1
Chapter 8 – Expenditure
Programs for the Poor
Public Economics
2
Quick Look at Welfare Spending
?, Welfare” in the United States is a
patchwork of dozens of different
programs.
? All welfare programs are means-tested –
only individuals with sufficiently low
income are eligible.
? Programs often have other requirements
related to family structure and assets.
3
Quick Look at Welfare Spending
? Spending on welfare programs,as a
fraction of GDP,has more than double in
the past 30 years.
? The role of direct cash assistance has
diminished,however,Subsidized health
care has grown enormously.
Table 8.1
5
Quick Look at Welfare Spending
? Table 8.1 shows that welfare spending is
a shared expense between the federal
and state/local governments.
? Subsidized medical care (mainly
Medicaid) exceeded $215 billion in 2000.
? Cash assistance (including the Earned
Income Tax Credit) exceeded $91 billion
in 2000.
6
TANF
? 1935-1996,AFDC
– Aid to Families with Dependent Children
? 1996-present,TANF
– Temporary Assistance for Needy Families
? Programs are largely targeted toward
single parent households with children
under 18.
7
AFDC/TANF differences
? AFDC
– Open-ended entitlement –
anyone who qualifies gets
AFDC.
– No time limits – could be
on program indefinitely
– No work requirements
– Cost sharing by federal
and state governments –
open ended costs.
– State determines benefit
levels subject to broad
federal guidelines
– High tax rates on earned
income
? TANF
– No,entitlement” – limited
funding.
– Time limited for at most 5
years
– Work requirements
– Block grant to states –
costs to federal
government are not open
ended.
– States have even more
control of the design of the
program
– States have option to lower
tax rates on earned income
8
TANF
? Benefit reduction rates (also known as
tax rates) vary from 33% to 100%.
– 100% tax rate means that if a welfare
recipient earns $1 in the labor market,her
welfare benefit is reduced by exactly $1.
9
TANF
? Welfare grant levels vary tremendously
? More than cost-of-living differences alone
could explain
? For a 3-person family with no other
sources of income,grant was:
– $801 for the family each month in Minnesota
– $164 for the family each month in Alabama
10
Income Maintenance and Work
Incentives
? Analyzing welfare programs is simply
utility maximization subject to a budget
constraint.
? The government’s welfare program
design changes the budget constraint,
and the economic agent then maximizes
utility.
11
Income Maintenance and Work
Incentives
? In the simplest possible case,a state’s
welfare program can be characterized by
two variables:
? G – the basic grant the individual receives
when not working.
? t – the rate at which the grant is taken away
when the recipient earns income; the tax rate.
12
Income Maintenance and Work
Incentives
? For example,suppose a state gives a grant of
$300,but benefits are reduced by 25 cents for
each dollar earned.
– G=300 and t=0.25
– If the individual earns $500,her welfare benefit is
reduced from $300 to ($300-0.25*500),or $175.
? Eventually,the person will earn too much
money to qualify for any welfare benefit.
13
Income Maintenance and Work
Incentives
? Algebraically,the actual benefit received (B) is
related to the tax rate (t),welfare grant (G),and
actual earnings (E).
B G tE? ?
14
Income Maintenance and Work
Incentives
? When benefits fall to zero (B=0),the person is no
longer eligible for welfare,This implies:
E
G
t
?
? When a welfare system only has two features,G
and t,the above equation tells the earnings level
where welfare eligibility ends.
15
Income Maintenance and Work
Incentives
? This formula is called the,break-even” level.
? It highlights the fundamental tradeoff in welfare program
design:
– Lower tax rates,t,provide better work incentives for welfare
recipients,but make more people eligible.
– For example,with G=300 and t=0.25,the income eligibility
limit is $1200.
– With a much higher tax rate of 100%,the income eligibility
limit is $300.
– Fewer people qualify with the 100% tax rate,but such a high
tax could discourage work among welfare recipients.
16
Analysis of work incentives
? Typical utility maximization problem includes a
utility function (U),prices of goods (p),and income
(I).
? The key change in an analysis of labor supply
and welfare programs is that rather than being
“endowed” with income,the person is endowed
with time,T.
? This is known as the time endowment – which
can be used for either labor or leisure.
17
Analysis of work incentives
? The utility function consists of two goods,leisure
and,all other consumption goods” (which will
simply be measured as income in the examples
below).
? U=u(L,C) or equivalently U=u(L,I) where
– L=Leisure
– C=Consumption goods
– I=income
18
Analysis of work incentives
? This utility function shows that leisure is a,good”
– all else equal,people prefer more to less.
? The reason why people work is to buy
consumption goods.
? If we denote H=hours of work,then:
– L+H=T
– The amount of leisure and hours of work equals the
time endowment.
