targeting welfare comment

8/9/2019 Targeting Welfare Comment

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THE ECONOMIC RECORD. VOL. 73. NO. 220. MARCH 1997.45-50

Targeting Welfare: A Comment"PETER WHITEFORDStrategic Planning Division,Department of Social Securiry,Canberra

Mitchell, Harding and Gruen (1994) survey the redistributiveimpact of Australia's targeted social security system using Lux-embou rg Income Study data. They argue that the Australian systemhas the highest target eficiency amon g ten countries, but the lowestbenefit generosity (aft er taking account of t ar clawba cks). implyingthat generosity is greater in universal or contributory systems. Th iscomment identifies methodological problems with the accountingframework used by Mitchell, Harding and Gruen. although alsoarguing that the Australian targeted incom e support system is likelyto be more eficient at reducing poverty than social insurancesystems. An alternative mcthodological approach is outlined.

I IntroductionIn the Economic Record (Vol. 70. No. 10. Sep-tember 1994, pp. 31540),Mitchell, Harding and

Gruen (hencefonvard MHG) survey the advan-tages and disadvantages of targeting welfare pay-ments. The authors' central argument relates towhether income-tested benefits are more or lessgenerous to the poor than universal or contribu-tory benefits.By definition. for a given expenditure level. ameans-tested system will provide more generousbenefits to the poor than universal or earnings-related benefits. The level of social securityexpenditure is not fixed, however, and may not beindependent of the structure of benefits (Saunders1994). A means-tested program with a highlyredistributive formula may achieve limited redis-tribution if the quantum of spending is low, but ahigh cost, earnings-related system may achievegreater redistribution by providing more generousbasic benefits (Barr 1992; Saunders 1994). Com-parative studies suggest the poor have done bestin large welfare states, benefiting from a 'benigntrickledown' from the middle class (Baldwin1990). Such arguments are particularly significant

The views expressed are my own. and not those ofthe Department of Social Security.

in Australia and New Zealand. which aloneamong OECD countries have non-contributorysocial security systems. If targeting is actuallyassociated with higher poverty and inequality thanuniversal benefits. a major rationale for thisapproach appears to collapse.Most comparative studies, including MHG,employ a specific framework for analyzingincome redistribution. This comment identifiessome methodological problems with this frarne-work, although also arguing that the Australiantargeted income support system is likely to bemore efficient at reducing poverty than socialinsurance systems. While MHG's conclusion iscorrect, their methodology is unreliable. An alter-native methodological approach is outlined.

11 Measuring the EBciency and Effectivenessof TransfersMHG use a framework derived from Becker-man (1979) and Beckennan and Clark (1982) toanalyze the efficiency and effectiveness of incomesupport. These measures assume that the differ-ence between the distribution of income 'before'and 'after' government intervention measures theextent to which policy reduces poverty. Theindexes developed all derive from the 'pre-transfer poverty gap', the shortfall between actual

451997. The Economic Society of Australia. ISSN 00134249.


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46 ECONOMICRECORD MARCH

incomes and the poverty line, for individualswhose incomes are below the poverty line beforereceiving transfers and paying taxes. Need is thepre-transfer poverty gap as a percentage of factorincome. The poverty reduction efficiency of thetransfer system is defined as the reduction in thepoverty gap as a proportion of transfer spending.Effectiveness is measured as the ratio of thepost-transfer poverty gap to the pre-transferpoverty gap. with outcomes being the post-trans-fer poverty gap as a proportion of factor income(MHG 1994, p. 324-5). The authors extend thisframework to take account of the clawback oftransfers through direct taxes.MHG use 1980s Luxembourg Income Study(LIS) data to compare the tax-transfer systems often countries and show that the Australian socialsecurity system has the highest targeting effi-ciency, and one of the lowest tax clawbacks. butthe generosity of the system after taking accountof tax clawbacks is lower than any other country(Table 2, p. 332). MHG conclude that generosityis greater in universal or contributory systems, butthe higher efficiency of the Australian systemleads to more favourable outcomes than expectedfrom spending levels. To this extent, targetingappears to be a partial success.

