Maximizing Social Welfare: Understanding Income Redistribution Today

1. Income redistribution Today: Conceptual issues Programs for the poor

2. Previously • Income redistribution through Social Security • Redistribution from young to old • Redistribution from rich to poor • Redistribution from those that die young to those that die old

3. Today • More on income redistribution • Chapter 12 • Conceptual issues • Distribution of income • Rationales for redistribution • In-kind versus cash transfers • Chapter 13 • Various welfare programs for the poor • TANF, EITC, Supplemental Security Income, Medicaid, Unemployment insurance, Nutrition programs, Housing assistance, Education/Job training

4. Conceptual issues • How is income distributed? • Is there such a thing as “too much” income inequality? • Why should there be redistribution? • Simple utilitarianism • Maximin criterion • In-kind versus cash transfers • When income is redistributed, should recipients be forced to consume a minimum amount of certain goods?

5. Is there “too much” income inequality • Some people would argue yes • “Marginal utility of income is lower for somebody with high incomes” • “Each person has a right to a minimum standard of living” • “Social unrest may occur unless each person is above the poverty line”

6. Is there “too much” income inequality • Some people would argue no • “When economic incentives to make a good living go away, the economic pie becomes smaller” • Think about communist systems • “People that have a good work ethic and work hard should make more money” • “There are plenty of opportunities for anybody born today in the US to become successful” • Free K-12 education; subsidized colleges and universities

7. Absolute income • Real income growth, 1980-2000 • Bottom 20% has been flat • Top 20% has seen huge growth (59%) • Note that the “economic pie” is getting bigger • See also Table 12.1, p. 259, for more on this topic Source: “Principles of Microeconomics” 3rd edition, by Frank and Bernanke

8. Problems with annual income figures • Ignores number of workers in a household • General trend from one earner to two • Expenses, such as child care, could be higher with in two-worker households • In-kind transfers ignored • Taxes change over time • Disposable income changes over time (given the same income) • Income changes over time • If a rich person earns no income in a calendar year, should she be considered “poor?”

9. Different views of income redistribution • Some people believe that utility, not income, should be maximized within a population • Additive social welfare functionW = U1 + U2 + … + Un • See Figure 12.2, p. 264, for a model of optimal income distribution

10. Different views of income redistribution • Others believe that social welfare should be the minimum of the utilities of each person in society • “Veil of ignorance” argument developed by John Rawls • Conceals knowledge and talents from people • Risk averse people will want to have income equality under these conditions • No inferiority, jealousy or envy based on income

11. Different views of income redistribution • Commodity egalitarianism • Some things should be made available to everyone without restrictions • Right to vote (if 18 or older) • Basic education • “Needed” items such as food, shelter, and clothing • Basic medical care • Recall issues presented in Chapters 9 and 10

12. Some other factors • Income redistribution does not directly take into account other factors • Number of hours worked • If our goal is to maximize utility from income, why not reduce leisure? • Not necessarily, since additional leisure likely increases utility • Income depends on number of hours worked • Does relative income matter? • Does someone get a decrease in utility when his income remains the same and someone else’s increase?

13. In-kind versus money transfers • With some views, such as commodity egalitarianism, in-kind transfers have more appeal than monetary ones • How does this affect individual utility? • See Figures 12.3, p. 272, and 12.4, p. 273

14. Summary: Conceptual issues • People have conflicting opinions as to whether or not there is too much income inequality • Most increases in income in recent decades have gone to the wealthiest of Americans • Some arguments support the use of in-kind transfers rather than monetary transfers

15. Welfare programs for the poor • Over $500 billion in expenditures in 2002 • TANF • EITC • Supplemental Security Income • Medicaid • Unemployment insurance • Nutrition programs • Housing assistance • Education/Job training

16. TANF • Temporary Assistance for Needy Families • Federal government provides block grants to states for welfare spending • Over 80% of recipients in every state must be on TANF for five years or less • States face penalties if a substantial percentage of recipients are not working or in work preparation programs

17. TANF • TANF replaced Aid to Families with Dependent Children (AFDC) • Under AFDC, some argued that many women on AFDC had children out of wedlock to continue get benefits and not have to work • If the mother had to work once the child reached kindergarten, then there would be an economic incentive to have another child

18. TANF and benefit reduction rates • TANF benefits are reduced when income reaches a certain level • Example: In California, recipients can earn up to $225 per month before benefits are reduced at a rate of 50% of money earned • How do people respond to these incentives in the short run?

