2. 20-2
Transfer Payments
• A transfer payment is paid out by
government to people who have been
determined to be eligible to receive the
payment.
– Legislation is passed authorizing these
payments.
– There is no exchange of goods or services.
3. 20-3
Transfer Payments
• The principal recipients of transfer
payments are the elderly (Social Security,
for example) and the “poor” (welfare
payments), although any government
subsidy is a transfer payment.
4. 20-4
Transfer Payments
• A transfer payment has a built-in incentive
for people to become eligible to receive it. It
is the “get something for nothing” or “free
ride” attitude.
5. 20-5
Learning Objectives
• 20-01. Know the major income transfer
programs.
• 20-02. Know how transfer programs affect
labor supply and total output.
• 20-03. Know the trade-offs between equity
and efficiency.
6. 20-6
Major Transfer Programs
• Payments can be in cash or in-kind
transfers.
– Cash transfer: a direct cash payout.
• Social Security and unemployment compensation.
– In-kind transfer: a payout of goods and services.
• Food stamps, Medicaid, housing subsidies.
7. 20-7
Major Transfer Programs
• Programs can be social insurance programs
or welfare programs.
– Social insurance programs are triggered by
events.
• Reaching a certain age makes one eligible for Social
Security.
• Being fired from a job makes one eligible for
unemployment compensation.
– Welfare programs are means-tested. For
eligibility, a family has to prove it has too little
income.
8. 20-8
Unintended Consequences
• Income transfers often change market
behavior and outcomes in unintended ways.
– If you get paid for not working, why work?
– Income transfers are a disincentive to work.
– If fewer people work, labor supply is reduced
and total output could shrink.
9. 20-9
Unintended Consequences
• Income transfers often change market
behavior and outcomes in unintended ways.
– Nonwork behavior could be altered.
– Welfare payments could encourage women to
have more children.
– Teens might become mothers to qualify for a
welfare payment.
– “Free” health care tends to be overused,
congesting the waiting rooms of hospitals and
doctors.
10. 20-10
Welfare Programs
• To identify potential recipients, the poverty
threshold was defined, based on how much
income is needed for families of different
sizes to buy basic necessities.
– For a family of four in 2010, the threshold was
about $22,000 a year.
– Thus a family of four earning $18,000 a year has
a poverty gap of $4,000.
11. 20-11
Welfare Programs
• One way to “solve” the poverty problem
would be to identify all who are eligible and
provide a cash sum to eliminate every
poverty gap.
– Send $4,000 to the family previously mentioned.
12. 20-12
Welfare Programs
• Problems:
• This provides a strong incentive to be poor.
– You make $25,000 working? Quit and get $22,000
without working.
• If you are already poor, does the welfare check
change your work behavior?
– You make $18,000 and get $4,000 in welfare. One of
the family members can earn $2,000 by working. If
she does, your welfare check drops to $2,000, and
your total income is still $22,000. Should she take
up this opportunity?
13. 20-13
Welfare Programs
• Can these work disincentives be eliminated (or
reduced)?
– To provide incentives to take on work, welfare
payments would not bring the family up to the
poverty threshold.
– Another incentive is to not reduce welfare dollar for
dollar, so added work increases family income.
• In the example we just looked at, earn an extra
$2,000 and lose $2,000 in welfare. That is the
same as a 100% implicit marginal tax rate.
14. 20-14
Welfare Programs
• The basic dilemma:
– Low implicit marginal tax rates encourage more work
effort but make more people eligible for welfare.
– High implicit marginal tax rates discourage work
effort but make fewer people eligible for welfare.
• Welfare costs can be minimized only if we sacrifice
welfare eligibility or sacrifice work incentives.
• One way to reduce welfare dependence is to limit
the amount of time a family will be eligible for
welfare. Time runs out? No more welfare
payments.
15. 20-15
Social Security
• Age is the primary determinant of eligibility.
• The formula to calculate Social Security
benefits is skewed toward the low-income
worker.
– A higher-income worker will receive a larger
number of dollars in benefits, but, after
retirement, the ratio of payout between high-
and low-income workers will be smaller than
when they were working.
16. 20-16
Social Security
• As you approach the age of eligibility for
Social Security payments, you make a
decision similar to a welfare recipient with a
job opportunity:
– Should I continue to work, or retire and collect
Social Security?
– Since the 1960s, the labor force participation
rate for men over 65 has been reduced by half.
17. 20-17
Social Security
• This reveals a major cost of Social Security
programs.
– When workers retire early, there is a reduction
in total output.
– To reduce this cost, the practice of heavily
taxing Social Security benefits of those who are
eligible but still working could be eliminated.
Then the cost of working goes down.
Editor's Notes
In the previous chapter we concentrated on the source of income distribution funds: taxes.
In this chapter we look at the distribution systems.
You might want to remind students of the concept of merit goods.
The owner of an angora goat ranch who gets an annual payment of $100,000 to run goats is a subsidy recipient.
One of the sad results of the well-intentioned program to provide support to single mothers with dependent children was that one could qualify by actively breaking up a family (send the man away) or by simply having a child out of wedlock.
We will use these objectives to review the chapter.
If a family gets an in-kind transfer, they do not have to use their meager income to fund those items, but can use those funds to purchase other goods.
In the means-tested programs, the definition of what is income and who is earning it becomes of paramount importance to determine eligibility.
The intent of unemployment compensation is to tide a family over while the wage earner is out of work until she gets new employment.
The unintended consequence might be to lessen the urgency of acquiring that new job.
Sociologists have cited the welfare programs of the 1960s and 1970s as the main reason why , in low-income areas, family breakups were more common and the number of unwed mothers was very high.
Many programs no longer use the poverty threshold as the eligibility point. Some now say a family is eligible if they earn less than 50% above the poverty threshold.
This method would be the most cost-effective one the government could use. Administrative and compliance costs would be almost zero.
Of course not all who are poor desire to remain poor. There is a strong inbuilt incentive of all people to make themselves better off. Here we are talking about taking the marginal step.
Earn $2,000 more and the government takes away $2,000. That is a 100% percent tax rate no matter what you call it.
A simple way to correct this is to let the family continue to receive its welfare payment for an extended period – say, six months or one year.
That makes taking the job worthwhile.
If the implicit tax rate is 0%, the family continues to receive welfare but the added work improves their income. They are still on welfare for the stated period of time.
If the implicit tax is 100%, all of the incentive to take that marginal step of getting the job is immediately wiped out.
The pertinent decision here is when the worker approaching eligibility must decide to continue working, or quit work and collect Social Security.
This decision is more important to the lower-income worker.
People who choose Social Security instead of work are experienced and usually trustworthy and valuable workers. Their retirement is a big loss to their employer.
They are usually replaced by a new, inexperienced worker who is not up to speed, and productivity takes a hit.
You can collect Social Security and continue working, but a huge amount of your Social Security payment will be taxed.
Again, here is a high implicit tax rate.
Eliminate that penalty, and more valued workers will continue to work and collect Social Security.
