Chapter 17: Poverty

Read Chapter 17 CarefullyMy lecture will not follow the textbook chapter as closely as it normally does. Instead I will discuss

-Poverty measurement-How many are poor in America and why should we

care-Constructive steps in anti-poverty policy

How is Poverty Measured? Adam Smith

Relative measures – the absence of a linen shirt.

U.S. today Mollie Orshansky in the mid 1960s took the

cost of a minimally adequate diet (the Economy Food Plan) and multiplied by 3.

Since then the Orshansky measure has been increased annually by the cost of living.

The poor are those whose yearly income was below this threshold for a family of a given size.

The poverty threshold for a family of 4 is $19,484. For 3 it is $14,776.

There are clear conceptual problems with how poverty is measured in the U.S. But I will focus on other things today.

Why Are So Many Poor 40 Years After the “War on Poverty?” There is, of course, no single explanation. But

the following play some role. Changes in the U.S. economy, particularly the shift

from agriculture and manufacturing base to a “knowledge-based” service economy.

Poor schools, particularly in the urban core. Drugs, gangs, anti-social behavior. Incarceration policy, particularly for African American

men. Changes in family structure, including a startling rise

in the fraction of children raised in single parent households.

Fairly anemic public interventions.

Let Me Say Something (Brief) on the Last Three Items Incarceration policy:

In 2001 16.6 percent for black men in 2001 had spent time in a state or federal prison

Among black men without a college education and born between 1965 and 1969, 30 percent had been in prison by 1999

Among those in this cohort without high school diplomas, the proportion is nearly 60 percent.

Single-parent households: In 1990, 26.6 percent of births were to single

women. In 1998, this percentage was 32.8.

Figure 3: Total Benefits or Program Costs for Various Cash and In-Kind Programs, 1970-2002

(constant 2002 dollars)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

To

tal B

en

efi

ts o

r P

rog

ram

Co

sts

($

mill

ion

)

Head Start Housing Aid Food Stamps AFDC/TANF EITC

Table 2

Share of Aggregate Income Receivedby Quintile of Household for OECD Nations

Country (year)

Income Quintile

FirstSecon

d ThirdFourt

h Fifth

Austria (1995) 7.0 13.2 17.9 24.0 37.9

Belgium (1996) 8.3 14.1 17.7 22.7 37.3

Canada (1997) 7.3 12.9 17.4 23.1 39.3

Czech Republic (1996) 10.3 14.5 17.7 21.7 35.9Portugal (1997) 5.8 11.0 15.5 21.9 45.9

Slovak Republic (1996) 8.8 14.9 18.7 22.8 34.8

Sweden (1995) 9.1 14.5 18.4 23.4 34.5

Turkey (2000) 6.1 10.6 14.9 21.8 46.7

United Kingdom (1995) 6.1 11.7 16.3 22.7 43.2

Unweighted average 7.6 12.7 16.9 22.5 40.3

United States (2002) 3.5 8.8 14.8 23.3 49.7

The poorest one-fifth in the U.S. receive a smaller share of

income than in the typical OECD country.

While the richest one-fifth receive considerably more.

Another Issue, Highlighted by the Krugman Reading, is that Americans appear to tolerate more income inequality than people in other

countries

One Reason to Care: Poverty and ChildrenSource: Duncan and Brooks-Gunn (1997)

11.7

16.3

10

8.1

28.8

21

11

15.9

5.4

6.5

4.7

5

4.1

14.1

9.6

3.6

1.6

0.8

0 5 10 15 20 25 30

Fair or poor health

Lead poisoning

Stunting

Hospitalizations (per 100 childen)

Grade repetition

High-school dropout

Female teen out-of-wedlock birth

Experience hunger

Reported cases of child abuse and neglect

Poor Children Non-poor Children

Central Issues for Poverty Research and Policy Child poverty

More than 1 in 6 children in America live in a household with income below the poverty line.

This is after the longest economic expansion in U.S. history (from 1992-2000) and 10 years after we “ended welfare as we know it.”

Violates fundamental American values of opportunity and has high social costs.

Welfare reform and ‘devolution’ Fundamental shift in responsibility for the safety net. Similarly far-reaching changes in what states are

doing.

Central Issues, continued…

Concerns arise with Antipoverty policy (as with many policy areas) about unintended consequences Cash payments can reduce employment and/or hours of

work, and create resentment from other working families. If employment is reduced, one might worry about “role models” for

children. “Living wage” proposals may make it difficult for low-skilled

workers to find jobs. Mandatory paternity establishment and child support

guidelines – does this lead to unmarried men working in the underground economy?

It is critical for policy to be ensure the incentives align with societal norms.