Figure 8.1
20
Analysis of work incentives
? In Figure 8.1,the x-axis therefore simultaneously
represents leisure (moving away from the origin),
and hours of work (moving toward the origin).
– Oa represents hours of leisure,and aT represents hours
of work.
? The y-axis represents consumption goods or
income (they are interchangeable).
21
Analysis of work incentives
? In Figure 8.1,if the person does not work at all,
then L=T (H=0),Smith earns no money,and
therefore has zero income (consumption goods).
– Thus,one point on her budget constraint is {T,0}
22
Analysis of work incentives
? If she gives up one hour of leisure,she works one
hours and earns a wage rate of w.
– Thus,another point on her budget constraint is {T-1,w},
which is labeled as point b.
? If she gives up two hours of leisure,she works two
hours and earns a wage rate of 2w.
– Thus,another point on her budget constraint is {T-2,2w},
which is labeled as point c.
23
Analysis of work incentives
? The most leisure she could give up is T hours (her
time endowment),which leads to y-intercept on
her budget constraint,{0,Tw}.
? This exercise traces out all the leisure/income
combinations along the line TD.
? The price of an additional hour of leisure is its
opportunity cost – the income forgone by not
working that hour – which is the wage rate,w.
24
Analysis of work incentives
? Given this budget constraint,the person
maximizes utility by choosing the indifference
curve tangent to the budget constraint.
? This is illustrated in Figure 8.2.
– The amount of leisure consumed is OF.
– The amount of income is OG.
Figure 8.2
26
Numerical example
? Assume that Smith has the following preferences
over leisure and consumption goods:
U u L C L C? ?(,)
1
4
3
4
? Further,assume that the price of leisure is $5,price
of consumption goods is $2,and the time
endowment is 100 hours.
27
Numerical example
? The,full” budget constraint is therefore:
wL p C wT L CC? ? ? ? ?5 2 500
? In general,the demand curve for good X in a
Cobb-Douglas utility function of the form:
U X Y? ? ?
X I
p x
?
?
?
??
?
??
?
? ?
is
28
Numerical example
? This translates easily into leisure demand:
? She therefore consumes 25 hours of leisure
(provides 75 hours of work),earns $375 (=75x$5),
and purchases 187.5 units of consumption goods
(=$375/2).
? ? ? ?L wT
w
?
?
?
?
?
?
?
? ?
?
?
?
?
?
?
? ?
?
? ?
1
4
1
4
3
4
500
5
25
29
Introducing the welfare system
into the analysis
? In the previous figures,the person would literally
starve if she did not work at all.
? The welfare system provides additional income for
those with low earnings (low hours of work).
? Figure 8.3 illustrates the budget constraint with
grant of $100 and a tax rate of 25%.
Figure 8.3
31
Introducing the welfare system
into the analysis
? In Figure 8.3,the budget constraint has changed
with the introduction of the welfare system.
? If the person does not work,she now collects $G
from the welfare system.
– Thus,point Q represents the leisure/income
combination {T,G}.
32
Introducing the welfare system
into the analysis
? As she begins to work,she still receives w from
her employer,but her grant is reduced by tw,or
0.25w.
? Her income therefore increases by 0.75w,not w,
from an additional hour of work.
– The (absolute value) of the slope is flatter than before.
33
Introducing the welfare system
into the analysis
? Where does she lose welfare benefits? Answer,
when her benefits fall to zero,which occurs at the
“breakeven level.”
? The earnings where welfare eligibility is lost is
equal to:
E Gt?
34
Introducing the welfare system
into the analysis
? The hours of work where welfare eligibility is
therefore:
H Ew w Gtw
G
t? ? ?
? It follows that the leisure where welfare eligibility
ends is:
L T H T Ew T w T Gtw
G
t? ? ? ? ? ? ? ?
35
Introducing the welfare system
into the analysis
? In Figure 8.3,this expression for leisure
corresponds to OV.
? After earning this amount,Smith no longer
collects welfare benefits,and gets to keep the
entirely hourly wage.
? Thus,the new budget constraint is given by the
kinked line QSD.
36
Introducing the welfare system
into the analysis
? How will Smith react to the new budget constraint
QSD rather than TD?
? It will depend on her indifference curves.
? Given the indifference curves in Figure 8.4,Smith
reduces her hours of work from FT to KT,Her
leisure increases from OF to OK.
Figure 8.4
38
Introducing the welfare system
into the analysis
? Note that Smith is clearly better off in Figure 8.4
after the welfare system is introduced – her utility
is higher than before.
39
Introducing the welfare system
into the analysis
? In the previous case,we assumed the tax rate
was t=25%.
