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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 Hazard of Welfare
17.5 Conclusion
Income Distribution and Welfare Programs
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Introduction: Differences in Life Expectancy
The last week of April 2015, was marked by several weeks of violence in Baltimore, Maryland. Sparked by the death of minority prisoner Freddie Gray while in custody of the police, the protests resulted in about 113 police injuries, 486 arrests, and an estimated $9 million in damage to businesses. But while the death of Freddie Gray may have incited this violence, the larger cause may have been the astounding level of inequality in the city of Baltimore. Even in neighborhoods only several miles apart, life circumstances in Baltimore are dramatically different.
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Introduction: Differences in Life Expectancy
The vast differences across close neighborhoods is immediately apparent.
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Introduction: Differences in Life Expectancy
In Freddie Gray’s neighborhood of Sandtown-Winchester, the average life expectancy is 67 years; just 3 miles away in the wealthy Baltimore neighborhood of Roland Park, life expectancy averages 84 years.
The life expectancy in Freddie Gray’s neighborhood is well below that in North Korea, one of the poorest countries in the world—and at about the same level as the U.S. average in 1948.
This is not an isolated example: 15 Baltimore neighborhoods have a life expectancy below that of North Korea.
This enormous discrepancy represents huge underlying differences in economic resources in these different neighborhoods.
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Income Distribution and Welfare Programs
This dramatic discrepancy in resources raises a central question for public finance.
Social welfare may be maximized by redistributing from high-income individuals to low-income individuals, but the private sector is unlikely to provide such income redistribution.
Government can solve this problem by taxing its citizens to provide public redistribution.
The most well-known source of redistributing income to low-income citizens is through cash welfare, government programs that make cash payments to low-income populations.
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Income Distribution and Welfare Programs
To some conservatives, the negative effects of cash payments to low-income single mothers are responsible for many of the social ills in the United States.
To some liberals, it is wrong to force low-income families off welfare and into the labor market.
Has cash welfare played a constructive or destructive role in the lives of lower-income groups
In this chapter, we discuss income redistribution and its effects.
17.1
Relative income inequality has increased in the United States.
Relative income inequality: The amount of income that the poor have relative to the rich.
Facts on Income Distribution in the United States: Relative Income Inequality
Income share of: 1967 1980 1990 2000 2010 2013
Lowest 20% 4 4.4 3.9 3.6 3.3 3.2
Second 20% 10.8 10.3 9.6 8.9 8.5 8.4
Third 20% 17.3 16.9 15.9 14.8 14.6 14.4
Fourth 20% 24.2 24.9 24 23 23.4 23.0
Highest 20% 43.8 43.7 46.6 49.8 50.2 51.0
Top 5% 17.5 15.8 18.6 22.1 21.3 22.2
17.1
Facts on Income Distribution in the United States: Relative Income Inequality
Much of the income inequality has been driven by enormous increases in income at the very top of the income distribution.
17.1
Relative Income Inequality: Select OECD Countries, 2013
Income Share in Total Income Bottom 10% Bottom 20% Bottom 40% Top 40% Top 20% Top
10%
Sweden 3.5 8.7 22.7 59.0 36.1 21.9
Austria 3.1 8.5 22.6 59.2 36.0 21.6
France 3.4 8.5 21.8 61.3 39.5 25.3
UK 2.7 7.2 19.3 64.5 42.6 28.0
USA 1.6 5.2 16.0 68.2 45.5 30.0
Mexico 1.2 3.9 12.5 73.9 52.9 36.7
OECD Average 2.9 7.7 20.6 62.2 39.4 24.6
Relative income inequality in the United States is much higher than
in other developed nations.
17.1
Inequality does not measure absolute deprivation.
Absolute deprivation: The amount of income the poor have relative to some measure of “minimally acceptable” income.
Measured by the share of people below poverty line.
Poverty line: The federal government’s standard for measuring absolute deprivation.
It was determined to be three times the cost of a minimally nutritionally accepted diet.
Absolute Deprivation and Poverty Rates
17.1
Poverty Lines by Family Size (2015)
Size of Family Unit Poverty Line
1 $11,170
2 15,930
3 20,090
4 24,250
5 28,410
For each additional person, add 4,160
Since their development in 1964, these amounts have simply been updated for inflation.
17.1
Poverty Rates over Time in the United States
Poverty rates declined rapidly in 1960s and early 1970s and then oscillated for all age groups. Poverty rates began to decline again after 2010.
17.1
Three problems in determining where poverty begins:
Bundle has changed.
Health care important, but only food price mattered in initial poverty line.
Differences in cost of living.
Rents differ enormously across areas.
Income definition is incomplete.
Medicaid does not count toward poverty line.