THE MORAL HAZARD COSTS OF WELFARE POLICY

Prominent economist Authur Okun once compared the process of income redistribution to a “leaky bucket” We are carrying money from the rich to the poor, but some money

leaks out along the way. Redistribution comes with potentially large moral hazard costs. The social

welfare function quantifies the efficiency-equity tradeoff between less redistribution and more social efficiency, and more redistribution and less social efficiency.

The “leakage” from transfers comes from: Administrative costs. Taxation on higher income individuals may affect their labor supply

and savings. And, by insuring against being poor, safety net programs create an

incentive for individuals to change behavior to qualify for transfers.

2,000 Hours of leisureper year

$ of consumptionper year

25,000

G = 9,000

A

B

C

Z

D

X

Y

5,000

20,000

1,6001,200400

10,000

slope = -wage = -12.50

1,280

Figure 3This is the budget constraint before welfare is introduced.

Individuals make different choices based on preferences.

Welfare is introduced with a $9,000 guarantee and a

BRR of 100%.

Some will be “mechanically” eligible and reduce hours of work.

Others are initially ineligible, but reduce their work effort, too.

Behavioral responses to a welfare program with 100 percent “clawback” rates on benefits

2,000 Hours of leisureper year

$ of consumptionper year

25,000

G = 9,000

A

B2

C

Z1

D

X1

Y1

slope = -net wage = -6.25

560

Y2

X2

B1

slope = -wage = -12.50

18,000 Z2

1,280

Figure 4

Lowering the BRR changes the

budget constraint.

Hours of work fall for person X.

Hours also fall for person Y.

And person Z becomes eligible.

Lowering the benefit reduction rate improves workincentives but may cost more money…

The moral hazard costs of welfare policy

The “iron triangle” of redistributive programs

The iron triangle means that there is no way to change either the benefit reduction rate or benefit guarantee to simultaneously encourage work (have desirable incentives), redistribute more income (be compassionate), and lower costs (be good stewards of scare taxpayer dollars). If the tax rate is lowered, work could be

discouraged for some and costs could go up. If the guarantee is lowered, work increases and

costs fall, but redistribution falls.

Reducing the moral hazard of welfare

Moving to categorical welfare payments

One way to mitigate the moral hazard problem is to focus eligibility on characteristics that are easy to verify, hard to change, and relate closely to low earnings.

What characteristics make a good targeting mechanism? Characteristics that are unchangeable. Characteristics that target those with low earnings

capacity. In reality, welfare programs target

characteristics like blindness, age, disability, and single motherhood.

Reducing the moral hazard of welfare

Using “ordeal mechanisms” An alternative approach is to try get individuals to reveal

themselves as less able through ordeal mechanisms. Ordeal mechanisms are features of welfare programs that make

them unattractive, leading to self-selection of only the most needy recipients.

Work or training requirements of TANF are an example of such a mechanism – they impose a cost on individuals who are just using welfare as a means of increasing their leisure.

The provision of in-kind benefits rather than cash is another example. If the government gives away cash, then individuals who are not needy will pretend to be needy to qualify. If the government offers, instead, a somewhat run-down public housing project, those with high ability may not be interested in taking up the benefit.

The paradox of ordeal mechanisms is that by making the less able worse off could make them better off, because the government can make a fixed budget go further.

Reducing the moral hazard of welfare

Increasing outside options

The third approach to reducing moral hazard is to increase the outside options available so that it is no longer as attractive to be on welfare.

There are five different approaches the government can take to increase outside opportunities for welfare recipients: Training Labor market subsidies Child care Child support Removing welfare lock

So, The Causes of Poverty Are Complex, the Consequences are Severe, and the There are Difficult Constraints in Designing Programs in a Way That Maintain Good Incentives…

Is the Current state of affairs inevitable? I want to say a little now about efforts

to combat poverty, focusing on “what works.”

What Works? Public Expenditures Can Reduce

Poverty and Inequality One possibility is to look at data from

other countries. These comparisons mask many differences:

structure and dynamism of the economies, ethnic homogeneity, and perhaps other cultural differences.

Cross-country measures are difficult to construct. Most common international standard is to measure the fraction of the population with income that is less than half the median.