? The next case considers a higher tax rate,
t=100%.
40
Introducing the welfare system
into the analysis
? Note that 100% tax rates are not unheard of in the
welfare system.
– Nine states and the District of Columbia impose this tax
rate.
? Assume that G=$338 per month.
41
Introducing the welfare system
into the analysis
? Now,when a welfare recipient works another hours and
earns w,her welfare benefit is reduced by exactly w.
? Her net wage is therefore $0!
? She moves from {T,$338} to {T-1,$338}
? This is illustrated as P1 in Figure 8.5.
– Regardless of her preferences,she would never choose point
P1 because it violates the non-satiation assumption.
Figure 8.5
43
Introducing the welfare system
into the analysis
? The breakeven level of earnings is
G/t=($338/1.0)=$338.
? After Smith earns $338,her welfare benefit has
fallen to zero,and she then keeps all of her
additional earnings.
? The absolute value of the slope of the budget
constraint becomes w.
? The budget constraint is therefore PRD.
44
Introducing the welfare system
into the analysis
? Given the 100% tax rate,and Smith’s indifference
curves in Figure 8.6,she rationally chooses to
leave the labor force,and consume {T,338}.
Figure 8.6
46
Introducing the welfare system
into the analysis
? It is never rational in Figure 8.6 to work between 0
and PR hours.
? This special case does not explicitly depend on a
person’s indifference curves,because the tax rate
is 100%.
47
Introducing the welfare system
into the analysis
? It is not true,however,that all people leave the
labor force when the tax rate on welfare benefits
is 100%.
? Figure 8.7 illustrates a person with a high level of
work effort,who attains higher utility at E2 than at
P.
Figure 8.7
49
Introducing the welfare system
into the analysis
? This person’s indifference curve is everyone
above the welfare part of the budget constraint.
? If the welfare grant,G,increased sufficiently,at
some point this person would respond by leaving
the labor force (assuming t=100%).
? But the current grant level in Figure 8.7 does not
induce this person to leave.
50
Introducing the welfare system
into the analysis
? Why impose such high tax rates if these tax rates
create work disincentives?
? Holding the grant constant,lowering the tax rate
increases welfare eligibility,For example,
lowering t in the previous figure (Figure 8.7) would
eventually induce this person to enter welfare.
51
Introducing the welfare system
into the analysis
? Do high tax rates really matter for work behavior
of welfare recipients?
– Moffitt (2002) concluded that AFDC led to a 10-50%
labor supply reduction among welfare recipients.
– When TANF was introduced and tax rates were lowered,
the proportion of welfare recipients who had any
earnings increased from 6.7% in 1990 to 28.1% in 1999.
? Other factors,like work requirements and an improving
economy,clearly matter too.
52
Work requirements
? Workfare is a welfare arrangement where able-
bodied individuals receive transfer payments only
if they agree to participate in a work-related
activity and accept employment.
? Returning to Figure 8.6,take away segment SP
from the budget constraint,The budget constraint
“jumps up” once the welfare recipient works at
least SP hours.
53
Work requirements
? Workfare is a welfare arrangement where able-
bodied individuals receive transfer payments only
if they agree to participate in a work-related
activity and accept employment.
? Returning to Figure 8.6,take away segment SP
from the budget constraint,The budget constraint
“jumps up” once the welfare recipient works at
least SP hours.
Figure 8.6
55
Time Limited Benefits
? TANF limits individuals to 5 years of receipt over
their lifetimes.
– Witnessed a drop of 50% in welfare caseloads from
1994 to 2000.
– Other factors,like the economy,would help explain
caseload reduction too.
? Grogger (2001) found that time limits did affect
welfare participation,as families with younger
children,bank” their benefits.
56
National versus state
administration
? States have much more choice over the structure of their
welfare programs.
? Would more generous states face influx of welfare-induced
migration? Would potential migration,in turn,lead to a
“race to the bottom” in terms of generosity?
? Although some studies have found welfare induced
migration,there has not been,race to the bottom.”
57
EITC
? The earned income tax credit (EITC) is the
largest cash transfer to low-income individuals,
and is administered through the tax system,not
the welfare system.
? Comes in form of tax credit,which is a reduction
in a person’s tax liability,It is possible to have a
negative tax liability – meaning the government
owes the person money rather than the other way
around.
58
EITC
? EITC has grown dramatically over time,with an
annual cost now exceeding $31 billion.
? Subsidy depends on:
– Family structure / number of children
– Earnings
? Figure 8.8A summarizes the size of the credit as
income increases for a family with 2 children.
Figure 8.8A
60
EITC
? Figure 8.8A shows that the credit can be as great
as 40% of income.
? It is phased out as income increases,which
creates a tax rate of 21.06%.
