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Cash transfers versus jobs programs
Socio-Econ. Plan. Sci. Vol. 16. No. 4, pp. 147-155, 1982 Printed in Great Britain.
0038-0121182/040147-09503.00/0 Pergamon Press Ltd.
CASH TRANSFERS VERSUS JOBS PROGRAMSt DAVID BETSON and DAVID GREENBERG Institute for Research on Poverty, University of Maryland Baltimore County, 5401 Wilkens Avenue, Catonville, MD 21228, U.S.A.
(Received 22 February 1982) Abstract--This paper uses a microsimulation computer model to compare the work incentive and distributional implications of public service employment programs and direct transfer programs. The simulationfindings suggest that a pure direct transfer program would diminish poverty and inequality by somewhat more than an equal cost plan than combined direct transfers with a jobs program. Moreover, the results imply that a redistribution scheme based entirely on direct transfers is at least as effective per dollar of tax expenditure in raising incomes as a combination of direct transfers and jobs. Furthermore, the simulated job and direct transfer combinations were predicted to cause reductions in private sector earnings that are at least as large as those that would result from comparable schemes that relied solely upon direct transfers. l. INTRODUCTION
Two major m;chanisms to insure minimally adequate incomes for poor families exist. Income can be directly provided to such families or, alternatively, income can be exchanged for the labor services of family members. From World War II until quite recently, major reliance in this country has been placed on the first of these mechanisms, as evidenced by the importance of the AFDC, Food Stamp, and Medicaid Programs and welfare reform proposals since the 1960s that emphasize negative income tax (NIT) features.~ During the Great Depression of the 1930s, however, much use was made of work programs as a transfer mechanism. Recently, moreover, the pendulum appears to be swinging strongly back towards greater reliance on exchanging income for labor services. The Carter Administration's Program for Better Jobs and Income, for example, while incorporating direct transfers, also had a large Public Service Employment (PSE) component. And the Reagan Administration's promotion of workfare programs would even go further by requiring members of certain families to "repay" the government for transfers they receive by performing services at publicly provided, minimum wage jobs. The recent increase in emphasis on job programs as a transfer mechanism seems to be mainly motivated by concern over potential work disincentives associated with such direct transfer programs as AFDC, Food Stamps, and NITs. The reason for this concern is obvious. Both economic theory and common sense suggest that direct transfers reduce the hours recipients
tThe authors are respectively affiliated with the Institute for Research on Poverty and University of Maryland. ~:Under an NIT, as under the AFI)C and Food Stamp Programs, families without other income are allowed a certain fixed amount of transfer benefits, known as the guarantee or basic benefit level, which increases with family size. As family income from other sources rise, transfer payments are reduced by an implicit tax rate, often referred to as the program's benefit reduction rate. When income from other sources are sufficiently high that the benefit reduction exactly offsets the income guarantee--a point known as the breakeven--payments under the program cease. SEPS VoL 16, No. 4--A
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work: the receipt of additional income engenders an income effect that is expected to adversely affect work incentives, and the implicit tax associated with most such programs lowers the reward for market work and consequently is expected to lower hours through a substitution effect. These reductions in hours reduce the output produced by the economy. Moreover, recent evidence from the Seattle and Denver Income Maintenance Experiments (see [1 or 6]) indicates that adverse work incentives associated with a direct transfer program considerably raise the budgetary costs of income maintenance and, by lowering the earnings of recipient families, do much to frustrate the program's intent to raise the overall incomes to those in need. In contrast to direct transfers, programs that provide transfers in exchange for labor services will probably increase overall work effort. Such programs have two potential effects on hours of work: first, they allow some individuals to fill in periods of unemployment; second, they may enable other workers to obtain employment at a higher wage than they could in the regular labor market. The first of these effects will unambiguously increase hours of work, while the direction of the second depends on the shape of labor supply curves over the relevant range of wages. Thus, if the first effect is sufficiently strong and the second is either positive or small, overall hours of work will increase. If employment in the jobs program is more attractive than working at jobs offered by some private sector employers, however, this hours increase will be associated with some transfer of employment from the private to the public sector, possibly resulting in reductions in aggregate productivity. Direct transfers and job programs not only have different effects on work incentives, but have differing distributional implications as well. Under such income conditional transfer programs as AFDC, Food Stamps, and NITs, welfare expenditures are in the form of direct benefits that have a strong inverse relation to household income from other sources. Under work programs, however, some welfare expenditures will be in exchange for labor services on public sector jobs and will not necessarily be closely related to households' positions within the income distribution. Thus, at least in the absence of work incentive effects, a dollar of direct
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transfer expenditure should more effectively raise the incomes of those in need than a dollar expended under a jobs program. The work incentive and distributional implications of direct transfer and job programs that have just been sketched, are obviously complex, making assessment of the relative merits of these two income support mechanisms difficult. A natural and direct method that can be used for this purpose, however, is to simulate how individual households are affected by prototype direct transfer and work programs. This is the approach taken here. Thesimulations on which the findings reported in this paper are based were conducted by means of a computer model developed within the Department of Health and Human Services and used extensively within the government to develop and evaluate various welfare reform alternatives, including the Carter Administration's Program for Better Jobs and Income. This microsimulation model (which has become known as the KGB model after its three developers, Richard Kasten, David Greenberg, and David Betson) treats various interactions among transfer programs, jobs programs, and the positive tax system, allowing for the labor supply adjustments that result from different combinations of these programs. The model can use data on a representative sample of the nation's households to simulate the effects of substantial changes in existing tax and transfer programs, including the provision of jobs to various subsets of the populations. The KGB based simulation results that we report in this paper focus on comparing work programs and direct transfers on the basis of their work incentive and distributional implications. A jobs program, however, is not merely an income transfer mechanism. On the one hand, unlike a direct transfer program, such a plan may result in the production of socially useful output and provide public service workers with valuable work experience. On the other hand, a jobs program will be more expensive to administer than a direct transfer program due to larger requirements for physical capital and supervisory personnel. Later, we shall briefly note some implications of these differences for conclusions based on the simulation results we report. However, a complete assessment of the value of the output or work experience resulting from a jobs program or the administrative costs associated with such a program is well beyond the scope of the present paper. Rather, the purpose of this paper is to indicate the relative impacts of job programs and direct transfers on total work effort, on the distribution of work effort between the public and private sectors, and on the income distribution and poverty. This will suggest the extent to which these two policy approaches should be evaluated on the basis of tradeoffs between their effects on work effort and their efficiency in providing adequate incomes for the poor. In the remainder of this paper, we first briefly describe the KGB simulation model we use and the prototype transfer and work programs we simulate. We then present simulation estimates of the effects of these prototype programs on hours, earnings, transfer receipts, tax