With these caveats…

Relative Poverty Rates and Antipoverty Effects in 8 Rich Nations at the Turn of the Century

(Percent of Persons with Market Income and Disposable Income Less than Half of Adjusted National Disposable Median Income)

Source: Smeeding (2004)

9.8

5.4

6.4

7.9

8.2

8.9

11.9

12.3

17.0

26.1

18.1

29.2

31

28.6

21.6

24.8

31.8

23.7

0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0

Overall Average

Finland 2000

Sweden 2000

Belgium 1997

Germany 2000

Netherlands 1999

Canada 1997

UK 1999

US 2000

Percent of Population

Market Income (Pre- Tax and Transfer) Poverty

Disposable Income (Post- Tax and Transfer) Poverty

Relationship of Cash Social Expenditures for the Non-elderly and 10/50 Ratios in Eighteen Countries in the 1990s, Source: Smeeding (2004)

United States

Italy

Canada United KingdomAustralia

Spain

Japan

Germany

Denmark

Netherlands

FinlandSweden

BelgiumFrance

Luxembourg

Norway

Russia

Mexico

R2 = 0.7224

25.0

30.0

35.0

40.0

45.0

50.0

55.0

60.0

65.0

70.0

0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0

Non-elderly and Cash and Near-Cash Social Expenditure Level (as Percent of GDP)

P10

(10

th t

o 5

0th

Per

cen

tile

)

What Works? A Strong Economy! March 1991-March 2001: 120 months free of

recession Payroll employment increased by over 20

million jobs over this period. Unemployment was around 4 percent. Wage growth since 1993 has been evenly

distributed across income groups. Poverty rates fell and welfare caseloads declined a

great deal. The 1980s, where growth was strong but poverty did not

fall much, differed from the 1990s, where growth was accompanied by sharp reductions in poverty.

What Works? The Earned Income Tax Credit The EITC raised the incomes of 4.3 million

people above the poverty line in 1998. 54 percent of the EITC directly fills the

“poverty gap.” It reduces the poverty gap by 5.2 percent.

The EITC positively affects labor market participation for single-parent families. One prominent study finds the EITC accounts

for 63 (37) percent of substantial increase in LFP of single mothers between 1984-96 (1992-96).

What Works? Investments in Early Childhood Education! “Recent studies of early childhood investment

show remarkable success…” “Early childhood interventions of high quality have

lasting effects on learning and motivation.” “An important lesson to draw from the entire

literature on successful early interventions is that the social skills and motivation of the child that are more easily altered – not IQ. These social and emotional skills affect performance in school and in the workplace. We too often have a bias that only cognitive skills are of fundamental importance to success in life.”

Nobel Laureate James Heckman

What Works? Welfare Reform

Good news Sharply declining caseloads. No systematic evidence of increased

homelessness, food pantry usage, etc. Substantial numbers of former

recipients have equal or higher family incomes.

Considerable diversity and creativity in State programs.

What Works? Welfare Reform (continued) Bad news

The safety net is gone. The food stamp eligibility process can be a nightmare in some places and TANF is time-limited.

Few families have reached time limits. No minimum national standards. Wicked problems remain: family structure, crime

and incarcerations, horrible schools, lack of affordable, high-quality child care, insurance…

Fiscal pressures burden state policymakers and their citizens. The safety net is frayed.

While We Know a Lot About the Poverty Problem Welfare reform is clearly not

A “silver bullet” – many households appear as well or better off, but child poverty rates are still very high.

Extreme US-style devolution can still lead to a “race to the bottom.”

The system appeared to have survived a mild recession, but can it stand up to a more severe fiscal downturn?

There is no systematic evaluation requirement.

In Closing The problems are exceptionally difficult.

Poorly performing schools, poor labor markets for low-skilled workers, drugs, crime, children being raised in single-parent households.

These create formidable problems for some families and individuals to achieve a standard of living above poverty.

The fiscal situation is fairly dire, though this can turn around reasonably quickly with prudent fiscal management.

The politics and problem of poverty have not yet stirred the voting public. Though some (John Edwards most recently) have tried to

push this forward.

An Essential Part of the Story: Combating Policy Cynicism We will never make progress if the public is

convinced that “nothing works.” Antipoverty policy requires an activist government. There is a long cycle of policy initiatives where initial

ideas are hyped, there is inadequate implementation and expenditures, and later, the problem remains.

This gives the perception that “nothing works.” It is essential for advocates, scholars, and citizens to

tell the stories and gather evidence for cost-effective approaches that work.

I have listed a set of policies today, that can form the basis of an efficient, successful anti-poverty strategy.

Moving Forward

Welfare reform, which many (including me) thought was punitive and ill-considered, may result in a more effective antipoverty policy, if… Careful evaluation is conducted on state initiatives to

better understand what works. Taxpayers believe that all need to work and that “poor

support” is targeted to families “doing the right thing.” There is a striking difference in American’s antipathy toward

“welfare” and their professed willingness to “assisting the poor.”

Serious, successful efforts to reduce poverty can be an enduring part of national politics.