? Figure 8.8B shows how the tax rates for the EITC
vary with income.
Figure 8.8B
62
SSI
? Supplemental Security Income (SSI) provides
cash benefits for the aged,blind,and disabled.
? SSI usually provides more generous benefits,
lower tax rates,and more uniformity than
TANF/AFDC.
? SSI recipients may be perceived as being,more
deserving” although there is some skepticism
about many of the disabled recipients.
63
Medicaid
? Medicaid is the largest spending program
for the poor.
– Initially established in 1965,provided health
insurance to recipients of cash welfare
(AFDC and SSI)
– Has expanded over time,now covers many
children and pregnant women who have no
other attachment to the welfare system
64
Medicaid
? By 2002,40.1 million Medicaid recipients.
? Program costs exceed $219 billion.
65
Medicaid
? A number of policy issues arise in the
provision of Medicaid.
?,Crowd-out”
?,Medicaid Notch”
66
Medicaid Crowd-out
? Providing Medicaid affects both the
uninsured and low income people with
private (employer) health insurance.
? To the extent that families give up costly
private insurance for the free Medicaid
coverage,Medicaid,crowds-out” private
coverage.
67
Medicaid Crowd-out
? The most credible estimates of private
insurance crowd-out suggest that it is
extremely important.
? As many as half of Medicaid recipients
who were covered by recent expansions
were previously privately insured.
68
Medicaid Notch
? The,taxation” of Medicaid is quite different from
the taxation of cash benefits or food stamps.
? Cash benefits are smoothly taken away,albeit
at high tax rates.
? Medicaid is retained in its entirety as long as a
person is eligible for cash assistance,and taken
away in its entirety if a person is ineligible for
cash assistance.
69
Medicaid Notch
? This structure creates implicit tax rates far
greater than 100% for becoming ineligible for
TANF/AFDC.
? Although a person might typically lose,say
$0.80 of cash benefits for earning an extra
$1.00 in the labor market,at the,Medicaid
notch” she would also lose health insurance
that could be valued at several thousand dollars.
70
Medicaid Notch
? Consider Figure 8.9,which abstracts from the
cash welfare benefits.
? Smith receives Medicaid valued at $1000,as
long as hours of work is less than XT (or
earnings are less than Z = w x XT).
? She loses Medicaid for working any more than
that.
Figure 8.9
72
Medicaid Notch
? As illustrated,Medicaid is untaxed for earnings
less than Z (= w x XT).
? At point R on the budget constraint,she loses
Medicaid eligibility,and the entire Medicaid
benefit is taken away from her.
? The blue lines in Figure 8.9 show Smith’s
budget constraint (NRSD),Clearly creates
potential work disincentives.
73
Medicaid and Health
? The main reason for providing (and
expanding) Medicaid is to improve the
health of vulnerable groups.
? Recent evidence suggests small but
important improvements in birthweight
and infant mortality.
74
Food Stamps
? Virtually all poor people can receive food
stamps (unlike cash assistance and
Medicaid).
? In 2001,around 17.3 million food stamp
participants each month,at an annual
cost of $16 billion.
75
Food Stamps
? Food stamps are an in-kind benefit,and
as shown in previous chapter,may be
valued as less than their face value.
? Evidence suggest people buy more food
when they have food stamps rather than
the cash equivalent transfer.
76
Food Stamps
? Takeup rate for food stamps is only
around 70% of eligible households.
– Possibly some,welfare stigma” associated
with participation.
77
Housing Assistance
? Several forms of subsidized housing:
– Public housing,projects”
– Section 8,vouchers” and certificates
? Projects are developed,owned,and run by
local government housing authorities.
? Vouchers are provided to tenants to find
apartments in private market.
78
Housing Assistance
? Projects have gained a reputation as a breeding
ground for crime and other social pathologies.
? As a consequence,little new project
construction since the 1970s.
? Currie and Yelowitz (2000) find that these
negative outcomes are largely illusory.
– Those who lived in projects would have fared poorly
even if they had lived elsewhere.
79
Housing Assistance
? One recent focus in housing policy is
increasing self-sufficiency.
– Perhaps poor neighborhoods or long
distances from employment harm recipients.
? Recent evidence does not find that
moving project households into better
neighborhoods helps their job prospects.
80
Programs to Enhance Earnings
? Education
– Head Start for preschool children
? Training
– Improve job skills
– Heckman (1999) finds,perhaps surprisingly,
that training programs are not very effective
at increasing earnings.
81
Recap of Expenditure Programs
for the Poor
? Welfare spending
? TANF
? Work incentives
? Other cash assistance – EITC & SSI
? Medicaid
? Other in-kind benefits – Food stamps & housing
Chapter 8 – Expenditure
Programs for the Poor
Public Economics
2
Quick Look at Welfare Spending
?, Welfare” in the United States is a
patchwork of dozens of different
programs.