111 The Standard ApproachIn common with the studies they criticise. MHGadopt the standard approach (Ringen 1987) toanalyze income data. This framework, shown inFigure I , is essentially an accounting device forrelating different components to each other andfor deriving aggregates such as cash disposableincome. Within the LIS and other microdata, thisframework is applied to each households incometo produce the income measures shown. Theredistribution achieved by taxes or transfers is cal-culated by comparing income shares, Gini coef-ficients, or poverty indexes at different stages inthe process in Figure 1. MHG use poverty linesset at different proportions of median disposableincome (Measure4). Pre-transfer poverty gaps arecalculated by comparing the difference betweenmarket income (Measure 2) and the poverty line.The need, generosity, efficiency and effectivenessmeasures are estimated from the pre-transferpoverty gaps; only the outcome measure is inde-pendent of the pre-transfer poverty gap.This framework is not only used by MHG, utby virtually all studies using LIS, nd most single-countq studies. There are a number of obvious

FIGUREThe Income Accounting Framework

wags ud S I h n

limitations, however, that invalidate statisticalmeasures based on this framework.IV T h e C o u n t e g a c t u a lAs is well known, any assessment of the distri-butional impact of social policies involves a com-parison of the observed distribution with acounterfactual-the hypothetical distributionexisting in the absence of the policies evaluated

(Pederson 1994). The Beckerman measures use acounterfactual in which taxes and transfers haveno behaviounl effects on the underlying incomedistribution. The accounting period is usually oneyear. and in some countries the original incomedata are weekly. The framework is linear, imply-ing that the distribution of factor and marketincomes precedes the operation of the tax andtransfer systems, with no interactions betweenthem, apart from the direct effect of governmentprograms in reducing final inequality. Thoseapplying this approach across countries implicitlyassume that wide variations in welfare state size


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1997 TARGETING WELFARE: A COMMENT 47have the same (zero) behavioural impact in eachcountry.The standard approach exaggerates the basicinequality of market incomes and then exagger-ates the amount of redistribution achieved bysocial policies (Layard 1977; Reynolds and Smo-lensky 1977). This is obvious in MHGs results.he-transfer poverty gaps are greatest in the UK.Sweden, France and Germany and lowest i nAustralia, Canada and the United States, the coun-tries with the lowest level of welfare spending(Table 3). Similarly, Smeeding and Coder (1993)find enormous differences in market income in -equality. and correspondingly in the effectivenessof different systems in reducing inequality. InAustralia. Canada and the United States. house-holds at the 80th percentile of market income haveincomes about five times greater than householdsat the 20th percentile. In the Netherlands andSweden this ratio is twice as great again, and i nthe United Kingdom inequality i n market incomesis nearly three times as great as in the UnitedStates. In Australia. Canada and the United States.the welfare state appears to reduce income in -equality by 40 per cent, while in the Netherlands,Sweden and the United Kingdom, inequality isreduced by around 80 per cent. These results area classic illustration of the counterfactual problem.It is scarcely plausible that underlying income in -equality in Sweden is twice as great &$ in theUnited States. Swedish earnings inequality ismuch lower than i n the USA and at the time ofthe LIS surveys Swedish unemployment wasmuch lower than in the United States.These results simply reflect the fact that moretransfer recipients have zero or extremely lowmarket incomes in larger welfare states. In effect,middle income groups in large welfare states aretreated as if they plunge into poverty on retire-ment, simply because the government providestheir pensions, Higher private provision reducesmeasured dispersion in market incomes inAustralia. Canada. and the United States. To theextent that transfers displace private savings inlarger welfare states, both inequality and redistri-bution are exaggerated. This effect is exacerbatedin Sweden (and France, Germany, Italy and Lux-embourg) because private and occupational pen-sions are aggregated with social insurance in thesecountries data. That is, occupational and privatepensions should be included in market income,but are actually included in transfer incomes forthese countries. Given this, it is doubtful whetherthe Beckerman measures are precisely meaningful

for the purposes used. Apart from the outcomemeasure, they are all derived from the pre-transferpoveny gap, a measure of dubious validity.Nevertheless, some may argue the general conclu-sions are still correct. The post-transfer povertygap is unaffected by these problems, and post-transfer poverty is lowest in the highest spendingwelfare states. While i t may not be valid to cal-culate precise measures of redistribution, this sug-gests an association between high levels ofspending and lower poverty outcomes.

V Accounting for GovernmentThere are further issues, however, to be takeninto account before reaching firm conclusions.The standard framework takes account of only

some government policies. Most income surveysinclude information only on cash transfers anddirect taxes (income taxes and employee socialsecurity contributions). This is problematic, as theeffective coverage in LIS of total taxes and ben-efits varies widely. Income taxes account for 46per cent of total tax revenue i n Australia, whilesocial transfers are around a third of governmentsocial spending. Overall, the average transfersreceived by Australian households (according tothe LIS data) are around half the average taxespaid by households. At the other extreme isFrance, where income taxes and employee socialsecurity contributions account for only 25 per centof revenue, but cash transfers are 55 per cent oftotal social spending. Thus. measured Frenchtransfers are around 2.75 times measured taxes inthe LIS data. French households are apparentlygetting nearly two-thirds of their social securitysystem for free!Cash transfers are more redistributive than ben-efits i n kind, while direct taxes are more progres-sive than indirect taxes (Saunders and K h u 1985).Analysis based on disposable cash incomes there-fore underestimates the quantum of redistributiveactivity, but over-estimates the progressivity ofthe tax-benefit structure. Such gaps are importantas the generosity of cash benefits is not independ-ent of the role of non-cash services or indirecttaxes. For example, Australian public spending onhousing assistance is split between measured cashsupplements for low income households in privaterental and unmeasured assistance through reducedrents paid by low income public tenants. In theUK and Germany, in contrast. most housingassistance is in the form of measured cashsupplements.


