Overview of Income Redistribution Programs

• Federal government plays large role redistributing income and supporting income of various groups

• Programs decrease uncertainty generated by market economy

• 2 broad categories of social insurance/redistribution programs

ProgramsA. Means Tested Programs

• Programs directed at those falling below predetermined income or asset level - poverty programs

• Examples: medicaid, food stamps, TANF

B. Non-means Tested Programs• Eligibility for program not determined by income means

test• Other criteria (for example age) establish eligibility; most

people fall under program at some point• Examples: unemployment insurance, social security

pension system, medicare

Non-means tested programs much larger than means tested programs

Poverty in US

• Families and individuals classified as poor if their incomes fall under a calculated poverty threshold

• Threshold varies by family characteristics, (family size etc)

• Threshold constructed as function of income needed to maintain adequate diet; Assumed families spend 1/3 of income on food

Poverty

2008 poverty threshold

• In 2008, 13.2% of the population under poverty line

• Only cash income (regardless of source) is used to establish poverty status

• Poverty has fallen dramatically in US since first calculated – in 1959 the poverty rate was 22.4%

Anti-poverty ProgramsMeans tested programs can be split into:

a. Cash transfer programsa. Earned Income Tax Credit (EITC)

b. Temporary Assistance to Needy Families (TANF)

c. Supplemental Security Income (SSI)

b. In-kind programs (direct provision of goods/services by government)a. Medicaid

b. Food Stamps

c. Housing Assistance

Earned Income Tax Credit

• Second largest federal anti-poverty program after medicaid

• Program began in 1970’s, greatly expanded in 1993

• Program directed at working poor, only those earning wages are eligible

• EITC is a system of direct income subsidies administered thru the tax system

EITCAssume a single woman with one child in 2003 with

$15,600 adjusted gross income

-7000 standard deduction (head of household)

-6,200 exemptions (herself and child)

-----------------------------------------------------------------------

$2,400 taxable income$240 tax owed before EITC

• Value of EITC subsidy - $2,248• The woman would pay no income taxes and receive a

$2008 refund ($2248-$240)• Roughly 21 million families received EITC refunds in 2004• The 36 billion in refunds lifted 5 million families above the

poverty line in 2004

Temporary Assistance to Needy Families (TANF)

• In 1996, TANF replaced the federal entitlement program called Aid to Families with Dependent Children (AFDC)

• Directed at non-working families with children

• The old AFDC program consisted mainly of cash subsidies in which

1. The federal government would determine eligibility

2. States would determine size of cash benefits

TANF

TANF is a federal program directed at same group as AFDC

1. States now have almost complete discretion over who receives benefits and the form of benefits

2. Generally fewer strings created by federal government but recipients are allowed federally subsidized cash benefits for a maximum of 5 years. States had option of lowering this limit.

3. The number of people within TANF fell compared to the program it replaced (AFDC)

In Kind Anti-poverty Programs1. Medicaid

– Single largest anti-poverty program – Medical insurance provided by federal

government for those who pass means test– Cost of program is shared with states and

program is administered by individual states– Most families with incomes below 130% of

poverty level will qualify

2. Food Stamp Program– Begun in 1971

3. Housing Assistance

Program Amount (billions) in 2005

Percent of Federal Spending

SSI 38 1.54

Family Support (including TANF)

24 0.97

EITC and Child Credits 49 1.98

All Cash Transfers 111 4.49

Medicaid 182 7.36

Food Stamps 33 1.33

Child nutrition, health, foster care and Social Services

29 1.17

All In-kind Transfers 244 9.87

Total 356 14.35

Anti-poverty Programs

• Cash benefit anti-poverty programs make up small percentage of federal expenditures

• In kind benefits for poor much larger than cash benefits

• Over half of federal anti-poverty expenditures are in Medicaid– Medicaid larger than all cash benefits

programs combined

The Economics of Income Redistribution

Costs related to Moral Hazard• Redistributing income from one

group to another may change the behavior of both groups

• This change in behavior increases the uncertainty regarding the governmental cost of the program; may also give rise to unanticipated changes in total output in economy

Costs Related to Moral Hazard

• Assume taxes increased for one group to redistribute income to another, this may reduce work effort for those whose taxes increased

• The redistribution of income may also affect the work incentive of those receiving the subsidy

The Economics of Income Redistribution

Assumptions for simple model:• One wage earner per household• Worker’s wage is $12.50/hour• Wage earner can work a maximum of

2000 hours per year (8 hours a day times 5 days a week times 50 weeks a year)

• Wage earner able to choose between work hours and leisure time

The Economics of Income Redistribution

Income Subsidy • Assume a program that guarantees a

minimum income ($9,000) to each American family

• Every family that earns an income below $9,000 receives subsidy to bring income up to $9,000 level

• Every dollar that a family earns below $9,000 means one less dollar in subsidy (a family with an earned income of $5,000 will get a subsidy of $4,000; a family with an earned income of $5,001 will receive $3,999)

The Economics of Income Redistribution

Families with earned income over $9,000 receive no subsidy

Program effectively amounts to a 100% tax for those with earned incomes below $9,000.

Model of Guaranteed Income Program with 100% Benefit Reduction

Model of Guaranteed Income Program with 50% Benefit Reduction

The Economics of Income Redistribution

• In redistributing income, want to target those subsidy recipients who

• have low incomes due to low capacity to earn income in labor market

• not those who have high ability to earn but choose to consume more leisure time

• therefore, will not change their behavior in the labor market due to the subsidy

The Economics of Income Redistribution

Example of a target group for income distribution

Single mothers• Poverty rate for families headed by single

woman is almost 3 times the national average

• Little evidence that people become single mothers due to income subsidies

The Economics of Income Redistribution

• Redistribution programs may attempt to distinguish between those with low earnings capacity and those who value leisure by setting making program unattractive for recipients

• Ordeal mechanism: only those who are truly less capable of earning in the labor market will suffer ordeal in subsidy program.

Work and Training requirements that are part of TANF programs in many states.

Eligibility requirements in the food stamp program

The Economics of Income Redistribution

• Economic theory suggests cash subsidies in some cases are a more efficient method than in-kind programs to redistribute income

• If in-kind benefits do not dramatically alter the choices open to a recipient, compared to an equivalent cash subsidy, it may be more efficient to provide cash

Example: Food Stamps