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1. chapter: 19 >> The Economics of the Welfare State Krugman/Wells Economics ©2009  Worth Publishers

2. What the welfare state is and the rationale for it • What defines poverty, what causes poverty, and the consequences of poverty • How income inequality in America has changed over time • How programs like Social Security affect poverty and income inequality • The special concerns presented by health care insurance • Why there are political differences and debate over the size of the welfare state

3. Poverty, Inequality, and Public Policy • The welfare state is the collection of government programs designed to alleviate economic hardship. • A government transfer is a government payment to an individual or to families—that provide financial aid to the poor, assistance to unemployed workers, guaranteed income for the elderly, and assistance in paying medical bills for those with large health care expenses.

4. The Logic of the Welfare State • One major rationale for the welfare state is alleviating income inequality. • A poverty program is a government program designed to aid the poor. • A second major rationale for the welfare state is alleviating economic insecurity. • A social insurance program is a government program designed to provide protection against unpredictable financial distress.

5. The Logic of the Welfare State • These two rationales for the welfare state are closely related to the ability-to-pay principle. • The ability-to-pay principle was used to justify progressive taxation: it says that people with low incomes, for whom an additional dollar makes a big difference to economic well-being, should pay a smaller fraction of their income in taxes than people with higher incomes, for whom an additional dollar makes much less difference. • The same principle suggests that those with very low incomes should actually get money back from the tax system.

6. Justice and the Welfare State • In 1971 the philosopher John Rawls published “A Theory of Justice,” the most famous attempt to date to develop a theory of economic fairness. • Decide economic and social policies behind a “veil of ignorance” about own identity  sort of a generalized version of the Golden Rule: do unto others as you would have them do unto you if you were in their place. • Argument for a generous welfare state

7. Justice and the Welfare State • In 1974, Robert Nozick, published the libertarian response, “Anarchy, State, and Utopia” • Nozick argued that justice is a matter of rights, not results, and that the government has no right to force people with high incomes to support others with lower incomes. • He argued for a minimal government that enforces the law and provides security—the “night watchman state”—and against the welfare state programs that account for so much government spending.

8. The Problem of Poverty • The poverty threshold is the annual income below which a family is officially considered poor. • The poverty rate is the percentage of the population with incomes below the poverty threshold. • The following graph shows the U.S. poverty rate since 1959.

9. Trends in the U.S. Poverty Rate, 1959–2006 U.S. Poverty Rate 25% 20 15 10 1959 1990 2000 2006 1970 1980 Year

10. Defining Poverty • Who decided how much income an American family needs to escape poverty? • Mollie Orshansky, a research analyst at the Social Security Administration, developed initial estimates of the poverty threshold in 1963–1964. • Orshansky started by estimating the cost of an inexpensive but nutritionally adequate diet. She then observed that families with children spent about one-third of their income on food. • She argued that any family earning less than three times the cost of purchasing an adequate diet did not have adequate income.

11. Defining Poverty • Was this the right measure of poverty? • Yes, when it was created. • This measure of poverty is badly outdated now because the composition of spending by low-income families has changed significantly since the 1960s. • On average, the share of income spent on food has fallen to less than 20%, but the share spent on things such as housing, health care, transportation, and child care has risen.

12. Who Are the Poor? • In 2006, about 36.5 million Americans were in poverty—12.3% of the population, or about one in eight persons. • About one-quarter of the poor were African-American and a roughly equal number, Hispanic. Within these two groups, poverty rates were well above the national average: 24.3% of African-Americans and 20.6% of Hispanics. • But there was also widespread poverty among non-Hispanic Whites, who had a poverty rate of 8.2%.

13. Who Are the Poor? • Adults who work full time are very unlikely to be poor: only 2.7% of full-time workers were poor in 2006. • Adults who worked part time or not at all during the year made up 88.3% of the poor in 2006.

14. Who Are the Poor? • Female-headed families with no husband present had a very high poverty rate: 30.5%. • Married couples were much less likely to be poor, with a poverty rate of only 4.9%; still, about 38% of poor families were married couples.

15. What Causes Poverty? • Lack of education • 83% “college premium” (2006) • Lack of proficiency in English • Racial and gender discrimination • Bad luck

16. Consequences of Poverty • Lack of access to health care • Affordable housing • Children raised in severe poverty tend to suffer from lifelong learning disabilities.  Poverty is self-perpetuating: the children of the poor start at such a disadvantage relative to other Americans that it’s very hard for them to achieve a better life.