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48 ECONOMIC RECORD MARCHMHG take account of clawback of cash benefitsthrough direct taxes, finding clawback is 27 percent in Australia, ranging between 12 per cent inFrance and 46 per cent in Norway. This measure

is useful, bu t incomplete. Indirect taxes are alsoresponsible for clawback, but not included. Taxeson general consumption account for 2.3 per centof GDP in Australia. compared to an OECDaverage of 6.7 per cent. In general the measuredgenerosity of benefits will be greater in countrieswith higher levels of consumption taxes, so longas consumption taxes are not included in theaccounting framework. For example, the proposedGST compensation package i n the 1985 DraftWhite Paper would have increased transfer spend-in g by more than 10 per cent. Most of this higherspending would have simply offset higher indirecttaxes, and would not improve the real generosityof benefits. Unless international comparisons takeaccount of consumption taxes, this churning willmake high tax countries look more generous tothe poor than countries with low indirect taxlevels, like Australia.Another gap is the non-inclusion of employersocial security contributions. These taxes do notexist i n Australia (orNew Zealand). and are insig-nificant in Denmark and Iceland. In all otherOECD countries they exceed 8 per cent ofrevenue, and they exceed 20 per cent of revenuein Belgium, France. Italy. Spain and Sweden. Asthese taxes finance a large part of social securityspending, their absence from most studies ofincome redistribution is particularly problematic.Differing interpretations of the incidence ofemployer contributions can have a substantialimpact on the measured generosity of cash bene-fits (Whiteford 1995). For example, an averageAustralian manufacturing production worker earnsabout 30 per cent more than similar workers inFrance or Sweden, when gross earnings areadjusted by OECD Purchasing Power Parities(PPPs), even though France and Sweden aresomewhat wealthier countries than Australia. InFrance and Sweden, however, employers arepaying social security contributions between 30and 35 per cent of g ross wages, so that producerswages are similar to those in Australia. Becausethese contributions are not included in the stan-dard framework. the measured gap between ben-efits and earnings is artificially narrowed incountries with high levels of employer contribu-tions. In fact, low benefit replacement rates inAustralia are the basis of the view that the Aus-tralian system is not generous to the poor (Esping-

Andersen 1990). But when the purchasing powerof basic benefits is compared rather than replace-ment rates, the Australian system is significantlymore generous to the poorest than the OECDaverage (Whiteford 1995; Eardley, Bradshaw,Ditch. Gough and Whiteford 1996).

VI The Accounting PeriodThe comparisons made by MHG are also viti-ated by the period over which redistribution ismeasured. Transfers have both insurance andredistributive elements, so the redistributiveelement cannot be examined using only annualinformation (Creedy 1994). This point is ofcrucial importance in comparing the effectivenessof different welfare systems, since the mix ofinsurance and redistribution differs betweencountries.This point is made by MHG (p. 324). althoughits implications are not explored in detail. Falk-ingham and Harding (1996) estimate that in thetargeted Australian system 38 per cent of lifetimebenefits received by individuals are paid for atanother stage in their life, with 62 per cent beingredistribution between individuals. In the U K only38 per cent of benefits is redistribution betweendifferent individuals. For example. assume thatAustralia spent 10 per cent of GDP on transfers,while the United Kingdom spent 15 per cent ofGDP. If we notionally separate out the redistrib-utive and self insurance components, then Austra-lian redistribution would be 6.2 per cent of GDP(0.62* o), while UK redistribution is 5.7 per centof GDP (0.38*15). That is. conrrary to the stan-dard approach, actual redistribution would begreater in Australia than in the UK. Other OECDcountries would achieve even less redistributionbetween income groups. because their eamings-related formulae are stronger than in the UK.While the Australian social security system isthe most radically redistributive (Aaron 1992) ofall developed countries. it still retains an elementof lifecycle redistribution. The problem with thestandard approach is that a single-year accountingperiod effectively assumes that all observed redis-tribution is between income groups. In a single-year accounting period taxes and social securitycontributions are treated as a burden, rather thanas a source of future income entitlements. Thisproduces the result that middle class householdsin larger welfare states appear worse off thansimilar households in smaller welfare states,because their tax liabilities are higher. The bene-


