2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. Chapter 11: Strategies for reform Barr: Economics of the Welfare State: 4e

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. Organization of the chapter 1. Approaches to income support 2. Income-testing: The negative income- tax approach 3. Indicator-targeting: The ‘Back-to- Beveridge’ approach 4. Mixed strategies 5. Conclusion: Cash benefits

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. 1. Approaches to income support Chapter 10 distinguished two approaches to identifying the poor: Benefits can be conditioned on income (i.e. means-tested), the archetypal example being negative income tax (section 2) Alternatively, they can be conditioned on the characteristics of recipients, using indicators such as being unemployed, sick, or retired. This strategy is sometimes called the ‘Back- to-Beveridge’ approach (section 3)

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. 2. Income-testing: The negative income-tax approach

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. 2.1 Negative income tax: the idea Archetypal scheme based on an income test In the simplest scheme a person’s tax bill is T = t(Y-B) where t = tax rate Y = the person’s income B = the breakeven level of income For someone with a low income, T is negative, i.e. he/she receives a transfer of T

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved Large-scale negative income-tax schemes Advantage: politically popular Libertarians see income transfers as loosening what they see as the stranglehold of in-kind transfers under the welfare state Socialists see negative income tax as guaranteeing everyone some income as a right of citizenship and without a means test Why has no country adopted a large-scale negative income tax? Disadvantage: the short answer, given the shape of the income distribution, is the cost of a large-scale negative income tax

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. How useful is a large-scale scheme? Given the shape of the income distribution, and current benefit levels: A universal negative income tax will be costly, necessitating high tax rates likely to cause labour-supply problems. Negative income tax will not be a strong redistributor

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved The role of a small-scale negative income tax A small-scale scheme will not solve poverty, and therefore contributes to poverty relief only if it makes other schemes more effective It can do so in two ways Increasing take-up Alleviating the poverty trap

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. 3. Indicator-targeting: The ‘Back- to-Beveridge’ approach

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved The idea In this approach, benefits are conditioned on characteristics such as being unemployed, ill, retired, or having children In its pure form, the approach is based wholly on indicator targeting, with no means testing As discussed in Chapter 10, the ideal indicators are Highly correlated with poverty, to ensure accurate targeting Exogenous to the individual, to minimize distortionary incentives Easy to observe, to assist administration

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. Choosing indicators Empirically, the major correlates of poverty are unemployment, ill health, large families, single-parent families, old age, and high housing costs In developing economies, indicators can include place of residence, being landless, pregnancy, infancy, and school attendance by young children The indicator approach can be organized via social insurance (e.g. unemployment benefit), but does not have to be (e.g. child benefit)

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. Pros and cons of the ‘Back to ‘Beveridge’ approach Advantages Somewhat better incentives Less stigma Administratively easier than income testing Disadvantages Gaps Leakages Some remaining adverse incentives

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. 3.2 An example James Meade advocated a system that Paid all national-insurance benefits (unemployment benefit, pensions, etc.) at or above the poverty line Paid child benefit at or above the poverty line Paid additional benefits to one-parent families and people with disabilities Phased out many means-tested benefits Advantages: Families are not trapped in poverty (an equity gain) Beneficial incentive effects (an efficiency gain)

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. 4 Mixed strategies Neither of the pure strategies is a complete solution Negative income tax faces all the problems of income testing A strategy based wholly on indicator targeting will have gaps and leakages This points towards strategies which make use of both approaches

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. Example of a mixed strategy: the Atkinson participation income A person is eligible if he/she is Working (employed or self-employed) Retired Unable to work because of ill-health Unemployed and available for work Engaged in education or training Caring for young, old or disabled dependants Undertaking approved types of voluntary work

2 H i g h e r E d u c a t i o n © Oxford University Press, All rights reserved. 4 Conclusion The ultimate constraint on policy design is the shape of the income distribution Thus there is an inescapable need to withdraw poverty relief as a person/ family becomes less poor