|Major Transfer Programs
- Cash vs. In-Kind Benefits
Social Insurance vs. Welfare
- Income transfer doesn’t always entail cash payments.
- In-Kind benefits, rather than cash, are intended to
specific objectives such as. For example, food stamps are offered
place of cash to assure that recipients purchase only food with the
- The target efficiency of a transfer program refers to how
well the transfers attain their intended purpose.
- Not all the $900 billion of income transfers goes to the
- A lot of student loans go to middle-class college
- Disaster relief helps rebuild both mansions and trailer
- Medicaid is an in-kind welfare program.
- Because there are so many income transfer programs, it’s
to keep track of their many purposes. In general, most transfer
aim to alter market outcomes.
- For WHOM to Produce
WHAT to Produce
- The most obvious goal of transfer programs is to alter
the distribution of income.
- Reducing poverty is the explicit goal of virtually all
welfare programs and is accomplished through transfer payments.
- Transfer payments also seek to change the mix of output.
- Food stamps increase food consumption, housing
increase the demand for housing, student loans increase college
- Reduced Output
- The provision of transfer payments may dull work
- If people reduce their labor supply in response to
income transfers, total output will shrink.
- Attempts to redistribute income may reduce total
- People may also change their nonwork behavior.
- Until 1997, federal welfare benefits (Aid to Families
Dependent Children) were largely available only to one-parent families.
- This created incentive for mothers to remain single and
for teenagers to give birth and establish their own households.
- The largest federal cash welfare program is called
Aid to Needy Families (TANF). The TANF program was created by
welfare reforms in 1996 and replaced an earlier program (AFDC)
- Benefit Determination
- The first task of the TANF program is to identify
- A four-person family with $12,000 of income in 1999 would
have been considered poor.
- Poverty Gap – The shortfall between actual income and the
- The Work Incentive Problem
- We could just give people a check for the amount of their
poverty gap. No one would be poor.
- This might encourage people who are not poor to become
By quitting their jobs, declaring themselves poor, and accepting a
income transfer, they would gain much more leisure at little financial
- Families that are already poor have reduced incentive to
harder to get out of poverty with transfer programs in place.
occurs because the programs are generally set up to reduce benefits as
- Less Compassion
- To reduce this moral hazard, Congress and the states
changed the way benefits are computed.
- They first set a much lower ceiling on welfare benefits.
- States don’t offer to close the poverty gap, instead,
they set a maximum benefit far below the poverty line.
- More Incentives
- To encourage welfare recipients to lift their own incomes
the poverty line, welfare departments made another change in the
- The implicit marginal tax rate was cut from 100 to 67
percent. So we now have a new benefit formula.
- Now a welfare recipient can increase their income above
the poverty level by losing only a portion of their welfare payment.
- Incentives vs. Costs
- Although this new benefit calculation is an improvement,
stills offers a 67 percent marginal tax rate. Why not improve the
- If we don’t impose a marginal tax rate at some point,
everyone will be eligible for welfare benefits.
- We must recognize a basic dilemma:
- Low marginal tax rates encourage more work effort buy
more people eligible for welfare. Low marginal tax rates
work but make it hard to get completely off welfare.
- High marginal tax rates discourage work effort buy make
fewer people eligible for welfare.
- Tax Elasticity of Labor Supply
- The trade-off between more welfare and less work depend
on how responsive people are to marginal tax rates.
- If the tax elasticity of labor supply were zero, it
matter how high the marginal tax rate was: People would work for
- In reality, the tax elasticity of labor supply is more in
range of 0.2 to 0.4, so the marginal tax rates do affect work effort.
- To sidestep this problem, the government simply requires
recipients to work rather than let them make an economic choice.
- The Social Security program faces the same conflicts among
compassion, incentives, and costs.
- Program Features
- Retirement Age
- People born before 1940 can choose early retirement at
62 – 64 and normal retirement at age 65-67. Those who choose
retirement do so with reduced benefits.
- The age threshold for “normal” retirement is increasing
year. By the year 2022, the age threshold for normal retirement
be age 67.
- Progressive Benefits
- Retirement benefits are based on an individuals wages.
- Although high-wage workers receive larger benefit
than low-wage workers, the ratio of benefits to prior wages isn’t
- The Social Security benefits formula is progressive
because the ratio of benefits to prior wages declines as wages increase.
- The Earnings Test
- The government imposes an “earnings test” to determine
much retirement benefits an older person can collect while still
- The Work Disincentive
- In 1999, the wage “ceiling” for workers 62 to 64 was
As a result, a person could earn as much as $9600 and still get maximum
benefits. Any income over $9600 will result in a fifty cent
in benefits for each dollar earned.
- This fifty-percent marginal tax rate creates a large
disincentive for Social Security recipients to work.
- Declining Labor Supply
- Not surprisingly, older people have exited the labor
market in droves.
- The labor force participation rates have declined
dramatically in the U.S. since the 1950s.
- Compassion, Incentives, and Cost
- The primary economic cost of the Social Security program
the benefits it pays, but the reduction in total output that occurs
workers retire early.
- The economic cost of Social Security is increased further
by a labor supply reduction among younger workers.
- As the behavior of both older and younger workers
the economic pie shrinks as we try to redistribute it from younger to
- Trade-Offs – Like any other program, the social security
faces trade-offs between work incentive, budgetary costs and equity
|Privatize Social Security?
- One major difference between private retirement programs
Social Security is that private retirement programs are advanced funded
Social Security is a pay-as-you-go program.
- Many people believe the Social Security system should be
by permitting workers to establish their own retirement plans.
of paying payroll taxes to fund someone else’s benefits, you'd make a
to your own pension fund.
- Although on the surface this seems attractive, it is not
- The primary goal of Social Security is to fend off poverty
the aged. By transferring income from workers to retirees and
income from high-wage workers to low-wage workers in retirement.
these ways, the program changes market outcomes.
- By contrast, a privatized system would let the market alone
FOR WHOM goods are produced. Low-income workers and other people
saved little while working would end up poor in their “golden
Even in a privatized system, some high earners and savers might end up
if their investments turned sour.