? All welfare programs are means-tested –
only individuals with sufficiently low
income are eligible.
? Programs often have other requirements
related to family structure and assets.
3
Quick Look at Welfare Spending
? Spending on welfare programs,as a
fraction of GDP,has more than double in
the past 30 years.
? The role of direct cash assistance has
diminished,however,Subsidized health
care has grown enormously.
Table 8.1
5
Quick Look at Welfare Spending
? Table 8.1 shows that welfare spending is
a shared expense between the federal
and state/local governments.
? Subsidized medical care (mainly
Medicaid) exceeded $215 billion in 2000.
? Cash assistance (including the Earned
Income Tax Credit) exceeded $91 billion
in 2000.
6
TANF
? 1935-1996,AFDC
– Aid to Families with Dependent Children
? 1996-present,TANF
– Temporary Assistance for Needy Families
? Programs are largely targeted toward
single parent households with children
under 18.
7
AFDC/TANF differences
? AFDC
– Open-ended entitlement –
anyone who qualifies gets
AFDC.
– No time limits – could be
on program indefinitely
– No work requirements
– Cost sharing by federal
and state governments –
open ended costs.
– State determines benefit
levels subject to broad
federal guidelines
– High tax rates on earned
income
? TANF
– No,entitlement” – limited
funding.
– Time limited for at most 5
years
– Work requirements
– Block grant to states –
costs to federal
government are not open
ended.
– States have even more
control of the design of the
program
– States have option to lower
tax rates on earned income
8
TANF
? Benefit reduction rates (also known as
tax rates) vary from 33% to 100%.
– 100% tax rate means that if a welfare
recipient earns $1 in the labor market,her
welfare benefit is reduced by exactly $1.
9
TANF
? Welfare grant levels vary tremendously
? More than cost-of-living differences alone
could explain
? For a 3-person family with no other
sources of income,grant was:
– $801 for the family each month in Minnesota
– $164 for the family each month in Alabama
10
Income Maintenance and Work
Incentives
? Analyzing welfare programs is simply
utility maximization subject to a budget
constraint.
? The government’s welfare program
design changes the budget constraint,
and the economic agent then maximizes
utility.
11
Income Maintenance and Work
Incentives
? In the simplest possible case,a state’s
welfare program can be characterized by
two variables:
? G – the basic grant the individual receives
when not working.
? t – the rate at which the grant is taken away
when the recipient earns income; the tax rate.
12
Income Maintenance and Work
Incentives
? For example,suppose a state gives a grant of
$300,but benefits are reduced by 25 cents for
each dollar earned.
– G=300 and t=0.25
– If the individual earns $500,her welfare benefit is
reduced from $300 to ($300-0.25*500),or $175.
? Eventually,the person will earn too much
money to qualify for any welfare benefit.
13
Income Maintenance and Work
Incentives
? Algebraically,the actual benefit received (B) is
related to the tax rate (t),welfare grant (G),and
actual earnings (E).
B G tE? ?
14
Income Maintenance and Work
Incentives
? When benefits fall to zero (B=0),the person is no
longer eligible for welfare,This implies:
E
G
t
?
? When a welfare system only has two features,G
and t,the above equation tells the earnings level
where welfare eligibility ends.
15
Income Maintenance and Work
Incentives
? This formula is called the,break-even” level.
? It highlights the fundamental tradeoff in welfare program
design:
– Lower tax rates,t,provide better work incentives for welfare
recipients,but make more people eligible.
– For example,with G=300 and t=0.25,the income eligibility
limit is $1200.
– With a much higher tax rate of 100%,the income eligibility
limit is $300.
– Fewer people qualify with the 100% tax rate,but such a high
tax could discourage work among welfare recipients.
16
Analysis of work incentives
? Typical utility maximization problem includes a
utility function (U),prices of goods (p),and income
(I).
? The key change in an analysis of labor supply
and welfare programs is that rather than being
“endowed” with income,the person is endowed
with time,T.
? This is known as the time endowment – which
can be used for either labor or leisure.
17
Analysis of work incentives
? The utility function consists of two goods,leisure
and,all other consumption goods” (which will
simply be measured as income in the examples
below).
? U=u(L,C) or equivalently U=u(L,I) where
– L=Leisure
– C=Consumption goods
– I=income
18
Analysis of work incentives
? This utility function shows that leisure is a,good”
– all else equal,people prefer more to less.
? The reason why people work is to buy
consumption goods.
? If we denote H=hours of work,then:
– L+H=T
– The amount of leisure and hours of work equals the
time endowment.
