Incentivizing poor and low-income persons to work and save more

Vijay K. Mathur

Published in Standard-Examiner, October 28, 2012, Ogden, Utah

Means-tested anti-poverty programs determine eligibility based on income and assets. If benefits to able-bodied low income and poor persons are cut in larger proportions of their increasing earnings and assets, it provides a disincentive to earn and save more. Benefit cuts are like a tax on work earnings.

The study by John Karl Scholz, Robert Moffitt and Benjamin Cowan (SMC), Discussion Paper no. 1350-08, September 2008 (www.irp.wisc.edu), cites a study of low-wage single-parent families in New York where benefit cuts were such that their extra dollar earnings, from working between 8 to 35 hours per week, would increase their take home by only 15 cents per dollar earned (a 85 percent cut in income). However, there is also an upside of anti-poverty programs. SMC study investigates the role of social insurance programs and means-tested transfers, including entitlements, in reducing poverty. Assuming no behavioral response, they show these programs do reduce percentage of poor across different family types between 35 percent to 86 percent. The investigators did not want to confound the effect of anti-poverty programs on poverty rates by including behavioral responses. Even though anti-poverty programs have substantially reduced poverty rates, there is still a significant fraction of poor people in the country.

It appears that a large proportion of post transfers residual poverty rates must be due to behavioral responses to programs’ benefit policies. Program benefit cuts are an increasingly larger proportion of increasing earnings and assets, as the above study for New York shows. In addition, more benefits are guided to single parent as opposed to two parent families, thus encouraging formation of single parent families and/or encouraging divorces. The data show that single parent families headed by females have a much higher poverty rate than two parent families.

Since benefits and Earned Income Tax Credit (EITC) increase with family size, they tend to encourage more children in a single-parent family. Large family size is another source of hardship for poor families. However EITC, one of the fastest growing means tested program after Medicaid, is a pro-work program. Mr. Romney once remarked that the 47 percent of Americans who do not pay federal income taxes claim victimhood and expect the government to provide these transfers. It includes all those low-income people and poor who receive EITC. The credit provides incentive to work. Therefore, if the credit is taken away, poverty roles will further increase. In fact all means tested poverty programs for able-bodied persons, including food stamps, TANF (Temporary Assistance to Needy Families), housing subsidies and supplemental nutrition program (WIC), should be tailored around the theme of work incentives.

If we are serious about reducing poverty, benefits should increase when able-bodied poor and low-income families earn and save more, until income reaches a threshold level equal to "Basic Needs Budget" (BNB) proposed by National Center for Children in Poverty (NCCP) at Columbia University (www. Nccp.org). NCCP’s budget based income thresholds are higher than the poverty income thresholds defined by the Census Bureau, and vary from high-cost to low-cost cities and types of families. For example, Kinsey Dinan of NCCP (March, 2009) proposed annual income need of $41,000 for a single-parent family with two children in moderate-cost city, Des Moines, Iowa. It is 233 percent of the federal poverty level.

There is another beneficial side effect of pro-work EITC. The study by Gordon Dahl and Lance Lochner (DL), American Economic Review, August 2012, investigates scholastic achievement of children five years old and over due to EITC. They use a data set of 4,500 children from the National Longitudinal Survey of Youth and sample period (1987-2000) and measure family income as total net income, including EITC net of federal and state taxes and transfers. Test scores on PIAT (Peabody Individual Achievement Tests) measure scholastic performance of children. These standardized scores measure ability in mathematics, oral reading, reading comprehension and ability to derive meaning from printed words.

They find that increase in current income due to EITC significantly increases a child’s math and reading scores. Increase in scores is larger for younger children growing up in poor disadvantaged families, such as unmarried households, minority families, families with low-educated mothers. The effects are also more pronounced for boys. These findings are predictive of a better future for poor children and economic well-being of poor families.

Evidence indicates that means tested anti-poverty programs would provide incentives for work if a smaller proportion of benefits were reduced with increase in earned income. Census Bureau’s measures of poverty income are inadequate and hence should be modified along the lines of BNB. Also, benefits should promote education and skills and asset accumulation to put poor families on a sustainable path to economic self-sufficiency and replace programs that subsidize employers such as Work Opportunity Tax Credit. These subsidies do not help fill the skill gap emerging in the labor market due to the changing structure of the economy.

This is the second part of a two-column series by Mathur, who wrote on Oct. 21 about a renewed focus on poverty and entitlements. Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also writes blogs for the Standard-Examiner at http://blogs.standard.net/economics,etc.

