Copyright © 2002 by Thomson Learning, Inc. Chapter 7 Government Subsidies and Income Support for the Poor Copyright © 2002 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license. ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval systems—without the written permission of the publisher. Printed in the United States of America ISBN X

Copyright © 2002 by Thomson Learning, Inc. Poverty in 1998  34.5 million  13% of the population classified as poor

Copyright © 2002 by Thomson Learning, Inc. Poverty in the United States Poverty threshold or poverty line in 1999 Family StructureThreshold Single$8,667 One Adult-Two Children $13,410 Two Adults-Two Children $16,600

Copyright © 2002 by Thomson Learning, Inc. Poverty line  The Poverty Line was originally created by the Social Security Administration as three times the cost of a nutritionally adequate diet  It is updated annually for inflation using the CPI

Copyright © 2002 by Thomson Learning, Inc. Poverty Rate Numbers in millions, rates in percent Note: The data points represent the midpoints of the respective years. The latest recession began in July 1990 and ended in March Source: U.S. Census Bureau, Current Population Survey, March Number in poverty Poverty rate 32.3 million Recession 11.8 percent

Copyright © 2002 by Thomson Learning, Inc. Changing the Poverty Line  A new definition proposed during the Clinton Administration would have included child care and other expenses and would raise the threshold to almost $20,000.

Copyright © 2002 by Thomson Learning, Inc. Why We Have Government Programs to Aid the Poor  We are concerned about Equity- Efficiency Trade-Offs.  It creates the Positive Externality of Social Stability.

Copyright © 2002 by Thomson Learning, Inc. Entitlement Programs  Means Tests are typically income and wealth criteria that must be met to be eligible for a program.  Status Tests are typically disability, children, and age criteria that must be met to be eligible for a program. Government programs that guarantee recipients benefits as long as they meet eligibility tests.

Copyright © 2002 by Thomson Learning, Inc. Cash Programs  TANF: Temporary Aid to Needy Families  The program most identified with a welfare check. Also may provide for child-care expenses or job retraining.  SSI: Supplemental Security Income  The program that provides a cash payment to the widowed, orphaned and disabled.  EITC: Earned Income Tax Credit  A program that increases the take-home pay of the working poor. As much as $3888 in 2000 for a family with two children.

Copyright © 2002 by Thomson Learning, Inc. In-Kind Programs  Food Stamps are vouchers that enable a broad class of the poor 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 is a federal and state funded program that provides health care services to the poor.  The Children’s Health Insurance Program is a federal program that subsidizes health insurance coverage for the working poor.

Copyright © 2002 by Thomson Learning, Inc. Major Federal Government Expenditures To Aid the Poor, 2000 ProgramFederal Spending Dollars (Billions) Percentage of Federal Spending SSI$ TANF$ EITC$ Subtotal of Cash Programs$ Medicaid$ Food Stamps$ Child Protection and Social Services $50.79 Child Nutrition$ Subtotal of In-Kind Programs$

Copyright © 2002 by Thomson Learning, Inc. Price Distorting Subsidies  Price Distorting Subsidies lower the price of the particular good relative to others for eligible people.

Copyright © 2002 by Thomson Learning, Inc. Figure 7.1 A Price Distorting Subsidy Expenditure on Other Goods per Month (Dollars) Housing Services per Month 0 L'H1H1 H2H2 H3H3 N3N3 N1N1 N2N2 S I B A L E1E1 E3E3 U2U2 U3U3 U1U1 E2E2 Subsidy

Copyright © 2002 by Thomson Learning, Inc. Dead Weight Loss or Excess Burden  Dead Weight Loss (sometimes called Excess Burden ) is the measure of the dollar value of the distortion that exceeds the amount transferred to the recipient.

Copyright © 2002 by Thomson Learning, Inc. Figure 7.2 Excess Burden of a Subsidy BE Q1Q1 F A E’ S’ D = MSB Number of Apartments Rented Q2Q2 0 C Rent (Dollars per Month) S = MSC Excess Burden of Subsidy

Copyright © 2002 by Thomson Learning, Inc. Figure 7.3 Full Subsidization of Medical Services Medical Office Visits per Year 0 Q* E1E1 QGQG 25 = P* E2E2 MB L B A Price (Dollars per Month) Excess Burden

Copyright © 2002 by Thomson Learning, Inc. Additional Effects of Subsidies: The Case of Increasing Costs  Medicaid not only costs taxpayers money to pay for the program, it also increases the amount they pay for medical services by increasing demand for those services.

Copyright © 2002 by Thomson Learning, Inc. Figure 7.4 The Impact of The Medicaid Program on Price: The Case of Increasing Cost Price (Dollars) Medical Office Visits per Year 0 QIQI O Q' E1E1 QLQL 35 Q2Q2 QGQG QLQL E2E2 25 S = MSC DODO D M = MSB DLDL D' M

Copyright © 2002 by Thomson Learning, Inc. Subsidizing Housing  Providing an Apartment: This subsidy allocates a standard apartment to an eligible recipient. With this type of subsidy the recipient cannot supplement the subsidy with their cash. It is a “take it or leave it” option.  Housing Vouchers: This subsidy allows the recipient a particular allotment of vouchers to rent housing but the recipient may supplement the subsidy with their cash.  Cash: This subsidy is not restricted to spending on housing.