payments, disposable income levels, the distribution of income, and several other program outcomes. A short concluding section follows. 2. THE KGB SIMULATIONMODEL
During the past decade, with the growing availability of high speed computers and large micro data bases (that is, data on nationally representative samples of individuals and households), microsimulation models have become an increasingly important tool in the analysis of tax and transfer policy (see [5]). In general, microsimulation models consist of a computer program that simulates the aggregate and distributional economic effects of proposed policy changes by aggregating predictions made for individual observations in a micro data base on the basis of empirically estimated microeconomic relationships. For example, if the aggregate effect of a change in transfer policy on work effort is to be simulated, a microsimulation model would first utilize empirically derived estimates of the relations between the hours different individuals work and their income levels and wage rates to predict how each person represented in a micro data base, such as the Current Population Survey (CPS), would adjust his or her working hours. The model would then sum these individual's predictions to obtain national totals. This methodology can be usefully contrasted to a macro modeling approach, which usually first obtains an empirical relationship between aggregate economic variables (such as the national labor force participation rate) and policy variables (such as total transfer payments) and then, utilizing this relationship directly, predicts aggregate effects of policy changes. Although in some instances the two approaches are equally appropriate, in other cases the microsimulation approach is far more desirable for many policy analysis purposes. First, more often than not, policy changes do not treat all persons similarly; however, it is rarely feasible to capture this differential treatment within an aggregate framework. Second, the distributional implications of a policy change are often of major interest, but must usually be ignored in using the macro approach. Since these two factors are of paramount importance to analysis of the policy options that we consider in this paper, we have adopted the microsimulation approach. As indicated earlier, the analysis in this paper is based on the KGB model, a microsimulation model that was expressly designed to examine alternative reforms of the tax-transfer system--including the provision of publicly sponsored jobs. In operation, the KGB model proceeds in four major steps:t (1) Characterization of U.S. population in absence of tax-transfer reform. (2) Characterization of the reform of policy interest and how its implementation would affect various economic variables in the absence of behavioral responses by individuals. (3) Predictions of how different individuals would alter their hours of work in response to the reform. (4) Predictions of whether or not given eligible individuals would accept a job under a work program.
Characterization of the pre-reform population tBecause of space limitationsand the complexityof the model, it is only sketched here. Greater detail, as well as an examination-and in some cases sensitivitytests--of major assumptions that underlie the simulationmethodology,may be found in [4].
In the first step, the Survey of Income and Education (SIE) is used to characterize the pre-reform economic status of a representative sample of the nation's families in 1975. Thus, simulation findings obtained with the
Cash transfers versus job programs KGB model are also applicable to the year 1975. The SIE, which is based on information collected from over 175,000 households in 1976, is a large micro data base containing various detailed demographic and economic variables--such as race, family size, composition, earnings, and hours worked. Although many of the variables needed for use in the model appear in the SIE, others, such as the payment of taxes and the receipt of benefits from government tax and transfer programs, must be obtained from other sources and then imputed to the SIE. At present, the list of current government programs explicitly considered by the model includes AFDC, SSI, Food Stamps, General Assistance, Unemployment Compensation, federal and state income taxes, and payroll taxes. Upon completion of this step, the KGB model will have characterized each SIE household's pre-reform economic status in terms of the components of its disposable income and the net return from work (that is, the net wage rater) received by each of its members.
The impact of the reform in the absence of any behavioral adjustments In the second step, the values of net wage rates and disposable income are adjusted to what they would be were the simulated reform measure implemented, but work effort and earnings remained unchanged. For each worker who is eligible for a job under a work program, it is necessary to compute what the values of the variables would be if: (1) the worker leaves the regular labor market to take the job (behavior that we characterize as the "pure strategy"); (2) he remains attached to the conventional job sector and takes the job only when he is unemployed (the "mixed strategy"); or (3) he does not
*An individual's "net" wage rate is simply his nominal wage times one minus the cumulative tax rate he faces. *These parameters are estimated by two variables that represent the net changes caused by the various payment plans in the experiment. The first variable measures the change in family income resulting from the experimental treatment in the absence of any adjustment in hours worked. The second is the change in an individual's net wage rate due to the program's benefit reduction rate. The estimates produced by this procedure indicate how individualswill adjust their work effort in response to changes in the amount of transfer payments they receive or in the size of the benefit reduction rates they face. The regression model that was used to obtain these estimates was developed by [6]. §The simulation methodology assumes that choices between the jobs program and alternatives to it are made on the basis of perfect information. However, unless persons are aware of the existence of a jobs program and know something about it, it is not a viable employment alternative for them. It is further assumed that an individual will participate in a work program whenever the job being offered is viewed by him as marginally superior to his best conventional job sector alternative. In actual practice, however, a substantial differential between public and conventionalemployment may be necessary, if only to overcome inertia. Nevertheless, many of the frictions that exist in labor markets would be reduced over the long run. For example, many persons may not actively consider voluntarily leaving thek present job to participate in a jobs program; but once they have been terminated or laid off they may seriously examine the program as a possible alternative to available regular employment opportunities. Thus, the methodology is best viewed as being based on a static model of economic behavior; the adjustments to the introduction of a work program would not take place instantaneously, but only over time. The larger the comparative advantage of the work program jobs, the more rapidly the adjustments would be expected to occur.
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participate in the work program at all (the "private strategy").
