1

Chapter 7

Government Subsidies and Income Support for the Poor

2

Poverty in 2001

33 million people in U.S. affected

12% of the population classified as poor

3

Poverty in the United StatesPoverty threshold or poverty line

in 2001 Family Structure Threshold ($

income annually)

Single $9,214

One Adult-Two Children $14,269

Two Adults-Two Children $17,960

4

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

5

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.

6

Poverty Rate 1960-2001

7

Why We Have Government Programs to Aid the Poor

Concern about equity-efficiency trade-offs.

Creates the positive externality of social stability.

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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.

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The Positive Externality: Social StabilityCharity 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.

10

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.

.

11

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.

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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 Children’s 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, 2003Program 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

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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.

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Figure 7.1 A Price Distorting Subsidy

B

I

A L'

L

H3

N2

Exp

end

itu

re o

n O

ther

Go

od

s p

er M

on

th (

Do

llar

s)

Housing Services per Month 0

U3

H2

N3 E3

U2

E2

H1

N1 E1

U1

S

Subsidy

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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.

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Figure 7.2 Excess Burden of a Subsidy

B E

Q1

D = MSB

Q2

F E’S’200

C

Number of Apartments Rented

0

Ren

t (D

oll

ars

per

Mo

nth

)

400 S = MSCA

Excess Burden of Subsidy

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Figure 7.3 Full Subsidization of Medical Services

B

25 = P*

MBL

QG

E2

A

Q*

E1

Medical Office Visits per Year0

Pri

ce (

Do

llar

s p

er M

on

th)

Excess Burden

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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.

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Figure 7.4 The Impact of The Medicaid Program on Price: The Case of Increasing Cost

QG

S = MSC

QO' QL QO

DM = MSB

QI

E1 25

Pri

ce

(D

olla

rs)

Medical Office Visits per Year

0

DO DL

DM'

35

Q2

E2

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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.

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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.

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Figure 7.5 Eligibility for Public Housing and the Effect on Housing Consumption

Ex

pe

nd

itu

re o

n O

the

r G

oo

ds

pe

r M

on

th (

Do

llars

)

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

800 = I

A B

I'

210

210 90

U2 U1

J H

400= F E1

M G

U3

E2

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Figure 7.6 Refusing a Public-Housing Subsidy

I

A

Ex

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nd

itu

re o

n O

the

r G

oo

ds

pe

r M

on

th (

Do

llars

)

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

U2 E1

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J

M

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Subsidizing FoodFood 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.

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

A' 0

B

Ex

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nd

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the

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on

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)

0

A

Food per Month

B

F

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B

LE2

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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.

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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.

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Figure 7.8 The Income Effect of a Transfer

A

Inco

me

per

Day

Leisure Hours per Day

0 24 L1

U1

E1

C

L2

U2

E2

U3

E3

F

G

D TransferPayment

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

24 Leisure Hours per Day

Inco

me

per

Day

U1 MaximumDaily

Transfer

D

A

B L*

C

L1

E1 U2

L2

E2

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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

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Break-Even Income

0 = IG – tNIB

IB = IG/tN

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Negative Income TaxEarned Income IE Transfer T = IG – tNIE Disposable Income ID

0 5,000 5,000

1,000 5,000 – (.5 × 1000) = 4,500 5,500

2,000 5,000 – (.5 × 2000) = 4,000 6,000

3,000 5,000 – (.5 × 3000) = 3,500 6,500

4,000 5,000 – (.5 × 4000) = 3,000 7,000

5,000 5,000 – (.5 × 5000) = 2,500 7,500

6,000 5,000 – (.5 × 6000) = 2,000 8,000

7,000 5,000 – (.5 × 7000) = 1,500 8,500

8,000 5,000 – (.5 × 8000) = 1,000 9,000

9,000 5,000 – (.5 × 9000) = 500 9,500

10,000 5,000 – (.5 × 10000) = 0 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

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Wage Rate SubsidiesWage Paid Subsidy

per HourTotal Wage Received

$2.00 $1.50 $3.50

$2.50 $1.25 $3.75

$3.00 $1.00 $4.00

$3.50 $0.75 $4.25

$4.00 $0.50 $4.50

$4.50 $0.25 $4.75

$5.00 $0.00 $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

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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 EITC

$0 $0

$2,000 $810

$4,000 $1,610

$6,000 $2,410

$8,000 $3,210

$10,000 $4,140

$15,000 $3,823

$20,000 $2,770

$33,200 $0

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Figure 7.11 Earned Income Tax Credit in 1999, By Number of Children and Earnings

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Figure 7.10 A Negative Income Tax Plan

IB

45º

IG

Transfers

Taxes

An

nu

al D

isp

os

ab

le In

co

me

(I D

)

Annual Earned Income

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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.

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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.

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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.

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Percent Share of Income by Quintile

Year LowestFifth

Second Fifth

Third Fifth

Fourth Fifth

Highest Fifth

1947 5.0 11.9 17.0 23.1 43.0

1967 4.0 11.1 17.6 24.6 42.7

1976 4.3 10.4 17.0 24.7 43.6

1987 3.8 9.6 16.1 23.3 46.7

1997 3.6 8.9 15.0 22.2 49.4

2001 3.5 8.7 14.6 23.0 50.1