chapter: 19 >> Krugman/Wells Economics ©2009  Worth Publishers The Economics of the Welfare State

WHAT YOU WILL LEARN IN THIS CHAPTER  What the welfare state is and the rationale for it  What defines poverty, what causes poverty, and the consequences of poverty  How income inequality in America has changed over time  How programs like Social Security affect poverty and income inequality  The special concerns presented by health care insurance  Why there are political differences and debate over the size of the welfare state

Poverty, Inequality, and Public Policy  The welfare state is the collection of government programs designed to alleviate economic hardship.  A government transfer is a government payment to an individual or to families—that provide financial aid to the poor, assistance to unemployed workers, guaranteed income for the elderly, and assistance in paying medical bills for those with large health care expenses.

The Logic of the Welfare State  One major rationale for the welfare state is alleviating income inequality.  A poverty program is a government program designed to aid the poor.  A second major rationale for the welfare state is alleviating economic insecurity.  A social insurance program is a government program designed to provide protection against unpredictable financial distress.

The Logic of the Welfare State  These two rationales for the welfare state are closely related to the ability-to-pay principle (see Chapter 7).  The ability-to-pay principle was used to justify progressive taxation.

The Logic of the Welfare State  The ability-to-pay principle says that people with low incomes should pay a smaller fraction of their income in taxes than people with higher incomes.  The same principle suggests that those with very low incomes should actually get money back from the tax system.

The Problem of Poverty  The poverty threshold is the annual income below which a family is officially considered poor.  The poverty rate is the percentage of the population with incomes below the poverty threshold.  The following graph shows the U.S. poverty rate since 1959.

U.S. Poverty Rate Year % Trends in the U.S. Poverty Rate, 1959–2006

Who Are the Poor?  In 2006, about 36.5 million Americans were in poverty—12.3% of the population, or about one in eight persons.  About one-quarter of the poor were African- American and a roughly equal number were Hispanic. Within these two groups, poverty rates were well above the national average: 24.3% of African-Americans and 20.6% of Hispanics.  But there was also widespread poverty among non- Hispanic Whites, who had a poverty rate of 8.2%.

Who Are the Poor?  Adults who work full-time are very unlikely to be poor: only 2.7% of full-time workers were poor in  Adults who worked part-time or not at all during the year made up 88.3% of the poor in 2006.

Who Are the Poor?  Female-headed families with no husband present had a very high poverty rate: 30.5%.  Married couples were much less likely to be poor, with a poverty rate of only 4.9%; still, about 38% of poor families were married couples.

What Causes Poverty?  Lack of education  83% “college premium” (2006)  Lack of proficiency in English  Racial and gender discrimination  Bad luck

Consequences of Poverty The consequences of poverty include:  lack of access to health care  lack of access to affordable housing  learning disabilities  Children raised in severe poverty tend to suffer from lifelong learning disabilities.

Consequences of Poverty  Poverty is self-perpetuating.  The children of the poor start at such a disadvantage relative to other Americans that it’s very hard for them to achieve a better life.

Economic Inequality  Mean household income is the average income across all households.  Median household income is the income of the household lying at the exact middle of the income distribution.

Economic Inequality  Income in the United States is quite unequally distributed.  The average income of the poorest fifth of families is less than a quarter of the average income of families in the middle.  The richest fifth have an average income more than three times that of families in the middle.  The incomes of the richest fifth of the population are, on average, about 15 times as high as those of the poorest fifth.  The distribution of income in America has become more unequal since 1980.

Economic Inequality  The Gini coefficient is a number that summarizes a country’s level of income inequality based on how unequally income is distributed across quintiles.

Income Inequality Around the World

The U.S. Welfare State

 A means-tested program is a program available only to individuals or families whose incomes fall below a certain level.  Social Security, the largest program in the U.S. welfare state, is a non-means-tested program that provides retirement income for the elderly. It provides a significant share of the income of most elderly Americans.  Unemployment insurance is also a key social insurance program.

The U.S. Welfare State  An in-kind benefit is a benefit given in the form of goods or services.  A negative income tax is a program that supplements the income of low-income working families.

The Effects of the Welfare State on Poverty and Inequality

 The American welfare state is redistributive.  It increases the share of income going to the poorest 60% while reducing the share going to the richest 20%.