Prediction of labor supply adjustments to implementation of the reform The third step consists of adjusting the values of the post-reform variables to account for labor supply responses to the changes in wage rates and disposable income that would occur under each of the strategies just listed. The values obtained from steps (1) and (2) are first used to calculate the changes in net wage rates and disposable incomes that would result from the welfare reform prior to any labor supply responses. Predictions of the effects on work hours of the reform are then derived by multiplying these calculated changes by labor supply parameters estimated from data obtained from the Seattle and Denver Income Maintenance Experiment.:~ Once these labor supply adjustments are computed, they are used to determine the number of hours individuals would work during the post-reform period. Given these estimates of the hours family members would work, household earnings, transfer payment receipts, and tax payments can then be recomputed.
Individual decisions on participation in public employment The first three steps of the simulation procedure provide estimates of post-reform income and hours of work for a sample of households. For those households in which a member is eligible for a job under a work program, it is necessary to compute what post-reform income and hours would be under each of the three alternative strategies listed earlier. The final step in the simulation involves using the resulting measures of income and hours to determine whether an individual who is eligible for a job under a work program will take the job whenever he is in the labor force, only when he is unemployed, or not at all. Since this is probably the most novel feature of the simulation methodology, it is discussed in some detail. It seems reasonable to view an individual who is eligible to participate in a work program as first engaging in a comparison between the jobs program and his best opportunity within the regular job sector, and then choosing the alternative that makes his family bes~ off. In general, one would expect that the chosen alternative will be the one that offers the higher income level at a fixed number of hours worked.§ As indicated earlier, however, individuals are not confined to an all or nothing choice between public and regular employment. They may also participate in the jobs program during their weeks of unemployment, returning to the regular job sector when the opportunity becomes available. Under certain circumstances, however, this "mixed strategy" may not be a viable alternative. Some unemployed persons may be unwilling to participate in a jobs program if the program wage is below their usual market wage or if they are required to relinquish unemployment compensation. Moreover, work programs may require a "waiting period" before unemployed persons become eligible for participation and this waiting period may exceed the length of their spell of unemployment. These considerations are explicitly treated by the simulation procedure. To determine whether or not various persons would participate in given work programs and whether they would select the pure or the mixed approach if they do
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participate, it has been necessary to develop participation tests. These tests assume that individuals will choose the strategy that maximizes the expected value of their family's stream of future disposable income after all labor supply adjustments have taken place.f
Description o/ the simulated prototype programs Using the simulation model just sketched, three prototype transfer plans were simulated that rely on various combinations of direct transfer programs and work programs to raise the incomes of poor families. Although a wide variety of such programs can be simulated with the KGB model, we focus here on relatively simple programs to facilitate comparisons among the three simulated plans. As will be evident, however, the major conclusions we draw from our simulation findings are applicable to many other transfer policy configurations. The particular direct transfer program that we simulate is modeled on the negative income tax (NIT) plans frequently advocated during the past two decades. The specific work program we simulate would provide minimum wage, public service employment (PSE) jobs to persons unable to find conventional employment. Similar programs have been seriously considered from time to time in the United States since the end of World War II. Since most recently proposed PSE programs would be limited to families with children, the simulation findings reported in this paper focus exclusively on this group. The first of the three simulated prototype transfer plans, the "pure NIT plan," contains only an NIT component. This plan consolidates most existing Federal tThis procedure does not allow for the fact that individuals may not always be able to choose freely the total number of hours they work, at either a regular job or a work program job. In such cases, income might be higher if individualspick one strategy over the other, but only becausethey wouldwork longer hours. If so, these individuals must trade-off a higher family income against lower hours, and their choice will only be clear with knowledgeof their utility map. For this reason, we plan to implement shortly a procedure developed by [2] that utilizes income and substitutioneffect estimates, such as those from the Seattle-Denver Experiment, to derive the informationwe need about households' underlying utility surfaces. Preliminarytests of this utility technique suggest that it produces results very similar to those producedby the simplerprocedure we currently use.
:~States assumed to supplement the federal benefit for singleparent familieswere Alaska,California,Connecticut,the District of Columbia, Illinois, Iowa, Kansas, Massachusetts, Michigan, Minnesota, New Jersey, New York, New Hampshire, Oregon, Pennsylvania, Rhode Island, Vermont, Washington and Wisconsin.
welfare programs (including AFDC, AFDC-U, SSI, the Earned Income Tax Credit, and Food Stamps) into a single negative income tax program that guarantees a minimum income of 75% of the federal poverty line to all households with children, but reduces transfer benefits at a rate of 50 cents for each dollar of earned or nonearned income. These program parameters are similar to those contained in many welfare reform proposals that were seriously considered during the 1970s. Since a number of states currently administer transfer programs that guarantee single-parent families more than 75% of the poverty line, many current single-parent recipients would be made worse off by the pure NIT plan unless the states supplement their benefits. Believing that the high benefit states would provide such supplements, we assume that single-parent families in states with high welfare benefits would be eligible for a combined federal and state income guarantee set at 100% of the poverty line. We further assume that transfer benefits for singleparents in these states would be reduced by 67 cents for each dollar of earned or nonearned income.~ The second of the transfer prototypes that was simulated for purposes of this paper, the "two-tier plan," places much more emphasis on encouraging work effort than does the pure NIT plan. Thus, the two-tier plan attempts to reduce work disincentives associated with the pure NIT by providing for both a lower guarantee level and a lower implicit tax rate for family units normally expected to work. Specifically, the plan maintains the provisions of the pure NIT for single-parent families, but reduces the income guarantee for twoparent families for 75 to 50% of the poverty line. Benefits received by two-parent families under the two-tier plan are assumed to be reduced by 33 cents for each dollar of earned or nonearned income. In addition to a NIT component that minimizes work disincentives, the two-tier plan also incorporates a PSE component that offers jobs that pay the 1975 minimum wage of $2.10 for up to forty hours of work per week. These jobs, which are assumed to be provided in sufficient numbers so that all qualified persons who want one can obtain one, are limited to primary earners who are in families with children and who have been without work for a minimum of five weeks. Each PSE participant can remain on the program for a maximum of one year, but then is required to take a five-week furlough, after which he may rejoin the program. To facilitate comparisons between the two-tier plan and the pure NIT plan, we have designed these two plans so that their net cost in terms of taxes are approximately equal. Consequently, a comparison of their effects should indicate some of the trade-offs between using all
Table 1. Number of persons participatingin the cash and jobs components of alternativetransfer plans (in 1000's) Pure NIT
Two-Tter Plan
High-Cost Plan
7,379
7,056
7,218
--
1,486
---
542 2,028
1,470 539 2,009
Number of Households Eligible f o r NIT B e n e f i t s Number o f PS( Parttclpants
NIT-Eligible NIT-Ineligible Tot.a1 Number of PSE Slots NIT-E119t bl • NIT- Ine1191 ble Total
---
804 224
794 224
--
1,028
1,018
