Chapter 7

Government Subsidies and

Income Support for the Poor

1
 Poverty in 2001

 33 million people in U.S. affected

 12% of the population classified as

poor

2
 Poverty in the United States
Poverty 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

3
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

4
Changing the Poverty Line
 New definition proposed during Clinton Administration
would have included child care and other expenses and
would have raised the threshold to almost $20,000.

 Such a change would have increased the poverty line in

1998 from 12.7% to 17%.

 Politics are involved in setting poverty thresholds because

many government means-tested programs are tied to the
definition of poverty.

5
Poverty Rate 1960-2001

6
 Why We Have Government
Programs to Aid the Poor
 Concern about equity-efficiency trade-
offs.

 Creates the positive externality of

social stability.

7
Equity-Efficiency Trade-offs
 Transfers to low-income persons can:
 decrease incentives to work.
 distort consumption patterns.

 This approach recognizes that the way

the “pie ” is divided can ultimately affect
its size.

8
The Positive Externality: Social Stability
Charity has characteristics of a public-good.
 It creates social stability that benefits everyone.
 Because of the free-rider problem, voluntary
donations to the poor are likely to result in an
undersupply of income redistribution to low-income
groups relative to the efficient amount.
 Government action to redistribute income can
establish uniform standards of eligibility for aid that
reflect political compromise.

9
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.

10
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
$3888 in 2000 for a family with two children.
11
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.

12
 Major Federal Government
Expenditures To Aid the Poor, 2003
Program Federal Percentage of
Spending Federal Spending
Dollars (Billions)
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 $4 0.52
Services
Child Nutrition $11 9.21
Subtotal of In-Kind Programs $287 13.62

13
Price Distorting Subsidies

Price Distorting Subsidies lower

the price of a particular
(subsidized) good relative to other
goods for eligible people.

14
 Figure 7.1 A Price Distorting Subsidy
L
Expenditure on Other Goods

N3 E3
per Month (Dollars)

N1 E1 E2
N2 U3
U1 U2
Subsidy
S

0 H1 H2 H3 A L' B
Housing Services per Month
15
Dead Weight Loss or Excess Burden

Dead Weight Loss (sometimes called

Excess Burden ) measures the dollar
value of the distortion that exceeds the
amount transferred to the recipient.

16
 Figure 7.2 Excess Burden of a Subsidy

Excess Burden of Subsidy

Rent (Dollars per Month)

B E A
400 S = MSC

C F E’
200 S’

D = MSB

0 Q1 Q2
Number of Apartments Rented 17
 Figure 7.3 Full Subsidization of Medical Services

B
Price (Dollars per Month)

E1 A
25 = P*
Excess Burden

MBL

E2
0 Q* QG
Medical Office Visits per Year
18
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.

19
 Figure 7.4 The Impact of The Medicaid Program
on Price: The Case of Increasing Cost
S = MSC
Price (Dollars)

E2
35
E1
25

DM'
DM = MSB
DL DO

0 QL QO' QOQI QG Q2
Medical Office Visits per Year
20
Medicaid and State Governments
 Medicaid allotments make up more than 20
percent of state government budgets.
 State Medicaid budgets have grown at 12% per
year (overall budgets have grown at 6%).
 In 2002:
 Medicaid payments per person were about $3,500
 Medicaid costs for the 11% of aged participants
were nearly $10,000 per person.

21
Subsidized Housing

Providing Apartments: allocates standard apartments

to eligible recipients. With this type of
subsidy,recipients cannot supplement the subsidy
with their own cash. It is a “take it or leave it” option.

Housing Vouchers: allows recipients particular

allotments of vouchers to rent housing, but recipients
may supplement the subsidy with their own cash.

Cash: not restricted to spending on housing.

22
 Figure 7.5 Eligibility for Public Housing and the
Effect on Housing Consumption
Expenditure on Other Goods

I'

800 = I 210
per Month (Dollars)

90 G
M
210
E2
H
J
400= F
E1
U3
U1 U2

A B
0 1 2 3 4 5 6 7
Housing per Month (Number of Rooms Rented)
23
 Figure 7.6 Refusing a Public-Housing Subsidy

I
G
Expenditure on Other Goods

J E1
per Month (Dollars)

U2
U3

0 1 2 3 4 5 6 7 A
Housing per Month (Number of Rooms Rented)
24
Subsidizing Food
Food 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.

25
 Figure 7.7 The Impact of an In-Kind Transfer:
Food Stamps
A B
Expenditure on Other Goods

B B
E2
F L
per Month (Dollars)

I I
C C U3
E2 M1
M2 E1 U2
E1
M1 U1
U2
U1
QF

0 QF QF1 QF2 A A' 0 QF2 QF3 A A'

Q F*
Food per Month
26
 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.

27
International Food Subsidies
 Several nations use price-reducing
subsidies 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.

28
 Figure 7.8 The Income Effect of a Transfer
F

U3

C
Income per Day

U2 E3
A
U1 G
E2
E1
D Transfer
Payment
0 L1 L2 24
Leisure Hours per Day
29
Figure 7.9 A Transfer that Declines with Earned
Income e.g. T=$300-.7IE
A
Income per Day

C E2 U
2
E1
D
U1
Maximum
Daily
Transfer
B
L* L1 L2 24
Leisure Hours per Day 30
Empirical Evidence
 A 10% increase in welfare payments to
individuals decreases work effort by
2%.

31
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

32
Break-Even Income
0 = I G – tN I B

IB = IG/tN

33
Negative Income Tax
Earned 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

34
Wage Rate Subsidies

Wage Rate Subsidies: government

additions to wages designed to
increase the pay of the working poor

35
Wage Rate Subsidies
Wage Paid Subsidy Total Wage
per Hour 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
$4.50 $0.25 $4.75
$5.00 $0.00 $5.00
36
Wisconsin Works
 Stringent Work Requirements

 Child Care Subsidies

 Health Insurance Coverage

 Welfare dependency in WI has dropped 60%

since 1987

37
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.

38
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
39
Figure 7.11 Earned Income Tax Credit in 1999,
By Number of Children and Earnings

40
 Figure 7.10 A Negative Income Tax Plan

Annual Disposable Income (ID )

Taxes

Transfers
IG

45º
IB
Annual Earned Income 41
 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.

42
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.

43
Welfare Rolls in New York City and the
2001 Recession
 TANF was introduced during a period of
almost unprecedented prosperity in the United
States.

 In New York City, the number of people

receiving aid under public assistance actually
decreased by 10 percent during the recession.

44
 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.
45
 Percent Share of Income by
Quintile
Year LowestF Second Third Fourth Highest
ifth Fifth Fifth Fifth 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
46