17. Poverty rate Absolute Relative 18% 17.0% 16 14 12.4% 11.4% 12 10 8.7% 8.3% 7.5% 7.6% 8 6.9% 6.5% 6 4 2 0 United States Canada Germany Sweden United Kingdom Poor People in Rich Counties

18. Poor People in Rich Counties • According to the relative definition of poverty (you’re poor if you have a low income compared with other people in your country) United States has high poverty compared with other rich nations. • According to absolute poverty (similar to the official U.S. poverty threshold), the U.S. is no longer the country with the highest poverty rate by this measure—it is in second place. • By either measure, the United States has a high poverty rate compared to other rich countries.

19. Economic Inequality • Mean household income is the average income across all households. • Median household income is the income of the household lying at the exact middle of the income distribution.

20. Economic Inequality • Income in the United States is quite unequally distributed. • The average income of the poorest fifth of families is less than a quarter of the average income of families in the middle. • The richest fifth have an average income more than three times that of families in the middle. • The incomes of the richest fifth of the population are, on average, about 15 times as high as those of the poorest fifth. • The distribution of income in America has become more unequal since 1980.

21. Economic Inequality • The Gini coefficient is a number that summarizes a country’s level of income inequality based on how unequally income is distributed across quintiles.

22. Income Inequality Around the World

23. Trends in U.S. Income Inequality (b) The Richest 10% of Americans, 1917-2006 (a) Rates of Income Growth Since 1947 Growth in Income Share of total income going to top 10% 1947–1980 1980–2005 2.5% 50% 2.37% 2.36% 2.30% 2.11% 2.05% 2.0 45 1.88% 1.5 40 0.99% 1.0 35 0.68% 0.48% 0.5 30 0.11% 0 Bottom Second Third Fourth Top 1917 1930 1960 1990 2006 Income Group (quintile) Year

24. The U.S. Welfare State

25. The U.S. Welfare State • A means-tested program is a program available only to individuals or families whose incomes fall below a certain level. • An in-kind benefit is a benefit given in the form of goods or services. • A negative income tax is a program that supplements the income of low-income working families. • Social Security, the largest program in the U.S. welfare state, is a non-means-tested program that provides retirement income for the elderly. It provides a significant share of the income of most elderly Americans. • Unemployment insurance is also a key social insurance program.

26. The Effects of the Welfare State

27. The Effects of the Welfare State The American welfare state is redistributive. It increases the share of income going to the poorest 60% while reducing the share going to the richest 20%.

28. (b) Britain’s Gini Coefficient, 1980-2006 (a) Britain’s Poverty Rate, 1979-2006 Percent of population with less than 50% of 1998-1999 median income Gini coefficient 0.39 25% 0.37 0.35 20 0.33 15 0.31 0.29 10 0.27 5 2006 1990 1995 2000 1980 1985 1979 1990 2000 2006 Year Y ear Effects of Policy on British Poverty

29. The Economics of Health Care • Health insurance satisfies an important need because expensive medical treatment is unaffordable for most families. • Under private health insurance, each member of a large pool of individuals pays a fixed amount to a private company that agrees to pay most of the medical expenses of the pool’s members.

30. Who Paid for U.S. Health Care in 2006? Out of pocket 12% Private Insurance 34% Other public 12% Medicare 19% Medicaid Other private 15% 7%

31. Who Paid for U.S. Health Care in 2006? • The majority of Americans not covered by private insurance are covered by • Medicare, which is non-means-tested and applies only to those age 65 and older, and • Medicaid, which is available based on income.

32. The Economics of Health Care

33. The Consequences of Being Uninsured (a) Barriers to Receiving HealthCare, 2003 (b) The Financial Burden of Paying Medical Bills, 2003 36% 42% Had problem paying medical bills No regular source of care 16% 9% Changed way of life significantly to pay medical bills 23% 47% Postponed seeking care because of cost 9% 15% 23% 35% Contacted by collection agency about medical bills Needed care but did not get it 8% 9% 0 10 20 30 40 50% 37% Did not fill a prescription because of cost Percent 13% Uninsured Insured 0 10 20 30 40 50% Percent

34. Health Care in Other Countries • The United States differs from other wealthy countries in its heavy dependence on private health insurance and its high health care spending per person. • Some countries, such as Canada, have a single-payer system. • A single-payer system is a health care system in which the government is the principal payer of medical bills funded through taxes. • Compared to other wealthy countries, the U.S. system has much higher costs. • The higher costs do not necessarily imply better care.