Cash transfers versus job programs of a given amount of tax revenue to finance cash transfer payments or using part of the funds to provide jobs. The third of the simulated transfer prototypes, the "high-cost plan," consists of an NIT component that is identical to that provided by the pure NIT plan and a PSE component that is the same that is offered under the two-tier plan.t In terms of tax expenditures, the cost of this plan is about 40% higher than either of the first two plans we described.:~ Thus, comparing the high-cost plan with its two alternatives suggests the marginal effects of spending additional tax revenues in two different ways: comparison of the pure NIT plan and the high-cost plan indicates the value of adding a jobs component to a cash transfer program; a comparison of the two-tier plan and the high-cost plan suggests the implications of using the +In addition to the three transfer plans we describe in the text, we also simulated and will briefly report on a plan that would implement a PSE program identical to that provided by the two-tier and high-cost plans, but leave the existing welfare system intact. It would, of course, be possible to simulate transfer plans that relied even more on jobs programs and less on direct transfers. However, a transfer system that depends exclusively on jobs would be unrealistic to simulate, since some low-income families have no members who are able to work and must therefore be dependent upon direct transfers. ~The simulationfindings reported in the text of this paper are based on prototype assumed to be deficit financed, an assumption that is implicit in most previous simulations of various transfer program alternatives. However, we have also conducted a simulation that finances the high-cost plan by adding a surcharge to the Federal income tax. Under this plan, non-NIT recipients would face substantially higher tax rates, and in response to this change in work incentives, they would apparently increase their earnings. Indeed, this predicted increase in private sector earnings is about three times larger than the estimated reduction in the private sector earnings of transfer recipients. Although this result may appear surprising at first, it is quite consistent with the backward bending labor supply curves implied by the SeattleDenver work response parameters used in this study. At first, in fact, we thought that this result might merely have been a consequence of basing our simulation on these particular parameters. However, we have now conducted a number of sensitivity tests with labor supply parameters estimated with nonexperimentaldata and have consistently found that earnings increases among the higher income persons who would finance various income redistribution schemes, such as NITs, would more than offset decreases in earnings among recipients. One implication of this finding is that reductions in private sector output resulting from work disincentives are not a major obstacle to large-scalecomprehensive transfer programs--at least if these programs are financed through the income tax system. §In practice, receipt of cash transfer benefits would depend on how the plans were actually administered, but would undoubtedly be under 100%. Thus, the simulation estimates of the size and costs of the NIT components of the various plans contain an upward bias of unknown (but probably small) magnitude. IIln 1975, 150% of the poverty line for a family with two parents and two children corresponded to an annual income of $6183. ¶A comparison of the pure NIT with the high-cost plan implies that adding guaranteed jobs to the NIT program would reduce the number of households eligible for cash transfer payments by about 2% by enabling 161 thousand families to "work their way off welfare." ttAs described in t, in addition to the three prototypes discussed in the text, we also simulated a plan that would implement a minimum PSE program, but leave the existing welfare system intact. Interestingly, this plan was predicted to cause about as large a reduction in private sector earnings as the pure NIT plan.
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additional tax revenue to provide more generous direct transfer benefits to two-parent families. Before presenting the results of simulations of the welfare reform plans described above, it is useful to clarify several additional points. First, it is assumed that all individuals eligible for transfer payments under the NIT components of these plans would actually receive them.§ Second, the breakeven levels of the NIT components of the simulated plans (that is, the income level at which eligibility for NIT benefits ceases) are consistently set at 150% of the poverty line.II Thus, a family that is eligible to receive NIT benefits under one prototype plan is usually also eligible under the other two plans. Third, it is assumed that any individual who is otherwise qualified can obtain a PSE job, regardless of his family income level. Hence, some PSE paritcipants will be from families with incomes that are above the NIT breakeven. 3. SIMULATIONRESULTS Table 1 reports simulation estimates of the number of families who would have been eligible for NIT payments and the number of persons who would have participated in PSE jobs during 1975 under each of the prototype transfer plans described above. Since many PSE participants----especially those following the mixed strategy-would not have remained at a public service job for the entire year, the number of full-time equivalent PSE job slots that would have been occupied are also reported. The estimates indicate that under any of the three plans more than seven million households with children would have been eligible for transfer payments during the year.¶ The estimates further imply that under either the two-tier or high-cost plans around two million households would have had a member employed at a PSE job at least sometime during the year. A little over one million job slots would have been required for these PSE participants, with three-quarters of the slots going to persons who also receive NIT benefits. Some perspective can be placed on these estimates by noting that in 1975 there were 31.2 m households with children. Thus, for example, had the high-cost plan been in existence in that year, about one-quarter (7.8m) of these households would have received either NIT benefits or PSE wages or both. The estimates in Table 2 show the predicted changes in earnings under each of the simulated prototypes. As may be seen, although the private sector earnings of persons ineligible for NIT payments slightly increase, earnings of NIT-eligibles are predicted to decline substantially, resulting in an overall reduction in private sector earnings. This reduction is attributable to both the NIT and the PSE programs.tt Private sector earnings decline under the NIT because of changes in work incentives that would induce many transfer recipients to reduce their hours of work. (These reductions by transfer recipients would be slightly offset, however, by increases in work effort by some families who receive benefits under current welfare programs, but who would no longer be eligible under the simulated NIT.) The PSE engenders a reduction in private sector earnings because some workers would leave the private sector jobs they currently hold to work at a PSE job. Thus, the program causes public work to be substituted for private work. Table 2 further indicates that the two equal cost plans (that is, the pure NIT and the two-tier plan) would be associated with virtually identical reduction in private
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Table 2. Aggregatechanges in earnings under alternativetransfer plans (in $billions) Pure NIT
Two-Tier Plan
High-Cost Plan
-1.9
-1.9
-2.7
.3
.2
.2
-1.7
-1.6
-2.5
NIT Eligibles
3.5
3.5
NIT-Ineligibles
1.0
1.0
Total
4.5
4.5
-I .9
1.6
.8
.3
1 .Z
I .Z
-I .6
2.8
2.0
Change in Total Private Sector Earnings NIT-Eliglbles NIT-Inellglbles Total
PSE Earnings
Change in Total Earnings NIT-Eligibles NIT-Ineligibles Total
sector earnings. However, earnings from the PSE component of the two-tier plan would be almost three times the size of this reduction in private sector earnings, and consequently, total earnings in the economy would actually rise under this plan. By contrast, the pure NIT plan, as anticipated, causes a reduction in total earnings in the economy. Table 3 provides a somewhat different perspective on the work incentive effects associated with the simulated welfare reform plans. The table suggests that NIT-eligibles would make substantial proportional adjustments in their total hours, total earnings, and private sector earnings in response to the simulated plans. However, because families eligible for NIT payments comprise only a minority of all families, the proportional effects on total hours and earnings in the overall economy are relatively small. tThe net cost to the governmentis equal to the PSE wage bill plus the sum of the changes in direct transfer payments,tax revenues (including Social Security taxes), and unemployment compensation. Neither the cost of PSE inputs nor the value of PSE output--two factors that will be briefly considered later-are included in these costs estimates.