Figure 8.1
20
Analysis of work incentives
? In Figure 8.1,the x-axis therefore simultaneously
represents leisure (moving away from the origin),
and hours of work (moving toward the origin).
– Oa represents hours of leisure,and aT represents hours
of work.
? The y-axis represents consumption goods or
income (they are interchangeable).
21
Analysis of work incentives
? In Figure 8.1,if the person does not work at all,
then L=T (H=0),Smith earns no money,and
therefore has zero income (consumption goods).
– Thus,one point on her budget constraint is {T,0}
22
Analysis of work incentives
? If she gives up one hour of leisure,she works one
hours and earns a wage rate of w.
– Thus,another point on her budget constraint is {T-1,w},
which is labeled as point b.
? If she gives up two hours of leisure,she works two
hours and earns a wage rate of 2w.
– Thus,another point on her budget constraint is {T-2,2w},
which is labeled as point c.
23
Analysis of work incentives
? The most leisure she could give up is T hours (her
time endowment),which leads to y-intercept on
her budget constraint,{0,Tw}.
? This exercise traces out all the leisure/income
combinations along the line TD.
? The price of an additional hour of leisure is its
opportunity cost – the income forgone by not
working that hour – which is the wage rate,w.
24
Analysis of work incentives
? Given this budget constraint,the person
maximizes utility by choosing the indifference
curve tangent to the budget constraint.
? This is illustrated in Figure 8.2.
– The amount of leisure consumed is OF.
– The amount of income is OG.
Figure 8.2
26
Numerical example
? Assume that Smith has the following preferences
over leisure and consumption goods:
U u L C L C? ?(,)
1
4
3
4
? Further,assume that the price of leisure is $5,price
of consumption goods is $2,and the time
endowment is 100 hours.
27
Numerical example
? The,full” budget constraint is therefore:
wL p C wT L CC? ? ? ? ?5 2 500
? In general,the demand curve for good X in a
Cobb-Douglas utility function of the form:
U X Y? ? ?
X I
p x
?
?
?
??
?
??
?
? ?
is
28
Numerical example
? This translates easily into leisure demand:
? She therefore consumes 25 hours of leisure
(provides 75 hours of work),earns $375 (=75x$5),
and purchases 187.5 units of consumption goods
(=$375/2).
? ? ? ?L wT
w
?
?
?
?
?
?
?
? ?
?
?
?
?
?
?
? ?
?
? ?
1
4
1
4
3
4
500
5
25
29
Introducing the welfare system
into the analysis
? In the previous figures,the person would literally
starve if she did not work at all.
? The welfare system provides additional income for
those with low earnings (low hours of work).
? Figure 8.3 illustrates the budget constraint with
grant of $100 and a tax rate of 25%.
Figure 8.3
31
Introducing the welfare system
into the analysis
? In Figure 8.3,the budget constraint has changed
with the introduction of the welfare system.
? If the person does not work,she now collects $G
from the welfare system.
– Thus,point Q represents the leisure/income
combination {T,G}.
32
Introducing the welfare system
into the analysis
? As she begins to work,she still receives w from
her employer,but her grant is reduced by tw,or
0.25w.
? Her income therefore increases by 0.75w,not w,
from an additional hour of work.
– The (absolute value) of the slope is flatter than before.
33
Introducing the welfare system
into the analysis
? Where does she lose welfare benefits? Answer,
when her benefits fall to zero,which occurs at the
“breakeven level.”
? The earnings where welfare eligibility is lost is
equal to:
E Gt?
34
Introducing the welfare system
into the analysis
? The hours of work where welfare eligibility is
therefore:
H Ew w Gtw
G
t? ? ?
? It follows that the leisure where welfare eligibility
ends is:
L T H T Ew T w T Gtw
G
t? ? ? ? ? ? ? ?
35
Introducing the welfare system
into the analysis
? In Figure 8.3,this expression for leisure
corresponds to OV.
? After earning this amount,Smith no longer
collects welfare benefits,and gets to keep the
entirely hourly wage.
? Thus,the new budget constraint is given by the
kinked line QSD.
36
Introducing the welfare system
into the analysis
? How will Smith react to the new budget constraint
QSD rather than TD?
? It will depend on her indifference curves.
? Given the indifference curves in Figure 8.4,Smith
reduces her hours of work from FT to KT,Her
leisure increases from OF to OK.
Figure 8.4
38
Introducing the welfare system
into the analysis
? Note that Smith is clearly better off in Figure 8.4
after the welfare system is introduced – her utility
is higher than before.
39
Introducing the welfare system
into the analysis
? In the previous case,we assumed the tax rate
was t=25%.