19. 0 Work incentives B = G – tE B = 0 if E = G/t The Basic Trade-offs G – basic grant if not working t – rate at which grant reduced when recipient earns money B – benefit received

20. Analysis of work incentives • Figure 13.1, p. 281 • Budget constraint for leisure and income • Figure 13.2, p. 282 • Utility maximization based on the labor-leisure options

21. Analysis of work incentives • Figure 13.4, p. 284 • In this example, someone can get $100 in TANF benefits if not working • Between point Q and point S, an implicit tax rate of 25% is imposed • Note that there are some incentives to work while still receiving benefits • Figure 13.6, p. 286 • In this case, a 100% implicit tax rate is imposed after a benefit of $338 is received

22. Analysis of work incentives This person is indifferent between working and receiving benefits. See also Figure 13.7, p. 286, for a case in which an individual chooses to work. D E2 Income per month (= earnings + transfers) R P G Hours worked (if working) 0 T M Hours of leisure per month

23. EITC • The earned income tax credit • A success story for the working poor • Provides credits to workers within low incomes • How it worked in 2006 for a family with 2 or more kids • 40% credit for first $11,340 earned • No additional credit for next $5,470 earned • Phased out at a 21.06% rate after $16,810 is earned, until the credit is gone at $38,348 earned • See Figure 13.8, p. 289, for two graphs about this

24. What has the EITC done? • Households with nobody working • Encourages one person to work • Households with one person working • Additional work not encouraged once a family with 2+ kids earns $11,340 • Does not encourage additional hours of work of the person already working • Does not encourage a second worker in the household to work

25. Supplemental Security Income (SSI) • Federal program that provides benefits for the aged, blind, and disabled with little or no assets • In 2003, average benefit was $342 • SSI recipients can earn up to $65 per month without loss in benefits • After $65 is earned, additional earnings have a 50% implicit tax rate

26. Medicaid affects incentives to work Under old incentive structures, people often lost eligibility once they earned enough money to get off of welfare This created a “Medicaid notch” See Figure 13.9, p. 292 For main details about Medicaid, see Chapter 10 Medicaid

27. Solving the Medicaid notch problem • In recent years, families that earn enough to leave welfare can often stay on Medicaid • 12 month coverage after leaving TANF • Low-income children and pregnant women

28. Unemployment insurance (UI) • States provides insurance for unemployment due to adverse selection and moral hazard reasons • Benefits • Average weekly benefit in 2005: $266 • Maximum length of benefits in most states: 26 weeks • Typically financed by a payroll tax on employers • Empirical studies find that increasing benefits increases the duration of unemployment

29. Food stamps • Many poor households are eligible for food stamps • Can only be used for purchasing domestically-produced food, excluding alcohol and animal food • 2004 averages • Monthly benefit was about $200 • 23.9 million people on food stamps in a given month

30. Housing assistance • Public housing projects • Largest program, currently about 1.3 million units • When kids see building with everyone with low incomes, there are no role models for being successful • Crime is a big problem • Section 8 • Recipients rent a unit in the private market • Government provides subsidy if unit meets certain requirements

31. Education and job training • Programs aimed at poor families • Head Start • Results mixed, but mostly positive • Training programs • Evidence shows that costs are higher than benefits • Job search programs • Not effective in increasing living standards of many people

32. Overview • See Figure 13.10, p. 299 • Estimates marginal tax rates for a one-parent, two-child household residing in Wisconsin • Negative until about $10,000 per year • Over 40% from about $12,000-$31,000 per year

33. Future of social insurance? • Academics are starting to study alternate ideas to help the poor • Providing benefits to those most in need, rather than those that are already “in the system” • “One-stop shopping” for help • Faith-based support • Government provides cash to the faith-based organization, and the organization provides the service

34. Summary: Welfare programs for the poor • Many programs exist to support poor people • Some programs give little economic incentive to work • Exception: Earned income tax credit

35. End of Unit 3 • Next lecture, begin Unit 4 • Tax-related topics • Read Chapters 14 and 15