Table 3 also implies that incentives to work tend to be minimized by transfer plans that provide relatively generous direct payments and do not emphasize jobs, such as the pure NIT, and maximized by reform plans that stress jobs and provide relatively ungenerous payments, such as the two-tier plan. However, all the simulated plans are predicted to cause declines in participant's private sector earnings, suggesting that such declines are inevitable, regardless of the mix between direct transfers and jobs. The loss of private sector production associated with declines in private sector earnings, however, will be at least partially offset under plans with PSE components, if output produced under these components is valued more highly by society than the physical capital and administrative inputs required to operate them. This issue will be further discussed later. The estimates reported in Table 4 indicate how direct transfer payments and disposable incomes would be changed by the simulated plans and what the net cost to the government of the simulated plans would be.i" It is interesting to note that although the pure NIT and the high-cost plans contain identical NIT components, the net outlay in direct transfer payments is smaller under the latter. The reason for this is that PSE earnings under
Table 3. Percentagechanges in hours and earnings under alternativetransfer plans Pure NIT
Two-Tier Plan
High-Cost Plan
Total Hours Worked NIT-Eligibles NIT-Ineligibles Total
-7.4 .0 -.7
5.0 .7 1.1
1.3 .7 .8
Total Earnings HIT-Eligibles NIT-Ineligibles Total
-8.8 .1 -.4
7.4 .3 .7
3.7 .3 .5
Private Sector Earnings NIT-Eligibles NIT-Ineligibles Total
-8.8 .1 -.4
-8.8 .1 -.4
-12.4 .1 -.6
Cash transfers versus job programs
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Table 4. Aggregate changes in net transfers and disposable incomes under alternative transfer plans (in $billions) Pure NIT
Two-Tier Plan
High-Cost Plan
Change in Transfer Payments NIT-Eligibles NIT-Ineligibles Total
6.32 -.40 5.92
2.55 -.48 2.07
4.91 -.46 4.45
Change in Disposable Income NIT-Eligibles NIT-Ineligibles Total
4.72 -.39 4.33
3.98 .18 4.16
5.62 .17 5.79
Total Net Cost
5.97
5.83
8.26
.73
.71
.70
Efficiency Ratio
the high-cost plan are "taxed" by the NIT program. In other words, the cost of the public service jobs would be partially offset by reductions in transfer payments to PSE participants. It is evident from Table 4 that the high-cost plan produces a considerably greater increase in disposable income than either of the two equal cost plans. The total net cost of this plan, however, is also considerably higher. To normalize for variation in program costs among the three prototype plans, we have divided the change in disposable income associated with each plan by the plan's net cost. The resulting "efficiency ratio", which is reported on the last line of Table 4, suggests that per dollar of expenditure, the three simulated plans are about equal in their effectiveness in raising participants' incomes. This finding may appear surprising at first. It is well known that reductions in earnings that result from the work disincentives associated with pure NITs mean that a dollar of transfers will raise disposable income by less than a dollar. But since public service jobs are associated with increases in earnings, it might appear that adding a PSE component to an NIT program should raise efficiency ratios. However, as a comparison of either the two-tier plan or the high-cost plan to the pure NIT plan indicates, this does not occur. In fact, the ratio slightly falls ! The explanation for this finding resides in the fact that PSE programs cause some persons to substitute public work for private work. To see this, consider a worker who leaves a private sector job that pays $2 hr for a PSE job that pays the 1975 minimum wage of $2.10hr. The efficiency ratio associated with the PSE program for this +The degree of substitution of PSE for private sector employment could potentially be reduced by increasing the relative attractiveness of low wage private sector employment through provision of wage or earnings subsidies. A simulation analysis of income maintenance systems that combine public sector employment with private sector wage or earnings subsidies is an important topic for future research. :~Theterm "pre-transfer poor" refers to households that would be counted as poor in the absence of either the existing welfare system or the simulated plans. §The numbers of households made worse-off are at first blush surprisinglylarge. These estimates, however, merely indicate that it is difficult,if not impossible, to construct an NIT program of moderate cost that does not make some households worse off. liThe high-cost plan is predicted to have a larger impact on income inequality and poverty than either the pure NIT or the two-tier plan, but this merely reflects the fact that the net cost of this plan is considerably larger.