? The next case considers a higher tax rate,
t=100%.
40
Introducing the welfare system
into the analysis
? Note that 100% tax rates are not unheard of in the
welfare system.
– Nine states and the District of Columbia impose this tax
rate.
? Assume that G=$338 per month.
41
Introducing the welfare system
into the analysis
? Now,when a welfare recipient works another hours and
earns w,her welfare benefit is reduced by exactly w.
? Her net wage is therefore $0!
? She moves from {T,$338} to {T-1,$338}
? This is illustrated as P1 in Figure 8.5.
– Regardless of her preferences,she would never choose point
P1 because it violates the non-satiation assumption.
Figure 8.5
43
Introducing the welfare system
into the analysis
? The breakeven level of earnings is
G/t=($338/1.0)=$338.
? After Smith earns $338,her welfare benefit has
fallen to zero,and she then keeps all of her
additional earnings.
? The absolute value of the slope of the budget
constraint becomes w.
? The budget constraint is therefore PRD.
44
Introducing the welfare system
into the analysis
? Given the 100% tax rate,and Smith’s indifference
curves in Figure 8.6,she rationally chooses to
leave the labor force,and consume {T,338}.
Figure 8.6
46
Introducing the welfare system
into the analysis
? It is never rational in Figure 8.6 to work between 0
and PR hours.
? This special case does not explicitly depend on a
person’s indifference curves,because the tax rate
is 100%.
47
Introducing the welfare system
into the analysis
? It is not true,however,that all people leave the
labor force when the tax rate on welfare benefits
is 100%.
? Figure 8.7 illustrates a person with a high level of
work effort,who attains higher utility at E2 than at
P.
Figure 8.7
49
Introducing the welfare system
into the analysis
? This person’s indifference curve is everyone
above the welfare part of the budget constraint.
? If the welfare grant,G,increased sufficiently,at
some point this person would respond by leaving
the labor force (assuming t=100%).
? But the current grant level in Figure 8.7 does not
induce this person to leave.
50
Introducing the welfare system
into the analysis
? Why impose such high tax rates if these tax rates
create work disincentives?
? Holding the grant constant,lowering the tax rate
increases welfare eligibility,For example,
lowering t in the previous figure (Figure 8.7) would
eventually induce this person to enter welfare.
51
Introducing the welfare system
into the analysis
? Do high tax rates really matter for work behavior
of welfare recipients?
– Moffitt (2002) concluded that AFDC led to a 10-50%
labor supply reduction among welfare recipients.
– When TANF was introduced and tax rates were lowered,
the proportion of welfare recipients who had any
earnings increased from 6.7% in 1990 to 28.1% in 1999.
? Other factors,like work requirements and an improving
economy,clearly matter too.
52
Work requirements
? Workfare is a welfare arrangement where able-
bodied individuals receive transfer payments only
if they agree to participate in a work-related
activity and accept employment.
? Returning to Figure 8.6,take away segment SP
from the budget constraint,The budget constraint
“jumps up” once the welfare recipient works at
least SP hours.
53
Work requirements
? Workfare is a welfare arrangement where able-
bodied individuals receive transfer payments only
if they agree to participate in a work-related
activity and accept employment.
? Returning to Figure 8.6,take away segment SP
from the budget constraint,The budget constraint
“jumps up” once the welfare recipient works at
least SP hours.
Figure 8.6
55
Time Limited Benefits
? TANF limits individuals to 5 years of receipt over
their lifetimes.
– Witnessed a drop of 50% in welfare caseloads from
1994 to 2000.
– Other factors,like the economy,would help explain
caseload reduction too.
? Grogger (2001) found that time limits did affect
welfare participation,as families with younger
children,bank” their benefits.
56
National versus state
administration
? States have much more choice over the structure of their
welfare programs.
? Would more generous states face influx of welfare-induced
migration? Would potential migration,in turn,lead to a
“race to the bottom” in terms of generosity?
? Although some studies have found welfare induced
migration,there has not been,race to the bottom.”
57
EITC
? The earned income tax credit (EITC) is the
largest cash transfer to low-income individuals,
and is administered through the tax system,not
the welfare system.
? Comes in form of tax credit,which is a reduction
in a person’s tax liability,It is possible to have a
negative tax liability – meaning the government
owes the person money rather than the other way
around.
58
EITC
? EITC has grown dramatically over time,with an
annual cost now exceeding $31 billion.
? Subsidy depends on:
– Family structure / number of children
– Earnings
? Figure 8.8A summarizes the size of the credit as
income increases for a family with 2 children.
Figure 8.8A
60
EITC
? Figure 8.8A shows that the credit can be as great
as 40% of income.
? It is phased out as income increases,which
creates a tax rate of 21.06%.
