Chapter 7

Government Subsidies and

Income Support for the Poor
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Poverty in 1998
34.5 million
13% of the population
classified as poor

Copyright 2002 by Thomson Learning, Inc.

Poverty in the United States

Poverty threshold or poverty
line in 1999
Family Structure
Single

Threshold
$8,667

One Adult-Two Children

$13,410

Two Adults-Two Children

$16,600

Copyright 2002 by Thomson Learning, Inc.

Poverty line
The Poverty Line was originally created
by the Social Security Administration as
three times the cost of a nutritionally
adequate diet
It is updated annually for inflation using
the CPI

Copyright 2002 by Thomson Learning, Inc.

Poverty Rate 1960-1998

Numbers in millions, rates in percent

45
40
35
30
25
20
15
10
5
0
1959

Recession
Number in poverty

32.3 million

Poverty rate

1964

1969

1974

1979

1984

1989

Note: The data points represent the midpoints of the respective years.
The latest recession began in July 1990 and ended in March 1991.
Source: U.S. Census Bureau, Current Population Survey, March 1960-2000.
Copyright 2002 by Thomson Learning, Inc.

11.8 percent

1994

1999

Changing the Poverty Line

A new definition proposed during the
Clinton Administration would have
included child care and other expenses
and would raise the threshold to almost
$20,000.

Copyright 2002 by Thomson Learning, Inc.

Why We Have Government

Programs to Aid the Poor
We are concerned about EquityEfficiency Trade-Offs.
It creates the Positive Externality of
Social Stability.

Copyright 2002 by Thomson Learning, Inc.

Entitlement Programs
Government programs that guarantee
recipients benefits as long as they meet
eligibility tests.
Means Tests are typically income and wealth
criteria that must be met to be eligible for a
program.
Status Tests are typically disability, children, and
age criteria that must be met to be eligible for a
program.

Copyright 2002 by Thomson Learning, Inc.

Cash Programs
TANF: Temporary Aid to Needy Families
The program most identified with a welfare
check. Also may provide for child-care
expenses or job retraining.

SSI: Supplemental Security Income

The program that provides a cash payment to
the widowed, orphaned and disabled.

EITC: Earned Income Tax Credit

A program that increases the take-home pay
of the working poor. As much as $3888 in
2000 for a family with two children.
Copyright 2002 by Thomson Learning, Inc.

In-Kind Programs
Food Stamps are vouchers that enable a broad
class of the poor 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 is a federal and state funded program that
provides health care services to the poor.
The Childrens Health Insurance Program is a
federal program that subsidizes health insurance
coverage for the working poor.

Copyright 2002 by Thomson Learning, Inc.

Major Federal Government

Expenditures To Aid the Poor, 2000
Program

Federal Spending
Dollars (Billions)

Percentage of
Federal Spending

SSI

$29

1.64

TANF

$21

1.16

EITC

$26

1.47

$76

4.30

$115

6.50

$19

0.28

$5

0.79

$11

8.48

$226

12.78

Subtotal of Cash Programs

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

Price Distorting Subsidies
lower the price of the
particular good relative to
others for eligible people.

Copyright 2002 by Thomson Learning, Inc.

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
H2
H3
A
L'
Housing Services per Month

Copyright 2002 by Thomson Learning, Inc.

Dead Weight Loss

or
Excess Burden
Dead Weight Loss (sometimes called
Excess Burden ) is the measure of the
dollar value of the distortion that
exceeds the amount transferred to the
recipient.

Copyright 2002 by Thomson Learning, Inc.

Rent (Dollars per Month)

Figure 7.2 Excess Burden of a Subsidy

Excess Burden of Subsidy

400

200

S = MSC

S
D = MSB

0
Copyright 2002 by Thomson Learning, Inc.

Q1

Q2

Number of Apartments Rented

Price (Dollars per Month)

Figure 7.3 Full Subsidization of Medical Services

B

E1

25 = P*

A
Excess Burden
MBL
E2

0
Copyright 2002 by Thomson Learning, Inc.

Q*
QG
Medical Office Visits per Year

Additional Effects of Subsidies:

The Case of Increasing Costs
Medicaid not only costs taxpayers
money to pay for the program, it also
increases the amount they pay for
medical services by increasing demand
for those services.

Copyright 2002 by Thomson Learning, Inc.

Figure 7.4 The Impact of The Medicaid Program on

Price: The Case of Increasing Cost

Price (Dollars)

S = MSC
E2

35
E1

25

D'
DM = MSB
DO

DL
0 QLQ'

QL QI QG Q2

Medical Office Visits per Year

Copyright 2002 by Thomson Learning, Inc.