particular worker is only 0.05 (i.e. at a net cost to the government of $2.10 the individual's income only increases by a dime). Given the large estimated amounts of substitution of public for private work implied by Table 2, it is hardly surprising that PSE programs do not succeed in raising efficiency ratios.? Table 5 reports several indices that measure the effects of the simulated plans on the income distribution and poverty. The measures of target efficiency, which are reported in the first two columns of the table, indicate the percentage of PSE earnings and NIT transfers that would be received by the pre-transfer poor.:~ Thus, these measures are intended to reflect the extent to which public expenditures on the PSE and NIT components of the various plans would be concentrated on households with the greatest needs. As is evident, there is very little variation among the alternative plans in terms of the target efficiency of either their NIT or PSE components. However, it does appear that target efficiency is considerably higher for direct transfer expenditures under any given plan than for PSE wage expenditures. The relatively greater target efficiency of transfers occurs because, by design, the size of payments received under an NIT is inversely related to income levels. By contrast, some payments under a PSE program will inevitably be received by relatively high income persons who are temporarily unemployed. The remaining five columns in Table 5 present several measures that may be used to assess the extent to which the simulated plans reduce income inequality and poverty. The first of these measures indicates the number of households whose annual disposable incomes would be increased or decreased by a minimum of $240 were each plan implemented.§ The next measure is an estimate of the percentage decrease in persons below the poverty line that would result from implementation. The final two measures are based on a proportion known as the welfare ratio, which is computed by dividing a household's disposable income by its poverty line. The mean of the logarithm of the welfare ratio is reported in the sixth column of Table 5 and the variance of the logarithm of the ratio, which indicates how the plans affect the size distribution of disposable income is reported in the seventh. The most interesting implications of Table 5 are suggested by comparing the pure NIT and two-tier plans-the two equal cost alternatives. This comparison implies that poverty and income inequality can be moderately more reduced by a welfare reform package that does not include a PSE component than by an equally expensive package that doesll a finding that reflects the fact that
D. BETSONand D. GREENBER6
154
Table 5. Effects of the alternative transfer plans on the income distribution and on poverty
Simulated Plans
Target Efftctenc~ of PSt Transfer Earntngs P~ments
Number of Households (in lrOOO's wtth Higher LOwer Incomes Incomes
Percent Change in Povert~y Popu|atton
Mean Log of Welfare Ratto
Yartance of Log of Welfare Ratto
Pure NIT Plan
--
88
4,772
],368
-37.1
.694
.21 8
Tio-Tler Plan
74
91
4,471
1,365
-27.5
.691
.231
High-Cost Plan
75
88
5,374
1,223
-49.2
.704
.210
expenditures on direct transfer payments are relatively more target efficient than expenditures on jobs. Thus, it appears that welfare expenditures on public service jobs must be justified on grounds other than their effectiveness as anti-poverty tools.# We shall discuss such justifications in the following section. 4. CONCLUSIONS In the previous section, we compared the simulated effects of a prototype transfer plan based solely on a NIT program with transfer plans that incorporate a PSE component as well as a NIT. Our findings imply that redistribution schemes that rely entirely upon direct transfer payments are in certain important respects equal or slightly superior to more complex schemes that couple direct transfers with job programs. For example, the pure NIT we simulated would diminish poverty and inequality by somewhat more than an equal cost plan that combined a PSE program with a NIT. Moreover, a redistribution scheme that is based solely on direct transfers is at least as effective per dollar of tax expenditure in raising incomes as a combination of direct transfers and jobs. In addition, job and direct transfer combinations would apparently cause reductions in
tResults from simulatingthe plan that would implementa PSE program identical to that provided by the two-tier and high-cost plans but leave the existing welfare system intact suggest that by themselves minimumwage public service jobs will make only a very modest contribution towards reducing income inequality or poverty. The simulated "pure" PSE plan, for example, would only pull about one-quarter as many persons out of poverty as the simulated pure NIT. ~:For example, a recent study by [7] of an experiment in supported work, a job program concept that places particular emphasis on the production of socially useful output, estimated that the average annual value of output per supported work participant was between $3298 and $6018. (The $3298 value represents a lower bound estimate based on the average amount paid in the market for output produced under the program; the $6018 value is based on an estimate of the average alternative supplier's price.) The annual cost of inputs used directly in the production of this output was estimated to equal $3797 and the annual cost of office space, staff salaries, and other administrative, management,and support services required by the supported work program was estimated at $3379. Thus, it can be seen that production cost substantially offset the value of the program's output. §The numerous studies of the post-program value of work experience and job training that have been conducted since the mid-1960s vary considerably in their results--depending on program characteristics, the characteristics of program participants, the state of the labor market, and the research methodologyand data that were used in the study. These studies have indicated a number of instances in which the work experience and job training received under particular programs was of considerable value to program participants and many other instances in which the experience and training was of little or no value.
private sector earnings that are as large, if not larger, than those resulting from comparable schemes that utilize only direct transfers. These findings suggest that job programs offer little advantage over direct transfers unless they satisfy objectives beyond merely redistributing income. One such objective, for example, may be the production of socially useful goods and services. However, the value that society would place on the goods and services produced under a large-scale PSE program is virtually impossible to predict at the present time. Furthermore, it is important to recognize that the cost of the physical capital, supervisory personnel, and other inputs required to produce such goods and services may exceed their social value.¢ Another potential benefit of a job program is that it may provide valuable work experience. However, if the work performed in the program has little transferable value, a worker's stock of human capital could actually deteriorate while he is participating in a jobs program. Moreover, some employers may be reluctant to hire job applicants who previously participated in a work program, thereby giving rise to a stigma effect.§ Perhaps, the case for utilizing job programs for redistribution purposes must ultimately depend on a value judgment, rather than on simulations and other forms of quantitative estimates. As indicated earlier, such programs tend to increase total work effort in the economy, while direct transfer programs cause decreases in overall hours of work. Indeed, although our findings suggest that a pure NIT and a transfer plan that incorporates both PSE and NIT components would result in similar private sector earnings reductions and would be about equally effective in raising the incomes of beneficiaries, it may be very important to many tax payers that increases in income that ensue from participation in PSE are in the form of earnings exchanged for labor service. Consequently, the decision on whether job programs should be an important part of the nation's income transfer system perhaps ultimately rests on the value society places on PSE output and in the work ethic.