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I997 TARGETING WEL FARE A COMMENT 49fits that accrue to these households are notcounted because they arise as future entitlements(o r are substitutes for private expenditure such ashealth insurance or home purchasing). Becausefuture benefits to the middle and higher incomegroups are not measured, low income groupsappear relatively better off in larger welfare states.By separating the processes of redistributionbetween income groups and redistribution acrossthe lifecycle more than oth er countries, the Austra-lian system has the paradoxical effect of makingoutcomes look more unequal than in countries withmore 'middle class' welfare. A greater proportionof redistribution across the lifecycle in Australia isthrough private means. including home purchase,private superannuation, endow ment insurance andother savings. The costs of these savings are notincluded in the standard framework, because theyare private. I n contmt. the costs of redistributionacross the lifecycle through social insurance areincluded, because they are financed from taxes andemployee contributions. The standard frameworkis systematically biased to make high taxing welfarestates look more equal than low taxing countries,such as Australia.These biases could be corrected with lifetimeincidence studies (Hardin g 1994;Stdhlberg 1985).To date, few studies compare the lifetime impactof benefits systems in different countries on a con-sistent basis, apart from Falkingham and Harding(1996). An alternative is to bring all public andprivate redistribution within the compass of asingle year's accounting period. This involves acomprehensive k o m e measure, covering all gov-ernment activities, including imputed wealth inpublic pension rights, as well as private provisionssuch as imputed income from owner-occupiedhousing. To date, there are two studies broadeningthe LIS income concept (h e e d i n g . Saunders etal. 1992; Whiteford and Kennedy 1995). toinclude government health, education and housingbenefits, plus imputed income from owner-occu-pied housing. Both find the extent of poverty andinequality declines under broader measures,although the ranking of countries is not greatlyaffected. These measures are still incomplete,however. Adding indirect taxes would increaseinequality in all countries, although to varyingdegrees. The addition of imputed pension orbenefit rights is likely to change differencesbetween countries as well as their ranking. Itcould be expected that inequality would increaseby a smaller amount in Australia, because of itstargeted benefit system.

V l l ConclusionThis comment argues that the measures used byMHG are not valid measures of the degree ofredistribution achieved by transfer systems, d ue to

the fundamental counterfactual problem affectingsuch studies. Comparisons are affected by incom-plete coverage of government redistributive activ-ities in most income surveys. The period overwhich incom e redistribution is measured results insystematic biases tending to make Australianwelfare arrangements look less effective thanthose in other countries. The standard frameworkmakes outcomes look less unequal in largewelfare states that give greater prominence toredistribution across the lifecycle. Broadening theincome definition to take account of these factorswill narrow the difference between measured out-comes in different countries, but the methodologyof comparative analysis of welfare state outcomesstill requires considerable development. I t followsthat strong conclusions about welfare outcomesshould be tempered by an appreciation of weak-nesses of the analytical frameworks producingthese outcomes.

REFERENCESAaron. H. 1992). 'The Economics an d Politics of Pen-sions: Evaluating the Choices'. in Privure Pensionsund Public Policy. OECD. Pais.Baldwin, P. (1990). The Polirics of Social Solidariry:Class Buses of the European W elfare State 1875-1975, Cambridge University Press, Cambridge.Ban. N. (1992). 'Economic Theory and the WelfareState: A Survey an d Reinterpretation', Journal ofEconomic Lirerafure 30, June, 741-803.Beckeman, W. (1979). 'The Impact of Income Main-tenance Payments on Poverty in Britain--1975'. Eco-nomic Journal, June, 261-79.- nd Clark (1982). Poverty and Social Security inBritain since 1961. Oxford University Press , London.Creedy. J. (1994). 'Statics and Dynamics of IncomeDistribution: An Introductory Survey', The Austra-lian Economic Review, 4th Quarter, 5 1-7 l .Eardley. T.. Bradshaw. J. , Ditch. J., Gough, I. an dWhiteford, P. (1996). Social Assistance in OECDCountries. Volumes I and 2 , Research Reports No.46 and 47, UK Department of Social Security,HMSO, ondon and OECD. Paris.Esping-Andersen, G . (1990). The Three Worlds ofWelfare Capitalism. Polity Press. Cambridge.Fdkingham, J. and Harding. A. (1996). Poveny Alle-viation versus Social Insurance Sysrems: A Compar-ison of Lifetime Redistriburion, Discussion PaperNo. 12, NATSEM. University of Canberra.


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