Chapter 7

Government Subsidies and Income Support for the Poor

Poverty in 2001

33 million people in U.S. affected 12% of the population classified as poor

Poverty in the United States Poverty threshold or poverty line in 2001

Family Structure Single
One Adult-Two Children Two Adults-Two Children Threshold ($ income annually)

$9,214 $14,269 $17,960

Poverty line

Poverty Line: originally created by the Social Security Administration as three times the cost of a nutritionally adequate diet Updated annually for inflation using the CPI
4

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.

Poverty Rate 1960-2001

Why We Have Government Programs to Aid the Poor

Concern about equity-efficiency tradeoffs. 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.
8

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.

10

Cash Programs
TANF: Temporary Aid to Needy Families

Program most identified with a welfare check; may provide for child-care expenses or job retraining Program provides cash payments to the widowed, orphaned and disabled. 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.

SSI: Supplemental Security Income

EITC: Earned Income Tax Credit

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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 Childrens Health Insurance Program: federal program that subsidizes health insurance coverage for the working poor.
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Major Federal Government Expenditures To Aid the Poor, 2003

Program SSI TANF EITC Subtotal of Cash Programs Medicaid Food Stamps Child Protection and Social Services Child Nutrition Subtotal of In-Kind Programs Federal Spending Dollars (Billions) $32 $26 $35 $93 $155 $24 $4 $11 $287 Percentage of Federal Spending 1.52 1.23 1.66 4.41 7.36 1.14 0.52 9.21 13.62

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Price Distorting Subsidies

Price Distorting Subsidies lower the price of a particular (subsidized) good relative to other goods for eligible people.
14

Figure 7.1 A Price Distorting Subsidy

L
Expenditure on Other Goods per Month (Dollars)

I N3 N1 N2 Subsidy S E3 E1 U1 E2 U3 U2

H1 H2 H3 A L' Housing Services per Month

B
15

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.

16

Figure 7.2 Excess Burden of a Subsidy

Rent (Dollars per Month)

Excess Burden of Subsidy 400 B E A S = MSC

200

S D = MSB

Q1

Q2
17

Number of Apartments Rented

Figure 7.3 Full Subsidization of Medical Services

Price (Dollars per Month) B

25 = P*

E1 Excess Burden MBL

E2 0 Q* QG Medical Office Visits per Year 18

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.
19

Figure 7.4 The Impact of The Medicaid Program on Price: The Case of Increasing Cost
S = MSC Price (Dollars) E2 E1 DM' DL 0 QL QO' QOQI QG Q2 Medical Office Visits per Year
20

35 25

DM = MSB DO

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.

21

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. 22

Figure 7.5 Eligibility for Public Housing and the Effect on Housing Consumption
Expenditure on Other Goods per Month (Dollars) I' 800 = I 90 M H 400= F 210 G 210 J E1 U1 U3 U2 A B
23

E2

0 1 2 3 4 5 6 7 Housing per Month (Number of Rooms Rented)

Figure 7.6 Refusing a Public-Housing Subsidy

Expenditure on Other Goods per Month (Dollars) I M G J E1 U3

U2

0 1 2 3 4 5 6 7 A Housing per Month (Number of Rooms Rented)

24

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.
25

Figure 7.7 The Impact of an In-Kind Transfer: Food Stamps

A Expenditure on Other Goods per Month (Dollars) B

B I M2 M1 F C E1 U2 U1 0 QF QF1 QF2 A A' E2

B L I M1

E2 C E1 U1 U3 U2

QF 0 QF2 QF3 QF* Food per Month A A'

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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.

27

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.
28

Figure 7.8 The Income Effect of a Transfer

F U3
Income per Day

C A U1 U2 E2 E1 D Transfer Payment 0 L1 L2 24
29 Leisure Hours per Day

E3 G

Figure 7.9 A Transfer that Declines with Earned Income e.g. T=$300-.7IE
A

Income per Day

C E1 U1

E2 U 2

D Maximum Daily Transfer

B L*
Leisure Hours per Day

L1

L2

24
30

Empirical Evidence

A 10% increase in welfare payments to individuals decreases work effort by 2%.

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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

32

Break-Even Income 0 = IG t N IB

IB = IG/tN
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Negative Income Tax

Earned Income IE 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000 Transfer T = IG tNIE 5,000 5,000 (.5 1000) = 4,500 5,000 (.5 2000) = 4,000 5,000 (.5 3000) = 3,500 5,000 (.5 4000) = 3,000 5,000 (.5 5000) = 2,500 5,000 (.5 6000) = 2,000 5,000 (.5 7000) = 1,500 5,000 (.5 8000) = 1,000 5,000 (.5 9000) = 500 5,000 (.5 10000) = 0 Disposable Income ID 5,000 5,500 6,000 6,500 7,000 7,500 8,000 8,500 9,000 9,500 10,000

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Wage Rate Subsidies

Wage Rate Subsidies: government additions to wages designed to increase the pay of the working poor

35

Wage Rate Subsidies

Wage Paid $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $5.00 Subsidy per Hour $1.50 $1.25 $1.00 $0.75 $0.50 $0.25 $0.00
Total Wage Received

$3.50 $3.75 $4.00 $4.25 $4.50 $4.75 $5.00

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Wisconsin Works

Stringent Work Requirements Child Care Subsidies Health Insurance Coverage Welfare dependency in WI has dropped 60% since 1987
37

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.
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EITC (2002; two-child family)

Total Earned Income $0 $2,000 $4,000 $6,000 $8,000 $10,000 $15,000 $20,000 $33,200 EITC $0 $810 $1,610 $2,410 $3,210 $4,140 $3,823 $2,770 $0
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Figure 7.11 Earned Income Tax Credit in 1999, By Number of Children and Earnings

40

Figure 7.10 A Negative Income Tax Plan

Annual Disposable Income (ID )

Taxes Transfers IG 45 IB
Annual Earned Income 41

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 have children over five and the parents refuse to work, families can be denied aid and children may be placed in foster care.

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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. 43

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.
44

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.
45

Percent Share of Income by Quintile

Year 1947 1967 1976 1987 1997 2001 LowestF Second Third ifth Fifth Fifth 5.0 4.0 4.3 3.8 3.6 3.5 11.9 11.1 10.4 9.6 8.9 8.7 Fourth Fifth Highest Fifth 43.0 42.7 43.6 46.7 49.4 50.1
46

17.0 17.6 17.0 16.1 15.0 14.6

23.1 24.6 24.7 23.3 22.2 23.0