REFERENCES
1. H. Aaron and J. Todd, The use of income maintenance experiment findingsin public policy, 1977-78. Industrial Relations Res. Assoc. Proc., pp. 46-56 (1979). 2. D. Betson, Labor supply functions and their implicit expenditure functions: theoretical deviation and application to micro-simulation analysis. Unpublished Ph.D. Thesis, University of Wisconsin-Madison(1980). 3. D. Betson, D. Greenberg and R. Kasten, A simulationanalysis of the economic efficiency and distribution effects of alternation program structures: the negative income tax versus the credit income tax. In Income-Tested Transfer Programs (Edited by Irwin Garfinkel).AcademicPress, New York (1982). 4. D. Betson, D. Greenberg and R. Kasten, A micro-simulation model for analyzing alternative welfare reform proposals: an
Cash transfers versus job programs application to the program for better jobs and income. In Microeconomic Simulation for Policy Analysis (Edited by R. Haveman and K, Hollenbeck, Academic Press, New York
(1980).
5. M. Greenberger, M. Creeson and B. Crissey, Models in the Policy Process: Public Decision Making in the Computer Era. Russell Sage Foundation, New York (1976).
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6. M. C. Keeley, P. K. Robins, R. G. Spiegelman and R. W. West, The estimation of labor supply models using experimental data. Amer. Econ. gev. 68, 873-887 (1978). 7. P. Kemper, D. Long and C. Thorton, The supported work evaluation: final benefit--cost analysis. Mathematica Policy Res. Paper, Princeton, NJ (1979).
0038-0121182/040147-09503.00/0 Pergamon Press Ltd.
CASH TRANSFERS VERSUS JOBS PROGRAMSt DAVID BETSON and DAVID GREENBERG Institute for Research on Poverty, University of Maryland Baltimore County, 5401 Wilkens Avenue, Catonville, MD 21228, U.S.A.
(Received 22 February 1982) Abstract--This paper uses a microsimulation computer model to compare the work incentive and distributional implications of public service employment programs and direct transfer programs. The simulationfindings suggest that a pure direct transfer program would diminish poverty and inequality by somewhat more than an equal cost plan than combined direct transfers with a jobs program. Moreover, the results imply that a redistribution scheme based entirely on direct transfers is at least as effective per dollar of tax expenditure in raising incomes as a combination of direct transfers and jobs. Furthermore, the simulated job and direct transfer combinations were predicted to cause reductions in private sector earnings that are at least as large as those that would result from comparable schemes that relied solely upon direct transfers. l. INTRODUCTION
Two major m;chanisms to insure minimally adequate incomes for poor families exist. Income can be directly provided to such families or, alternatively, income can be exchanged for the labor services of family members. From World War II until quite recently, major reliance in this country has been placed on the first of these mechanisms, as evidenced by the importance of the AFDC, Food Stamp, and Medicaid Programs and welfare reform proposals since the 1960s that emphasize negative income tax (NIT) features.~ During the Great Depression of the 1930s, however, much use was made of work programs as a transfer mechanism. Recently, moreover, the pendulum appears to be swinging strongly back towards greater reliance on exchanging income for labor services. The Carter Administration's Program for Better Jobs and Income, for example, while incorporating direct transfers, also had a large Public Service Employment (PSE) component. And the Reagan Administration's promotion of workfare programs would even go further by requiring members of certain families to "repay" the government for transfers they receive by performing services at publicly provided, minimum wage jobs. The recent increase in emphasis on job programs as a transfer mechanism seems to be mainly motivated by concern over potential work disincentives associated with such direct transfer programs as AFDC, Food Stamps, and NITs. The reason for this concern is obvious. Both economic theory and common sense suggest that direct transfers reduce the hours recipients
tThe authors are respectively affiliated with the Institute for Research on Poverty and University of Maryland. ~:Under an NIT, as under the AFI)C and Food Stamp Programs, families without other income are allowed a certain fixed amount of transfer benefits, known as the guarantee or basic benefit level, which increases with family size. As family income from other sources rise, transfer payments are reduced by an implicit tax rate, often referred to as the program's benefit reduction rate. When income from other sources are sufficiently high that the benefit reduction exactly offsets the income guarantee--a point known as the breakeven--payments under the program cease. SEPS VoL 16, No. 4--A
147
work: the receipt of additional income engenders an income effect that is expected to adversely affect work incentives, and the implicit tax associated with most such programs lowers the reward for market work and consequently is expected to lower hours through a substitution effect. These reductions in hours reduce the output produced by the economy. Moreover, recent evidence from the Seattle and Denver Income Maintenance Experiments (see [1 or 6]) indicates that adverse work incentives associated with a direct transfer program considerably raise the budgetary costs of income maintenance and, by lowering the earnings of recipient families, do much to frustrate the program's intent to raise the overall incomes to those in need. In contrast to direct transfers, programs that provide transfers in exchange for labor services will probably increase overall work effort. Such programs have two potential effects on hours of work: first, they allow some individuals to fill in periods of unemployment; second, they may enable other workers to obtain employment at a higher wage than they could in the regular labor market. The first of these effects will unambiguously increase hours of work, while the direction of the second depends on the shape of labor supply curves over the relevant range of wages. Thus, if the first effect is sufficiently strong and the second is either positive or small, overall hours of work will increase. If employment in the jobs program is more attractive than working at jobs offered by some private sector employers, however, this hours increase will be associated with some transfer of employment from the private to the public sector, possibly resulting in reductions in aggregate productivity. Direct transfers and job programs not only have different effects on work incentives, but have differing distributional implications as well. Under such income conditional transfer programs as AFDC, Food Stamps, and NITs, welfare expenditures are in the form of direct benefits that have a strong inverse relation to household income from other sources. Under work programs, however, some welfare expenditures will be in exchange for labor services on public sector jobs and will not necessarily be closely related to households' positions within the income distribution. Thus, at least in the absence of work incentive effects, a dollar of direct
148
D. BETSONand D. GREENBERG