? Figure 8.8B shows how the tax rates for the EITC
vary with income.
Figure 8.8B
62
SSI
? Supplemental Security Income (SSI) provides
cash benefits for the aged,blind,and disabled.
? SSI usually provides more generous benefits,
lower tax rates,and more uniformity than
TANF/AFDC.
? SSI recipients may be perceived as being,more
deserving” although there is some skepticism
about many of the disabled recipients.
63
Medicaid
? Medicaid is the largest spending program
for the poor.
– Initially established in 1965,provided health
insurance to recipients of cash welfare
(AFDC and SSI)
– Has expanded over time,now covers many
children and pregnant women who have no
other attachment to the welfare system
64
Medicaid
? By 2002,40.1 million Medicaid recipients.
? Program costs exceed $219 billion.
65
Medicaid
? A number of policy issues arise in the
provision of Medicaid.
?,Crowd-out”
?,Medicaid Notch”
66
Medicaid Crowd-out
? Providing Medicaid affects both the
uninsured and low income people with
private (employer) health insurance.
? To the extent that families give up costly
private insurance for the free Medicaid
coverage,Medicaid,crowds-out” private
coverage.
67
Medicaid Crowd-out
? The most credible estimates of private
insurance crowd-out suggest that it is
extremely important.
? As many as half of Medicaid recipients
who were covered by recent expansions
were previously privately insured.
68
Medicaid Notch
? The,taxation” of Medicaid is quite different from
the taxation of cash benefits or food stamps.
? Cash benefits are smoothly taken away,albeit
at high tax rates.
? Medicaid is retained in its entirety as long as a
person is eligible for cash assistance,and taken
away in its entirety if a person is ineligible for
cash assistance.
69
Medicaid Notch
? This structure creates implicit tax rates far
greater than 100% for becoming ineligible for
TANF/AFDC.
? Although a person might typically lose,say
$0.80 of cash benefits for earning an extra
$1.00 in the labor market,at the,Medicaid
notch” she would also lose health insurance
that could be valued at several thousand dollars.
70
Medicaid Notch
? Consider Figure 8.9,which abstracts from the
cash welfare benefits.
? Smith receives Medicaid valued at $1000,as
long as hours of work is less than XT (or
earnings are less than Z = w x XT).
? She loses Medicaid for working any more than
that.
Figure 8.9
72
Medicaid Notch
? As illustrated,Medicaid is untaxed for earnings
less than Z (= w x XT).
? At point R on the budget constraint,she loses
Medicaid eligibility,and the entire Medicaid
benefit is taken away from her.
? The blue lines in Figure 8.9 show Smith’s
budget constraint (NRSD),Clearly creates
potential work disincentives.
73
Medicaid and Health
? The main reason for providing (and
expanding) Medicaid is to improve the
health of vulnerable groups.
? Recent evidence suggests small but
important improvements in birthweight
and infant mortality.
74
Food Stamps
? Virtually all poor people can receive food
stamps (unlike cash assistance and
Medicaid).
? In 2001,around 17.3 million food stamp
participants each month,at an annual
cost of $16 billion.
75
Food Stamps
? Food stamps are an in-kind benefit,and
as shown in previous chapter,may be
valued as less than their face value.
? Evidence suggest people buy more food
when they have food stamps rather than
the cash equivalent transfer.
76
Food Stamps
? Takeup rate for food stamps is only
around 70% of eligible households.
– Possibly some,welfare stigma” associated
with participation.
77
Housing Assistance
? Several forms of subsidized housing:
– Public housing,projects”
– Section 8,vouchers” and certificates
? Projects are developed,owned,and run by
local government housing authorities.
? Vouchers are provided to tenants to find
apartments in private market.
78
Housing Assistance
? Projects have gained a reputation as a breeding
ground for crime and other social pathologies.
? As a consequence,little new project
construction since the 1970s.
? Currie and Yelowitz (2000) find that these
negative outcomes are largely illusory.
– Those who lived in projects would have fared poorly
even if they had lived elsewhere.
79
Housing Assistance
? One recent focus in housing policy is
increasing self-sufficiency.
– Perhaps poor neighborhoods or long
distances from employment harm recipients.
? Recent evidence does not find that
moving project households into better
neighborhoods helps their job prospects.
80
Programs to Enhance Earnings
? Education
– Head Start for preschool children
? Training
– Improve job skills
– Heckman (1999) finds,perhaps surprisingly,
that training programs are not very effective
at increasing earnings.
81
Recap of Expenditure Programs
for the Poor
? Welfare spending
? TANF
? Work incentives
? Other cash assistance – EITC & SSI
? Medicaid
? Other in-kind benefits – Food stamps & housing