35. Health Care in Other Countries

36. Changes in Health Insurance Status, 2000–2006 Change (millions) 20 17.3 15 8.7 8.6 10 5 0 –2.3 –5 Employment-based coverage Population Uninsured Medicaid and SCHIP

37. Rising Health Care Costs Health care expenditure (percent of GDP) 16% 12 8 4 Year 1990 2000 1970 1980 2006 1960

38. Number of procedures (thousands) Angioplasty Dialysis Hip Replacement 1,200 1,000 800 600 400 200 0 1970 1980 1990 2000 2004 Year The Cost of Medical Progress, 1970–2004

39. The Debate Over the Welfare State • How large should the welfare state be? • Philosophical concerns about government involvement • Trade-off between efficiency and equity • Although high marginal tax rates to finance an extensivewelfare state can reduce the incentive to work, meanstestingprograms in order to reduce the cost of the welfarestate also reduce the incentive to work.

40. The Debate Over the Welfare State

41. French Family Values • The United States has the smallest welfare state of any major advanced economy. • France has one of the largest. As we’ve already described, France has much higher social spending than America as a percentage of total national income, and French citizens face much higher tax rates than Americans. • One argument against a large welfare state is that it has negative effects on efficiency. • Is France less efficient compared to the U.S.?

42. French Family Values • Yes, French work less (French GDP per capita is only 72% of the U.S. level). • But, young people in France need to work because college education is generally free, and students receive financial support. • Also, French law requires employers to offer at least a month of vacation, but most U.S. workers take less than two weeks off. French get to spend more time with family. • French retirement system allows workers to collect generous pensions even if they retire very early. This is a big burden on the French welfare state.

43. 1.The welfare state absorbs a large share of governmentspending in all wealthy countries. Government transfersare the payments made by the government to individualsand families. Poverty programs alleviate incomeinequality by helping the poor; social insurance programsalleviate economic insecurity. 2.Despite the fact that the poverty threshold is adjustedaccording to the cost of living but not according tothe standard of living, and that the average Americanincome has risen substantially over those 30 years, thepoverty rate, the percentage of the population with anincome below the poverty threshold, is no lower than itwas 30 years ago. There are various causes of poverty:lack of education, the legacy of discrimination, and badluck. The consequences of poverty are particularly harmfulfor children.

44. 3. Median household income, the income of a family atthe center of the income distribution, is a better indicatorof the income of the typical household than meanhousehold income because it is not distorted by theinclusion of a small number of very wealthy households.The Gini coefficient, a number that summarizes acountry’s level of income inequality based on howunequally income is distributed across quintiles, is usedto compare income inequality across countries.

45. 4.Both means-tested and non-means-tested programsreduce poverty. The major in-kind benefits programsare Medicare and Medicaid, which pay for medical care.Due to concerns about the effects on incentives to workand on family cohesion, aid to poor families has becomesignificantly less generous even as the negative incometax has become more generous. Social Security, thelargest U.S. welfare state program, has significantlyreduced poverty among the elderly. Unemployment insuranceis also a key social insurance program.

46. 5.Health insurance satisfies an important need becausemost families cannot afford expensive medical treatment.Private health insurance, unless it is employmentbased,has the potential to fall into an adverse selectiondeath spiral. Most Americans are covered byemployment-based private health insurance; most of theremaining are covered by Medicare (for those over 65) orMedicaid (for those with low incomes). 6.Compared to other countries, the United States reliesmore heavily on private health insurance and has substantiallyhigher health care costs per person withoutproviding better care. Some countries have a singlepayersystem, a system in which the government paysmost medical bills, funded through taxes.

47. 7.Debates over the size of the welfare state are based onphilosophical and equity-versus-efficiency considerations. 8.Politicians on the left tend to favor a bigger welfarestate and those on the right oppose it. This left–rightdistinction is central to today’s politics. America’s twomajor political parties have become more polarized inrecent decades, with a much clearer distinction than inthe past about where their members stand on the left-rightspectrum.

48. The End of Chapter 19 coming attractionChapter 20:Factor Markets and the Distribution of Income