Subsidizing Housing
Providing an Apartment: This subsidy
allocates a standard apartment to an eligible
recipient. With this type of subsidy the
recipient cannot supplement the subsidy with
their cash. It is a take it or leave it option.
Housing Vouchers: This subsidy allows the
recipient a particular allotment of vouchers to
rent housing but the recipient may supplement
the subsidy with their cash.
Cash: This subsidy is not restricted to
spending on housing.
Copyright 2002 by Thomson Learning, Inc.

Expenditure on Other Goods

per Month (Dollars)

Figure 7.5 Eligibility for Public Housing and the

Effect on Housing Consumption

I'
800 = I
90
M

210
G
210

H
400= F

E2
J
E1
U1

U3
U2
A

0 1 2 3 4 5 6 7
Housing per Month (Number of Rooms Rented)
Copyright 2002 by Thomson Learning, Inc.

Expenditure on Other Goods

per Month (Dollars)

Figure 7.6 Refusing a Public-Housing Subsidy

I
M

G
J

E1
U3

U2

0 1 2 3 4 5 6 7
A
Housing per Month (Number of Rooms Rented)
Copyright 2002 by Thomson Learning, Inc.

Subsidizing Food
Food Stamps are the subsidy that
allows the recipient a particular
allotment of vouchers to buy food but
the recipient may supplement the
subsidy with their cash. It is illegal to
sell the food stamps though it may be in
the recipients interests for them to do
so.
Copyright 2002 by Thomson Learning, Inc.

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

C
E1

QF
A

A'

0 QF2 QF1
Q*

Food per Month

Copyright 2002 by Thomson Learning, Inc.

U3
U2
U1

U2
U1

0 QF QF1 QF2

E1

A'

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.

Copyright 2002 by Thomson Learning, Inc.

International Food Subsidies

Several nations use a price-reducing
subsidy 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.

Copyright 2002 by Thomson Learning, Inc.

Figure 7.8 The Income Effect of a Transfer

Income per Day

U3
C
A

U1

E3

U2

G
E2
E1
D Transfer
Payment

L1

L2

24

Leisure Hours per Day

Copyright 2002 by Thomson Learning, Inc.

Figure 7.9 A Transfer that Declines with Earned Income

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

Income per Day

E2 U
2

E1
U1

Maximum
Daily
Transfer
B

L*
Copyright 2002 by Thomson Learning, Inc.

L1

L2

24

Leisure Hours per Day

Empirical Evidence
A 10% increase in welfare payments to
individuals decreases work effort by
2%.

Copyright 2002 by Thomson Learning, Inc.

A Negative Income Tax

A Negative Income Tax is a system where there is no
status test but there is an income guarantee and a takeback rate.

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

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

Copyright 2002 by Thomson Learning, Inc.

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

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Wage Rate Subsidies

Wage Rate Subsidies are government
additions to wages designed to
increase the pay of the working poor.

Copyright 2002 by Thomson Learning, Inc.

Wage Rate Subsidies

Wage Paid

Subsidy
per Hour

Total Wage
Received

$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00

$1.50
$1.25
$1.00
$0.75
$0.50
$0.25
$0.00

$3.50
$3.75
$4.00
$4.25
$4.50
$4.75
$5.00

Copyright 2002 by Thomson Learning, Inc.

EITC
The Earned Income Tax Credit goes to
the working poor and varies with the
number of children. Typically the
recipient receives the assistance with
their tax refund but papers can be filed
to receive the money in their paychecks
throughout the year.

Copyright 2002 by Thomson Learning, Inc.

EITC (1999; two-child family)

Total Earned Income
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$15,000
$20,000
$30,580
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EITC
$0
$810
$1,610
$2,410
$3,210
$3,816
$3,265
$2,212
$0

Annual Disposable Income (ID )

Figure 7.10 A Negative Income Tax Plan

Taxes
Transfers
IG
45
IB

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Annual Earned Income

Wisconsin Works

Stringent Work Requirements

Child Care Subsidies
Health Insurance Coverage
Welfare dependency in WI has dropped
60% since 1987

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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:

subsidized child care

Teen Mothers:
no longer eligible to receive their own payments
must live with responsible adult.

Refusal to work: recipients with children over five

who refuse work can be denied aid and have their
children placed in foster care
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Figure 7.11 Earned Income Tax Credit in 1999,

By Number of Children and Earnings

EITC (Dollars)

4,000

Two or More
Children

3,000

2,000

One Child

1,000

No Children
0

5,000

10,000 15,000 20,000 25,000 30,000 35,000

Taxpayers Earnings or Adjusted Gross Income (Dollars)

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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.

Copyright 2002 by Thomson Learning, Inc.

43
24
17

1997

1995

1989

1983

1976

1973

1969

10
5
1947

Share of Income

Percent Share of Income by

Quintile

year

lowest
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second

third

fourth

highest