Chapter 7

Government Subsidies and

Income Support for the Poor

Poverty in 2001

33 million people in U.S. affected

12% of the population classified as

poor

Poverty in the United States

Poverty threshold or poverty line
in 2001
Family Structure
Single

Threshold ($
income annually)

$9,214

One Adult-Two Children

$14,269

Two Adults-Two Children

$17,960

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

Poverty Rate 1960-2001

Why We Have Government

Programs to Aid the Poor

Concern about equity-efficiency tradeoffs.

Creates the positive externality of

social stability.

Entitlement
Programs:
.

Government programs that

guarantee
recipients
as long
as they and
meet wealth
eligibility tests
Means
Tests:benefits
typically
income

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.

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
$4140 in 2002 for a family with two children.

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 Childrens Health Insurance Program:
federal program that subsidizes health
insurance coverage for the working poor.
9

Major Federal Government

Expenditures To Aid the Poor, 2003
Program

Federal
Spending
Dollars (Billions)
$32

Percentage of
Federal Spending

TANF

$26

1.23

EITC

$35

1.66

$93

4.41

$155

7.36

$24

1.14

$4

0.52

$11

9.21

$287

13.62

SSI

Subtotal of Cash Programs

Medicaid
Food Stamps
Child Protection and Social
Services
Child Nutrition
Subtotal of In-Kind Programs

1.52

10

Price Distorting Subsidies

Price Distorting Subsidies lower
the price of a particular
(subsidized) good relative to other
goods for eligible people.
11

Figure 7.1 A Price Distorting Subsidy

Expenditure on Other Goods
per Month (Dollars)

L
I
E3

N3
N1
N2

E1
Subsidy

E2
U1

U3
U2

H1
H3
A
L'
H2
Housing Services per Month

B
12

Dead Weight Loss or Excess Burden

Dead Weight Loss (sometimes called
Excess Burden ) measures the extra
benefit a recipient can enjoy from the
dollar amount of the price-distorting
subsidy if instead the grant was
received in a lump sum.
13

Rent (Dollars per Month)

Figure 7.2 Excess Burden of a Subsidy

Excess Burden of Subsidy

400

200

S = MSC

S
D = MSB

Q1

Q2

Number of Apartments Rented

14

Price (Dollars per Month)

Figure 7.3 Full Subsidization of Medical Services

B

E1

25 = P*

A
Excess Burden
MBL
E2

Q*
QG
Medical Office Visits per Year

15

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.
16

Figure 7.4 The Impact of The Medicaid Program

on Price: The Case of Increasing Cost

Price (Dollars)

S = MSC
E2

35
E1

25

DM'
DM = MSB
DO

DL
0 QLQO'

QO QI QG Q2
Medical Office Visits per Year

17

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.
18

Figure 7.7 The Impact of an In-Kind Transfer:

Food Stamps

Expenditure on Other Goods

per Month (Dollars)

B
F

M2
M1

L
I
M1

E2
E1

E2
C
E1

U3
U2
U1

U2
U1

0 QF QF1 QF2

A'

0 QF2 QF

A'

QF*
Food per Month

19

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.

20

Figure 7.8 The Income Effect of a Transfer

F

Income per Day

U3
C
A

U1

E3

U2

G
E2
E1
D Transfer
B Payment

L1

L2

24

Leisure Hours per Day

21

Figure 7.9 A Transfer that Declines with Earned Income

e.g. T=$300-.7IE

Income per Day

E2 U
2

E1
U1

D
Maximum
Daily
Transfer

B
L*

L1

L2

24

Leisure Hours per Day

22

Empirical Evidence

A 10% increase in welfare payments to

individuals decreases work effort by
2%.

23

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 = I G tN I E

Where
IG = Income guarantee
tN = take back rate
IE = earned income
T = Transfer

24

Break-Even Income
0 = I G tN I B
IB = IG/tN

25

Negative Income Tax

Earned Income IE

Transfer T = IG tNIE

Disposable Income ID

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

26

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.
27

EITC (2002; two-child family)

Total Earned Income
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$15,000
$20,000
$33,200

EITC
$0
$810
$1,610
$2,410
$3,210
$4,140
$3,823
$2,770
$0
28

Figure 7.11 Earned Income Tax Credit in 1999,

By Number of Children and Earnings

29

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.

30

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.

31

Percent Share of Income by

Quintile
Year

Lowest Second Third

Fifth
Fifth
Fifth

Fourth Highest
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
32