the tragedy of means tests

Greg Mankiw is one of a handful of economists who worry about the effect of means tests on the welfare of the poor. Some time ago, he  posted a quote of “Kennedy School economist Jeff Liebman (via Jeff Frankel’s new blog) [who] tells a sad story about the incentive effects of government programs aimed at helping the poor”:

the poverty trap is still very much a reality in the U.S. A woman called me out of the blue last week and told me her self-sufficiency counselor had suggested she get in touch with me. She had moved from a $25,000 a year job to a $35,000 a year job, and suddenly she couldn’t make ends meet any more. I told her I didn’t know what I could do for her, but agreed to meet with her. She showed me all her pay stubs etc. She really did come out behind by several hundred dollars a month. She lost free health insurance and instead had to pay $230 a month for her employer-provided health insurance. Her rent associated with her section 8 voucher went up by 30% of the income gain (which is the rule). She lost the ($280 a month) subsidized child care voucher she had for after-school care for her child. She lost around $1600 a year of the EITC. She paid payroll tax on the additional income. Finally, the new job was in Boston, and she lived in a suburb. So now she has $300 a month of additional gas and parking charges. She asked me if she should go back to earning $25,000.

Greg Mankiw, “The Poverty Trap”, 10 February 2008.

Jeffrey Liebman is now Executive Associate Director of Obama’s Office of Management and Budget (OMB).

More recently, Mankiw linked to work by Boston University economists Kotlikoff and Rapson, who give the tax-transfer system of the US very low marks:

America’s tax-transfer system confronts the vast majority of American households with either high, very high, or astronomically high total effective marginal tax rates on labor supply and saving. It also provides very substantial tax arbitrage opportunities to a subset of households, particularly those with high incomes or advanced ages.

The pattern of net marginal tax rates and arbitrage opportunities with respect to age, marital status, and earnings is quite simply all over the map. But this is what one would expect given the amazing complexity of the fiscal system, the fact that the various components of the system are being developed with little or no thought to their interaction, and that the various governmental bodies responsible for the different elements of our tax-transfer system appear to make little or no attempt to understand the overall work and saving disincentives as well as arbitrage opportunities they are producing.

Laurence J. Kotlikoff and David Rapson, “Does It Pay, at the Margin, to Work and Save? — Measuring Effective Marginal Taxes on Americans’ Labor Supply and Saving”, Boston University, October 2006.

For reasons that I do not fully understand, political conservatives like Mankiw frequently fail to draw the obvious conclusion that universal benefits trump targeted transfers. The unwritten implication is the poor would be better off without transfers, but with their work incentives intact. Where are the ‘compassionate conservatives’?

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2 Responses to “the tragedy of means tests”

  1. Administrator says:

    Douglas, a loyal TdJ reader, has taken up my challenge:

    As one political conservative, let me quickly respond to Larry with the following comment: Universal benefits are certainly better than means tested benefits for all the reasons that Mankiw and others have given about the negative effects of means tests. The problem with universal benefits is that they are universal, and because they are universal they are subject to “benefit bloating” and “benefit creep”, that is, there are strong incentives to overuse them and immense pressures to expand them. This is especially true when the universal benefits are given at the national level where the distance between the people who pay and the people who use benefits is wide. Giving the benefits to everyone simply means that everyone will overuse the available benefits and demand that they be expanded, making the approach fiscally unsound.

    Tightly circumscribed and specifically tailored universal benefits, such as those for major medical problems where no one would want to make a claim and which can be closely monitored by financing authorities, are a great idea. If government benefits are to be extended to all, it would be better to provide them “universally” at the local level, which is better situated to judge what is needed and whether the resources being distributed are being wasted.

    I would not be surprised if research on the negative incentives associated means tests is likely to have a significant effect on policy development in the future.

  2. […] rates of taxation of incomes of the working poor. But they rarely do, with the notable exception of Greg Mankiw. Remember, marginal rates of taxation of low incomes often exceed […]