impact of Government Assistance Programs on Work • Transfers could cause people to work more or less, depending on whether leisure is a normal good.
International Food Subsidies • Several nations use price-reducing subsidies to make food more affordable. • Programs that reduce the price of food benefit higher-income people as well. • Some nations only subsidize food that is typically consumed by the poor. • Some nations distribute food directly.
Figure 7.8 The Income Effect of a Transfer F U3 C E3 U2 A Income per Day G U1 E2 E1 D Transfer Payment 0 L1 L2 24 Leisure Hours per Day
Figure 7.9 A Transfer that Declines with Earned Income e.g. T=$300-.7IE A Income per Day C E2 U2 E1 D U1 Maximum Daily Transfer B L* L1 L2 24 Leisure Hours per Day
Empirical Evidence • A 10% increase in welfare payments to individuals decreases work effort by 2%.
Negative Income Tax • The Negative Income Tax is a system with no status test, but there is an income guarantee and a take-back rate. • T = IG– tNIE Where • IG= Income guarantee • tN= take back rate • IE= earned income • T = Transfer
Break-Even Income 0 = IG– tNIB IB= IG/tN
Wage Rate Subsidies Wage Rate Subsidies: government additions to wages designed to increase the pay of the working poor
Wisconsin Works • Stringent Work Requirements • Child Care Subsidies • Health Insurance Coverage • Welfare dependency in WI has dropped 60% since 1987
EITC • The Earned Income Tax Credit goes to the working poor and varies with the number of children. Typically, recipients receive the assistance with their tax refund, but papers can be filed to receive the money in their paychecks throughout the year.
Figure 7.11 Earned Income Tax Credit in 1999, By Number of Children and Earnings
Figure 7.10 A Negative Income Tax Plan Taxes Annual Disposable Income (ID ) Transfers IG 45º IB Annual Earned Income
Welfare Reform of 1996 Time Limits: • 5-year lifetime limit • 2-years at a time • If states meet certain goals, they can waive this rule for up to 20% of their caseloads. Work and Training: • Half a states TANF recipients must be in work programs • subsidized child care Teen Mothers: • no longer eligible to receive their own payments • must live with responsible adult. Refusal to work: • If recipients havechildren over five and the parents refuse to work, families can be denied aid and children may be placed in foster care.
Impact of Welfare Reform • Welfare caseloads have declined. • Labor force participation among less-skilled single mothers has increased more than expected. • State governments have greatly increased their spending for work support programs, including: • child care subsidies, • transportation subsidies, • help with job search expenses, • subsidized wages.
Welfare Rolls in New York City and the 2001 Recession • TANF was introduced during a period of almost unprecedented prosperity in the United States. • In New York City, the number of people receiving aid under public assistance actually decreased by 10 percent during the recession.
Programs to Aid the Poor and the Distribution of Money Income in the US • Most of the “War on Poverty” began in the 1960s. • The share of income going to each quintile (20% grouping) has remained constant during that time.