APPLICATION: Problems in Poverty Line Measurement
17.1
APPLICATION: Problems in Poverty Line Measurement
In the early 1990s, a National Academy of Sciences panel proposed changes to correct these problems.
But there are practical difficulties:
How to quantify the value from income smoothing due to receiving Medicaid when adjusting income
Implementing these changes would lead to huge redistribution from the South and Midwest to the East and West.
17.1
Why does it matter how much money the rich have
The “minimal” standard of living may be best defined relative to the standard of living of others.
Greater relative income inequality itself may decrease individual well-being.
What Matters—Relative or Absolute Deprivation
17.2
Welfare programs can be categorical or means-tested.
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.
Welfare Policy in the United States
They can also be cash or in-kind.
Cash welfare: Welfare programs that provide cash benefits to recipients.
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.
In-kind welfare: Welfare programs that deliver goods, such as medical care or housing, to recipients.
17.2
Welfare Policy in the United States
17.2
Two prominent cash welfare programs:
Temporary Assistance for Needy Families (TANF)
Low-income families, one parent absent.
Benefit guarantee and benefit reduction rate vary across states.
Supplemental Security Income.
Serves aged, blind, and disabled.
Cash Welfare Programs
17.2
Supplemental Nutrition Assistance Program
Provides a debit card that can be used to buy food.
Medicaid
Largest categorical welfare program.
Public Housing
“Section 8 vouchers” subsidize housing.
Other Nutritional Programs
WIC; school lunch program.
In-Kind Programs
17.3
Means-tested transfer systems cause moral hazard.
Consider a simplified version of TANF, with benefits B:
G is the guarantee, t the benefit reduction rate, w wages and h hours worked.
Setting G = $10,000 and t = 1, it would cost $218 billion to eliminate poverty, less than Social Security spending.
This ignores behavioral responses.
Moral Hazard Effects of a Means-Tested Transfer System
2,000
$25,000
$ of consumption per year
Hours of leisure
per year
0
Moral Hazard Effects of a Means-Tested Transfer System
17.3
A
B
C
D
X
Y
Z
400
1,600
20,000
12,170
5,000
G = 11,170
1,027
1,106
Slope = wage = 12.50
100% Benefit Reduction Rate: All families with income below the poverty line and many individuals with income above the poverty line immediately stop earning income so they can get more leisure and consumption.
2,000
C
$25,000
$ of consumption per year
Hours of leisure
per year
0
Solving Moral Hazard by Lowering the Benefit Reduction Rate
17.3
A
B1
D
X1
Y1
Z1
200
1,600
22,500
12,170
5,000
G = 11,170
1,027
1,106
Slope = wage = 12.50
268
X2
Y2
Z2
Slope = net wage = 6.25
B2
22,340
50% Benefit Reduction Rate: The net impact of new rate on labor supply is ambiguous and depends on relative sizes and preferences of worker groups.
17.3
Reducing the benefit rate ends up redistributing less.
This illustrates 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.
The “Iron Triangle” of Redistributive Programs
17.3
There are three approaches that might get around this “Iron Triangle.”
Moving to categorical welfare payments
Using “Ordeal Mechanisms”
Increasing outside options
The “Iron Triangle” of Redistributive Programs
17.4
Moral hazard arises because the government wants to redistribute to poor people, but people control their income.
If we could target benefits to earnings capacity, there would be no moral hazard.
Two targets are people with disabilities and single mothers.
What Makes a Good Targeting Mechanism
No way to change behavior in order to qualify.
Targets people with low earning capacity.
Moving to Categorical Welfare Payments
17.4
Targeting by Single Motherhood
Time series evidence shows that in the 1960s, single motherhood and welfare benefits rose in lockstep. In subsequent years, however, single motherhood continued to rise despite dramatic declines in welfare benefits in real terms.
17.4
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.
Using “Ordeal Mechanisms”
17.4
In setting up a soup kitchen to support the needy, the government can:
Hire many workers, keeping wait times down.
Hire few workers, producing long lines.
The long line might discourage high-earners from using the soup kitchen.
The ordeal mechanism works because the target population has a relatively high value for the good (soup) and a relatively low cost for the ordeal.
APPLICATION: An Example of Ordeal Mechanisms
17.4
Increase the outside options available to individuals so that it is no longer attractive to be on welfare:
Training
Modest declines in welfare use, earnings increases.
Labor Market Subsidies
Increase employment, reduces welfare use.
Child care
Increases mother’s employment.
Child Support
Shifts burdens to “deadbeat dads.”
Remove Welfare Lock
Increasing Outside Options
Hours of leisure
per year
C
2,000
$ of consumption per year
0
A
B
D
Y1
1,000
1,381
17,500
25,000
12,170
$35,000
G = 11,170
1,027
1,106
Slope = wage = 17.50
Y2
F
E
Slope = wage = 12.50
Increasing Outside Options
17.4
Higher wage makes welfare a less attractive option relative to work.