Renewed focus on poverty and entitlements

Vijay K. Mathur

Published in Standard-Examiner October 19, Ogden, Utah

Election times in slow-growth economy bring attention to poverty and safety net programs to alleviate poverty. In the first presidential debate, Mitt Romney blamed President Barack Obama for the increase in the poverty rate. He promised to create 12 million jobs. Such a statement on jobs recognizes that increase in poverty is due to lack of job opportunities. However, this statement contradicts his remarks at the private fundraiser that 47 percent of Americans, who do not pay federal income taxes, consider themselves as victims and are dependent on government for entitlements.

Perhaps Mr. Romney’s views on 47 percent of Americans also fit his tax and spending agenda. Cutting income tax rates by 20 percent across all income brackets and other tax cuts, on top of Bush tax cuts, primarily benefit the rich. He also intends to increase defense spending and reduce the budget deficit. His claim, that he can accomplish his goal by reducing tax loopholes and deductions and increase the level of economic growth, is far fetched at best. Therefore, in all likelihood, Mr. Romney has to dip into Social Security, Medicare, Medicaid and other entitlements, which would be extremely burdensome to low-income and poor households and even to many middle-income households.

Let us look at some facts about poverty and then examine how much difference safety-net programs make in the lives of the poor. Census Bureau defines a family as poor if its annual pretax money income falls below the poverty threshold. Thresholds vary with the size of family.

For example, in 2011 poverty thresholds were $11,484 for one person with no children, $15,504 for two-person household under 65 years of age with one child, $18,106 and $18,123 for three person households with one child and with two children respectively, and $10,788 for those 65 years old and over with no children.

Census Bureau data shows that in 1959 poverty rate for all people in the U.S. was 23 percent of the population. It declined throughout 1960s, reaching a low point of 11.1 percent in 1973. This decline was partly due to the passage of The Economic Opportunity Act in 1964 during President Johnson’s administration. The poverty rate has increased to 15.9 percent in 2011. Among children 18 and under it has always been higher than for all people since 1973, and in 2011 it was a scandalous rate of 27 percent. The elderly poverty rate in 1959 was 35 percent, but in 2011 it was close to 12 percent, due mainly to social insurance programs. I am sure deep recession of 2007 worsened these rates.

The question is, how much difference is made in reducing poverty by social insurance programs (SIP), and Means-tested Transfers (MTT), including entitlements. SIP has dedicated funding and provide benefits to those who have made contributions to the programs. MTT are financed by general tax revenues, and provide benefits to eligible persons and families based on income and assets.

A major study by Professors John Karl Scholz, Robert Moffitt and Benjamin Cowan (SMC), Discussion Paper no. 1350-08, September 2008 at http://www.irp.wisc.edu, is instructive in gauging the effectiveness of these programs. They investigate SIP (Social Security, Medicare, unemployment insurance, workers’ compensation and disability insurance) and MTT. MTT includes three types of programs: 1) Medicaid and Supplemental Security Income for the aged, blind and disabled, 2) cash transfers, for example, Temporary Assistance for Needy Families that replaced AFDC (Aid to Families with Dependent Children) in 1996, Earned Income Tax Credit, and 3) in-kind transfers, for example, food stamps, housing assistance, head start, school lunches, and nutrition programs for women, infants, and children,

SMC analysis includes 1984, 1993 and 2004, but I report here their findings for only 2004. They assume away behavioral responses to the anti-poverty programs that may provide work disincentives and hence may increase the poverty rate. They find that in 2004 all transfers (including SIP, all cash transfers, all in-kind transfers, all MTT except child care credit and foster child payments) reduced percentage of poor families and individuals from 30.3 percent with no transfers to 12 percent after transfers.

In 2004 for different family types, the transfer system was very effective as well. For example, from pre-transfers to post-transfers, percentage of single-parent and two-parent poor families decreased 71 percent and 66 percent respectively, the percentage of employed poor decreased 51 percent and the percentage of elderly families and individuals decreased 86 percent.

Using SMC data I find that in 2005 spending on MTT (including Medicaid) was 53 percent of spending on SIP. The evidence suggests that safety-net programs with minimum disincentives for work would be very effective in reducing poverty. SMC cite past evidence that reducing entitlement benefits had imposed a heavy indirect tax on the poor for working.

Therefore, any trimming of these programs to offset tax cuts for the rich must be done with careful thought and not be guided by ideology. The character of a nation and its people is determined by how its most vulnerable people are treated.

This is the first part of a two-column series by Mathur. Next week he will write about incentivizing poor and low-income persons to work and save more. Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland Sate University, Cleveland, Ohio. He also writes blogs for the Standard-Examiner at http://blogs.standard.net/economics,etc.