Chapter 34: Transfer Payments: Welfare and Social Security Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 13e

34-2 Transfer Payments A transfer payment is paid out by government to people who have been determined to be eligible to receive the payment. – Legislation is passed authorizing these payments. – There is no exchange of goods or services.

34-3 Transfer Payments The principal recipients of transfer payments are the elderly (Social Security, for example) and the “poor” (welfare payments), although any government subsidy is a transfer payment.

34-4 Transfer Payments A transfer payment has a built-in incentive for people to become eligible to receive it. It is the “get something for nothing” or “free ride” attitude.

34-5 Learning Objectives Know the major income transfer programs Know how transfer programs affect labor supply and total output Know the trade-offs between equity and efficiency.

34-6 Major Transfer Programs Payments can be in cash or in-kind transfers. – Cash transfer: a direct cash payout. Social Security and unemployment compensation. – In-kind transfer: a payout of goods and services. Food stamps, Medicaid, housing subsidies.

34-7 Major Transfer Programs Programs can be social insurance programs or welfare programs. – Social insurance programs are triggered by events. Reaching a certain age makes one eligible for Social Security. Being fired from a job makes one eligible for unemployment compensation. – Welfare programs are means-tested. For eligibility, a family has to prove it has too little income.

34-8 Unintended Consequences Income transfers often change market behavior and outcomes in unintended ways. – If you get paid for not working, why work? – Income transfers are a disincentive to work. – If fewer people work, labor supply is reduced and total output could shrink.

34-9 Unintended Consequences Income transfers often change market behavior and outcomes in unintended ways. – Nonwork behavior could be altered. – Welfare payments could encourage women to have more children. – Teens might become mothers to qualify for a welfare payment. – “Free” health care tends to be overused, congesting the waiting rooms of hospitals and doctors.

34-10 Welfare Programs To identify potential recipients, the poverty threshold was defined, based on how much income is needed for families of different sizes to buy basic necessities. – For a family of four in 2010, the threshold was about $22,000 a year. – Thus a family of four earning $18,000 a year has a poverty gap of $4,000.

34-11 Welfare Programs One way to “solve” the poverty problem would be to identify all who are eligible and provide a cash sum to eliminate every poverty gap. – Send $4,000 to the family previously mentioned.

34-12 Welfare Programs Problems: This provides a strong incentive to be poor. – You make $25,000 working? Quit and get $22,000 without working. If you are already poor, does the welfare check change your work behavior? – You make $18,000 and get $4,000 in welfare. One of the family members can earn $2,000 by working. If she does, your welfare check drops to $2,000, and your total income is still $22,000. Should she take up this opportunity?

34-13 Welfare Programs Can these work disincentives be eliminated (or reduced)? – To provide incentives to take on work, welfare payments would not bring the family up to the poverty threshold. – Another incentive is to not reduce welfare dollar for dollar, so added work increases family income. In the example we just looked at, earn an extra $2,000 and lose $2,000 in welfare. That is the same as a 100% implicit marginal tax rate.

34-14 Welfare Programs The basic dilemma: – Low implicit marginal tax rates encourage more work effort but make more people eligible for welfare. – High implicit marginal tax rates discourage work effort but make fewer people eligible for welfare. Welfare costs can be minimized only if we sacrifice welfare eligibility or sacrifice work incentives. One way to reduce welfare dependence is to limit the amount of time a family will be eligible for welfare. Time runs out? No more welfare payments.

34-15 Social Security Age is the primary determinant of eligibility. The formula to calculate Social Security benefits is skewed toward the low-income worker. – A higher-income worker will receive a larger number of dollars in benefits, but, after retirement, the ratio of payout between high- and low-income workers will be smaller than when they were working.

34-16 Social Security As you approach the age of eligibility for Social Security payments, you make a decision similar to a welfare recipient with a job opportunity: – Should I continue to work, or retire and collect Social Security? – Since the 1960s, the labor force participation rate for men over 65 has been reduced by half.

34-17 Social Security This reveals a major cost of Social Security programs. – When workers retire early, there is a reduction in total output. – To reduce this cost, the practice of heavily taxing Social Security benefits of those who are eligible but still working could be eliminated. Then the cost of working goes down.