Copyright © 2002 by Thomson Learning, Inc. Figure 7.5 Eligibility for Public Housing and the Effect on Housing Consumption Expenditure on Other Goods per Month (Dollars) Housing per Month (Number of Rooms Rented) = I M H 400= F J BA E1E1 U1U1 U2U2 U3U3 I'I' G E2E2

Copyright © 2002 by Thomson Learning, Inc. Figure 7.6 Refusing a Public-Housing Subsidy Expenditure on Other Goods per Month (Dollars) Housing per Month (Number of Rooms Rented) 0 U3U3 E1E1 U2U2 I M G J A

Copyright © 2002 by Thomson Learning, Inc. Subsidizing Food  Food Stamps are the subsidy that allows the recipient a particular allotment of vouchers to buy food but the recipient may supplement the subsidy with their cash. It is illegal to sell the food stamps though it may be in the recipients interests for them to do so.

Copyright © 2002 by Thomson Learning, Inc. Figure 7.7 The Impact of an In-Kind Transfer: Food Stamps 0 B B I A U2U2 U1U1 A' M1M1 QF1QF1 L U3U3 QFQF Expenditure on Other Goods per Month (Dollars) 0QFQF A B I A U2U2 U1U1 A' M2M2 M1M1 Q F1 Q F2 Food per Month C Q* 1 F QF2QF2 E1E1 E1E1 C E2E2 E1E1

Copyright © 2002 by Thomson Learning, Inc. 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.

Copyright © 2002 by Thomson Learning, Inc. International Food Subsidies  Several nations use a price-reducing subsidy 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.

Copyright © 2002 by Thomson Learning, Inc. Figure 7.8 The Income Effect of a Transfer Income per Day Leisure Hours per Day 0L1L1 24 F C A L2L2 D U3U3 U2U2 U1U1 E1E1 E2E2 E3E3 G Transfer Payment

Copyright © 2002 by Thomson Learning, Inc. Figure 7.9 A Transfer that Declines with Earned Income e.g. T=$300-.7I E L*24L2L2 L1L1 Maximum Daily Transfer Leisure Hours per Day Income per Day U2U2 U1U1 A D B C E1E1 E2E2

Copyright © 2002 by Thomson Learning, Inc. Empirical Evidence  A 10% increase in welfare payments to individuals decreases work effort by 2%.

Copyright © 2002 by Thomson Learning, Inc. A Negative Income Tax  A Negative Income Tax is a system where there is no status test but there is an income guarantee and a take-back rate.  T = I G – t N I E Where  I G = Income guarantee  t N = take back rate  I E = earned income  T = Transfer

Copyright © 2002 by Thomson Learning, Inc. Break-Even Income 0 = I G – t N I B I B = I G /t N

Copyright © 2002 by Thomson Learning, Inc. Negative Income Tax Earned Income I E Transfer T = I G – t N I E Disposable Income I D 05,000 1,0005,000 – (.5 × 1000) = 4,5005,500 2,0005,000 – (.5 × 2000) = 4,0006,000 3,0005,000 – (.5 × 3000) = 3,5006,500 4,0005,000 – (.5 × 4000) = 3,0007,000 5,0005,000 – (.5 × 5000) = 2,5007,500 6,0005,000 – (.5 × 6000) = 2,0008,000 7,0005,000 – (.5 × 7000) = 1,5008,500 8,0005,000 – (.5 × 8000) = 1,0009,000 5,000 – (.5 × 9000) = 5009,500 10,0005,000 – (.5 × 10000) = 010,000

Copyright © 2002 by Thomson Learning, Inc. Wage Rate Subsidies  Wage Rate Subsidies are government additions to wages designed to increase the pay of the working poor.

Copyright © 2002 by Thomson Learning, Inc. Wage Rate Subsidies Wage PaidSubsidy per Hour Total 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 $0.25$4.75 $5.00$0.00$5.00

Copyright © 2002 by Thomson Learning, Inc. EITC  The Earned Income Tax Credit goes to the working poor and varies with the number of children. Typically the recipient receives the assistance with their tax refund but papers can be filed to receive the money in their paychecks throughout the year.

Copyright © 2002 by Thomson Learning, Inc. EITC (1999; two-child family) Total Earned IncomeEITC $0 $2,000$810 $4,000$1,610 $6,000$2,410 $8,000$3,210 $10,000$3,816 $15,000$3,265 $20,000$2,212 $30,580$0

Copyright © 2002 by Thomson Learning, Inc. Figure 7.10 A Negative Income Tax Plan IGIG IBIB Annual Disposable Income (I D ) 45º Transfers Taxes Annual Earned Income

Copyright © 2002 by Thomson Learning, Inc. Wisconsin Work’s  Stringent Work Requirements  Child Care Subsidies  Health Insurance Coverage  Welfare dependency in WI has dropped 60% since 1987

Copyright © 2002 by Thomson Learning, Inc. 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:  subsidized child care  Teen Mothers:  no longer eligible to receive their own payments  must live with responsible adult.  Refusal to work: recipients with children over five who refuse work can be denied aid and have their children placed in foster care

Copyright © 2002 by Thomson Learning, Inc. Figure 7.11 Earned Income Tax Credit in 1999, By Number of Children and Earnings One Child Two or More Children No Children 0 1,000 2,000 3,000 4,000 EITC (Dollars) 5,00010,00015,000 Taxpayer’s Earnings or Adjusted Gross Income (Dollars) 20,00025,00030,00035,000

Copyright © 2002 by Thomson Learning, Inc. 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.

Copyright © 2002 by Thomson Learning, Inc. Percent Share of Income by Quintile year Share of Income lowestsecondthirdfourthhighest