The Economics of Health Care  Health insurance satisfies an important need because expensive medical treatment is unaffordable for most families.  Under private health insurance, each member of a large pool of individuals pays a fixed amount to a private company that agrees to pay most of the medical expenses of the pool’s members.

Private Insurance 34% Medicare 19% Medicaid 15% Who Paid for U.S. Health Care in 2006? Out of pocket 12% Other private 7% Other public 12%

Who Paid for U.S. Health Care in 2006? The majority of Americans not covered by private insurance are covered by:  Medicare, which is non-means-tested and applies only to those age 65 and older, and  Medicaid, which is available based on income.

The Economics of Health Care

Percent (a) Barriers to Receiving HealthCare, % % 9% 35% 9% 37% 47% 15% 13% No regular source of care Postponed seeking care because of cost Needed care but did not get it Did not fill a prescription because of cost (b) The Financial Burden of Paying Medical Bills, % % 16% 23% 9% 8% InsuredUninsured Had problem paying medical bills Changed way of life significantly to pay medical bills Contacted by collection agency about medical bills The Consequences of Being Uninsured Percent

Health Care in Other Countries  The United States differs from other wealthy countries in its heavy dependence on private health insurance and its high health care spending per person.  Compared to other wealthy countries, the U.S. system has much higher costs.  The higher costs do not necessarily imply better care.

Health Care in Other Countries  Some countries, such as Canada, have a single- payer system.  A single-payer system is a health care system in which the government is the principal payer of medical bills funded through taxes.

Health Care in Other Countries

Medicaid and SCHIP –5 Change (millions) Employment-based coverage PopulationUninsured 17.3 – Changes in Health Insurance Status, 2000–2006

Health care expenditure (percent of GDP) Year % Rising Health Care Costs

The Debate Over the Welfare State The debates over the welfare state include the following questions and concerns:  about how large the welfare state should be  philosophical concerns about government involvement  about the trade-off between efficiency and equity  that high marginal tax rates to finance an extensive welfare state can reduce the incentive to work  that means-testing programs to reduce the cost of the welfare state also reduce the incentive to work

The Debate Over the Welfare State

SUMMARY 1.The welfare state absorbs a large share of government spending in all wealthy countries. Government transfers are the payments made by the government to individuals and families. Poverty programs alleviate income inequality by helping the poor; social insurance programs alleviate economic insecurity. 2.The poverty threshold is adjusted according to the cost of living, but not according to the standard of living. The average American income has risen substantially over those 30 years. However, the poverty rate in the U.S. — the percentage of the population with an income below the poverty threshold — is no lower than it was 30 years ago. There are various causes of poverty: lack of education, the legacy of discrimination, and bad luck.

SUMMARY 3. Median household income, the income of a family at the center of the income distribution, is a better indicator of the income of the typical household than mean household income because it is not distorted by the inclusion of a small number of very wealthy households. The Gini coefficient, a number that summarizes a country’s level of income inequality based on how unequally income is distributed across quintiles, is used to compare income inequality across countries.

SUMMARY 4. Both means-tested and non-means-tested programs reduce poverty. The major in-kind benefits programs are Medicare and Medicaid, which pay for medical care. Due to concerns about the effects on incentives to work and on family cohesion, aid to poor families has become significantly less generous even as the negative income tax has become more generous. Social Security, the largest U.S. welfare state program, has significantly reduced poverty among the elderly. Unemployment insurance is also a key social insurance program.

SUMMARY 5. Health insurance satisfies an important need because most families cannot afford expensive medical treatment. Private health insurance, unless it is employment-based, has the potential to fall into an adverse selection death spiral. Most Americans are covered by employment-based private health insurance; most of the remaining are covered by Medicare (for those over 65) or Medicaid (for those with low incomes). 6. Compared to other countries, the United States relies more heavily on private health insurance and has substantially higher health care costs per person without providing better care. Some countries have a singlepayer system, a system in which the government pays most medical bills, funded through taxes.

SUMMARY 7. Debates over the size of the welfare state are based on philosophical and equity-versus-efficiency considerations. 8. Politicians on the left tend to favor a bigger welfare state and those on the right oppose it. This left-right distinction is central to today’s politics. America’s two major political parties have become more polarized in recent decades, with a much clearer distinction than in the past about where their members stand on the left-right spectrum.