19 CHAPTER Government Redistribution Programs PUBLIC SECTOR ECONOMICS: The Role of Government in the...

19CHAPTER

Government Government Redistribution ProgramsRedistribution Programs

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

19-2

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe

Cash Versus Payment In Cash Versus Payment In KindKind

Redistribution can be paid in cash or Redistribution can be paid in cash or in kindin kind

Cash payments:Cash payments: Unemployment compensationUnemployment compensation Temporary Aid to Needy Families Temporary Aid to Needy Families

In kind payments:In kind payments: Food stampsFood stamps Housing vouchersHousing vouchers

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Cash Payments and Cash Payments and Utility MaximizationUtility Maximization

Cheaper to distribute cash paymentsCheaper to distribute cash payments Recipients best know their utility Recipients best know their utility

functionfunction Are in best position to know how Are in best position to know how

transfer should be spenttransfer should be spent Cash transfer may make an Cash transfer may make an

individual better off than payment in individual better off than payment in kindkind

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Cash Payments and Cash Payments and Utility MaximizationUtility Maximization

Payment in Kind vs.

Cash Transfer

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Rationale for In-Kind Rationale for In-Kind PaymentsPayments

Justified by considering utility of Justified by considering utility of taxpayertaxpayer

In kind payments paternalisticIn kind payments paternalistic Increase dependency on system by Increase dependency on system by

limiting ability to make decisionslimiting ability to make decisions

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Negative Income TaxNegative Income Tax

Policy option to simplify transfer Policy option to simplify transfer systemsystem

If person’s income below certain If person’s income below certain level, government pays person level, government pays person income supplementincome supplement

If income above that level, person If income above that level, person pays taxpays tax

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Negative Income TaxNegative Income Tax

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Incentive to Substitute Incentive to Substitute Into LeisureInto Leisure

Substitution effect - incentive to Substitution effect - incentive to substitute leisure for income-earning substitute leisure for income-earning activityactivity

Disincentive effects from income Disincentive effects from income transfer no different from those of transfer no different from those of tax on earned incometax on earned income

Substitution effect inevitableSubstitution effect inevitable Transfer programs do not necessarily Transfer programs do not necessarily

result in higher incomeresult in higher income

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Incentive to Substitute Incentive to Substitute Into LeisureInto Leisure

A Reduction in Income with a

Negative Income Tax

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Redistribution and Redistribution and Income of the PoorIncome of the Poor

Redistribution increases well-being of Redistribution increases well-being of recipientsrecipients May not appear to do so if only dollar figures May not appear to do so if only dollar figures

examinedexamined Necessary to be poor to qualify for Necessary to be poor to qualify for

programsprograms Disincentive to earn other incomeDisincentive to earn other income

Redistributive programs do no simply add Redistributive programs do no simply add amount of redistributed income to income amount of redistributed income to income recipients would have without programrecipients would have without program

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Excess Burden of Excess Burden of Negative Income TaxNegative Income Tax

Substitution effect creates negative Substitution effect creates negative excess burdenexcess burden

Applies to any transfer program Applies to any transfer program reducing benefits to less needy reducing benefits to less needy

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Virtues of Negative Income TaxVirtues of Negative Income Tax Simple to administerSimple to administer Could reduce total number of Could reduce total number of

transfer programstransfer programs Cash transferCash transfer

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Earned Income Tax Earned Income Tax Credit (EITC)Credit (EITC)

Closest program to negative income Closest program to negative income taxtax

Created in 1975Created in 1975 Amount of credit variesAmount of credit varies Implies 20% marginal tax rateImplies 20% marginal tax rate Given to taxpayer even if larger than Given to taxpayer even if larger than

amount of taxes dueamount of taxes due

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Temporary Aid to Needy Temporary Aid to Needy Families (TANF)Families (TANF)

Created in 1997Created in 1997 Restricts recipients to maximum of 5 years Restricts recipients to maximum of 5 years

of benefitsof benefits Welfare rolls have declined since its Welfare rolls have declined since its

inceptioninception Funding shared between federal and state Funding shared between federal and state

governmentsgovernments Administered at state levelAdministered at state level Gives assistance to transition from welfare Gives assistance to transition from welfare

to workto work

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Temporary Aid to Needy Temporary Aid to Needy Families (TANF)Families (TANF)

TANF replaced Aid to Families with TANF replaced Aid to Families with Dependent Children (AFDC)Dependent Children (AFDC)

AFDC gave incentive to remain on AFDC gave incentive to remain on welfarewelfare

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Work or WelfareWork or Welfare

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Food StampsFood Stamps

Established in 1964 to increase Established in 1964 to increase agricultural demand/provide better agricultural demand/provide better nutrition to low income familiesnutrition to low income families

Financed by federal government and Financed by federal government and administered by statesadministered by states

Provides benefits in kindProvides benefits in kind 30% marginal tax rate30% marginal tax rate May act like income transferMay act like income transfer

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Food Stamps Are Like a Cash Transfer

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EffectsEffects Do not increase demand for agricultural Do not increase demand for agricultural

productsproducts May not provide better nutritionMay not provide better nutrition

Effects would be little different if Effects would be little different if replaced by cash transferreplaced by cash transfer

Underground market for food stampsUnderground market for food stamps

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Selling Food Stamps

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Housing SubsidiesHousing Subsidies

Low income housingLow income housing Rent subsidiesRent subsidies Low interest loansLow interest loans

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Public HousingPublic Housing

Government-owned apartment at Government-owned apartment at below market rentbelow market rent

Individual can choose government Individual can choose government housing or forgo subsidyhousing or forgo subsidy

Unlikely to provide same benefit Unlikely to provide same benefit level as cash transferlevel as cash transfer

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Public HousingPublic Housing

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Rent SubsidiesRent Subsidies

Federal government expenditureFederal government expenditure Section 8 housingSection 8 housing

Formula determines subsidy amount Formula determines subsidy amount each recipient eligible foreach recipient eligible for

Creates disincentive for earning incomeCreates disincentive for earning income Can spend money to rent any qualifying Can spend money to rent any qualifying

apartmentapartment

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Rent SubsidiesRent Subsidies

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HomelessnessHomelessness

Most visible in major citiesMost visible in major cities Many suffer from drug/alcohol abuse Many suffer from drug/alcohol abuse

or mental illnessor mental illness In urban areas individuals may not In urban areas individuals may not

be able to afford minimum level of be able to afford minimum level of housinghousing

Makes it difficult to obtain Makes it difficult to obtain employmentemployment

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Possible solutions:Possible solutions: Income transfer programsIncome transfer programs More inexpensive housingMore inexpensive housing

Public policy has removed much Public policy has removed much inexpensive housing from marketinexpensive housing from market

19 CHAPTER Government Redistribution Programs PUBLIC SECTOR ECONOMICS: The Role of Government in the...

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