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Chapter 7

Government Subsidies and Income Support for the Poor

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Poverty in 2001

33 million people in U.S. affected

12% of the population classified as poor

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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

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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

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Poverty Rate 1960-2001

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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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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.

.

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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 $4140 in 2002 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

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H2

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Housing Services per Month 0

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Subsidy

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Dead Weight Loss or Excess Burden

Dead Weight Loss (sometimes called Excess Burden ) measures the extra benefit a recipient can enjoy from the dollar amount of the price-distorting subsidy if instead the grant was received in a lump sum.

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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

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400 S = MSCA

Excess Burden of Subsidy

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Figure 7.3 Full Subsidization of Medical Services

B

25 = P*

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Medical Office Visits per Year0

Pri

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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

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DM = MSB

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E1 25

Pri

ce

(D

olla

rs)

Medical Office Visits per Year

0

DO DL

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35

Q2

E2

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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

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0

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Food per Month

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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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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

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D TransferPayment B

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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

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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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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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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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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