17.4
Remove “Welfare Lock”
For many low-income mothers, health insurance is tied to non-work, through Medicaid.
Unlinking cash and in-kind benefits increases the value of working.
Under current system, working more than a small amount produces a large penalty from lost Medicaid benefits.
A
24,340
$25,000
$ of consumption per year
Hours of leisure
per year
0
C
D
E
2,000
G = 11,170
268
Slope = net wage = 6.25
B
22,340
F
Slope = net wage = 12.50
Health insurance =
$2,000
Cash =
$11,170
Remove “Welfare Lock”
17.4
Uncouple women’s eligibility for health insurance from their receiving cash welfare payments; however, even the largest estimates suggest that such uncoupling only very modestly decreases the number on welfare rolls.
17.4
Randomized evaluation of a work subsidy program.
Offered large wage subsidies to a (random) group of Canadians on welfare for more than one year.
The subsidy increased employment by 43% in the short-run, relative to control group.
The rate of welfare enrollment fell by roughly the same amount.
After five years, the impact on employment welfare use fell to zero.
EVIDENCE: The Canadian Self-Sufficiency Project
17.4
While subsidized or free child care or pre-school may be a means of promoting work among mothers who might otherwise be on welfare, the most important impacts of such programs may be on the children themselves. An open and crucial question is how shifting across modes of care for children, from home to child care to pre-school, affects both the short- and long-run outcomes for these children.
APPLICATION: Child Care, Preschool, and Child Outcomes
17.4
Currie and Thomas (1995) compared siblings to evaluate the Head Start program.
Children in the Head Start program had higher test scores and better health at younger ages, and higher test scores, greater graduation rates, lower likelihood of arrests, and lower likelihood of smoking at older ages.
This approach suffers from the problem, however, that there may be other things that differ across siblings.
APPLICATION: Child Care, Preschool, and Child Outcomes
17.4
Carneiro and Ginja (2008) use a discontinuity strategy to study outcomes of children in the Head Start program.
Head Start participation reduces behavior problems and obesity at ages 12–13, and reduces depression, obesity, and criminality for those ages 16–17.
A limitation of this approach is that family income is not perfectly verified by Head Start, so that families may be able to manipulate their income to qualify for the program.
APPLICATION: Child Care, Preschool, and Child Outcomes
17.4
The Head Start Impact Study (2002) randomly assigned children who had applied to an oversubscribed Head Start program to two groups: a treatment group that was granted admission and a control group that was denied.
The findings support the notion that Head Start leads to significant improvements in child outcomes in the short run.
The studies also find that these effects fade out over time, so that any test score gains have largely disappeared by first grade (Bitler et al., 2014).
APPLICATION: Child Care, Preschool, and Child Outcomes
17.4
Studies from the 1960s, recent studies using quasi-experimental variation, and numerous studies of the introduction of pre-kindergarten programs:
Paints a fairly consistent picture of positive effects of child care and pre-school access for the educational and social outcomes of disadvantaged youth, especially for highly intensive interventions.
The effects appears modest or even negative for youth from families with more resources.
Suggests that policies that endeavor to direct resources to the most disadvantaged children, rather than universal entitlement to child care, may be more productive in the long run.
APPLICATION: Child Care, Preschool, and Child Outcomes
17.4
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.
APPLICATION: Evaluating the 1996 Welfare Reform
In 1996, President Clinton signed into law the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA).
17.4
APPLICATION: Evaluating the 1996 Welfare Reform
Note the association between the timing of this law and the reduction in welfare caseloads. After reaching a peak in 1994, welfare caseloads had declined by more than three-fourths by 2014.
17.4
PRWORA is difficult to evaluate because it was implemented all-at-once across the states.
So many different aspects of the welfare laws changed that it is hard to assign a causal impact to any one of the changes.
Two prominent approaches:
Compare outcomes of single mothers to others.
Look at states that experimented with alternative policies before national reform.
APPLICATION: Evaluating the 1996 Welfare Reform
17.4
Overall conclusion of evaluations:
About one-third of the decline in the welfare rolls can be ascribed to reform, with the rest due to the improving economy.
Despite enormous reduction in use of welfare, 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.
Effects of the 1996 Welfare Reform
17.4
Welfare rolls have fallen without lowering incomes of single mothers.
Although incomes did not fall for single mothers on average, they didn’t rise much either. Leisure clearly declined, suggesting a reduction in overall well-being.
The reform was passed during an economic expansion, and the welfare system has not responded well to the deep recession.
Was Welfare Reform a Success
17.5
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.
Conclusion

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