transfer expenditure should more effectively raise the incomes of those in need than a dollar expended under a jobs program. The work incentive and distributional implications of direct transfer and job programs that have just been sketched, are obviously complex, making assessment of the relative merits of these two income support mechanisms difficult. A natural and direct method that can be used for this purpose, however, is to simulate how individual households are affected by prototype direct transfer and work programs. This is the approach taken here. Thesimulations on which the findings reported in this paper are based were conducted by means of a computer model developed within the Department of Health and Human Services and used extensively within the government to develop and evaluate various welfare reform alternatives, including the Carter Administration's Program for Better Jobs and Income. This microsimulation model (which has become known as the KGB model after its three developers, Richard Kasten, David Greenberg, and David Betson) treats various interactions among transfer programs, jobs programs, and the positive tax system, allowing for the labor supply adjustments that result from different combinations of these programs. The model can use data on a representative sample of the nation's households to simulate the effects of substantial changes in existing tax and transfer programs, including the provision of jobs to various subsets of the populations. The KGB based simulation results that we report in this paper focus on comparing work programs and direct transfers on the basis of their work incentive and distributional implications. A jobs program, however, is not merely an income transfer mechanism. On the one hand, unlike a direct transfer program, such a plan may result in the production of socially useful output and provide public service workers with valuable work experience. On the other hand, a jobs program will be more expensive to administer than a direct transfer program due to larger requirements for physical capital and supervisory personnel. Later, we shall briefly note some implications of these differences for conclusions based on the simulation results we report. However, a complete assessment of the value of the output or work experience resulting from a jobs program or the administrative costs associated with such a program is well beyond the scope of the present paper. Rather, the purpose of this paper is to indicate the relative impacts of job programs and direct transfers on total work effort, on the distribution of work effort between the public and private sectors, and on the income distribution and poverty. This will suggest the extent to which these two policy approaches should be evaluated on the basis of tradeoffs between their effects on work effort and their efficiency in providing adequate incomes for the poor. In the remainder of this paper, we first briefly describe the KGB simulation model we use and the prototype transfer and work programs we simulate. We then present simulation estimates of the effects of these prototype programs on hours, earnings, transfer receipts, tax
payments, disposable income levels, the distribution of income, and several other program outcomes. A short concluding section follows. 2. THE KGB SIMULATIONMODEL
During the past decade, with the growing availability of high speed computers and large micro data bases (that is, data on nationally representative samples of individuals and households), microsimulation models have become an increasingly important tool in the analysis of tax and transfer policy (see [5]). In general, microsimulation models consist of a computer program that simulates the aggregate and distributional economic effects of proposed policy changes by aggregating predictions made for individual observations in a micro data base on the basis of empirically estimated microeconomic relationships. For example, if the aggregate effect of a change in transfer policy on work effort is to be simulated, a microsimulation model would first utilize empirically derived estimates of the relations between the hours different individuals work and their income levels and wage rates to predict how each person represented in a micro data base, such as the Current Population Survey (CPS), would adjust his or her working hours. The model would then sum these individual's predictions to obtain national totals. This methodology can be usefully contrasted to a macro modeling approach, which usually first obtains an empirical relationship between aggregate economic variables (such as the national labor force participation rate) and policy variables (such as total transfer payments) and then, utilizing this relationship directly, predicts aggregate effects of policy changes. Although in some instances the two approaches are equally appropriate, in other cases the microsimulation approach is far more desirable for many policy analysis purposes. First, more often than not, policy changes do not treat all persons similarly; however, it is rarely feasible to capture this differential treatment within an aggregate framework. Second, the distributional implications of a policy change are often of major interest, but must usually be ignored in using the macro approach. Since these two factors are of paramount importance to analysis of the policy options that we consider in this paper, we have adopted the microsimulation approach. As indicated earlier, the analysis in this paper is based on the KGB model, a microsimulation model that was expressly designed to examine alternative reforms of the tax-transfer system--including the provision of publicly sponsored jobs. In operation, the KGB model proceeds in four major steps:t (1) Characterization of U.S. population in absence of tax-transfer reform. (2) Characterization of the reform of policy interest and how its implementation would affect various economic variables in the absence of behavioral responses by individuals. (3) Predictions of how different individuals would alter their hours of work in response to the reform. (4) Predictions of whether or not given eligible individuals would accept a job under a work program.
Characterization of the pre-reform population tBecause of space limitationsand the complexityof the model, it is only sketched here. Greater detail, as well as an examination-and in some cases sensitivitytests--of major assumptions that underlie the simulationmethodology,may be found in [4].
In the first step, the Survey of Income and Education (SIE) is used to characterize the pre-reform economic status of a representative sample of the nation's families in 1975. Thus, simulation findings obtained with the
Cash transfers versus job programs KGB model are also applicable to the year 1975. The SIE, which is based on information collected from over 175,000 households in 1976, is a large micro data base containing various detailed demographic and economic variables--such as race, family size, composition, earnings, and hours worked. Although many of the variables needed for use in the model appear in the SIE, others, such as the payment of taxes and the receipt of benefits from government tax and transfer programs, must be obtained from other sources and then imputed to the SIE. At present, the list of current government programs explicitly considered by the model includes AFDC, SSI, Food Stamps, General Assistance, Unemployment Compensation, federal and state income taxes, and payroll taxes. Upon completion of this step, the KGB model will have characterized each SIE household's pre-reform economic status in terms of the components of its disposable income and the net return from work (that is, the net wage rater) received by each of its members.
The impact of the reform in the absence of any behavioral adjustments In the second step, the values of net wage rates and disposable income are adjusted to what they would be were the simulated reform measure implemented, but work effort and earnings remained unchanged. For each worker who is eligible for a job under a work program, it is necessary to compute what the values of the variables would be if: (1) the worker leaves the regular labor market to take the job (behavior that we characterize as the "pure strategy"); (2) he remains attached to the conventional job sector and takes the job only when he is unemployed (the "mixed strategy"); or (3) he does not
*An individual's "net" wage rate is simply his nominal wage times one minus the cumulative tax rate he faces. *These parameters are estimated by two variables that represent the net changes caused by the various payment plans in the experiment. The first variable measures the change in family income resulting from the experimental treatment in the absence of any adjustment in hours worked. The second is the change in an individual's net wage rate due to the program's benefit reduction rate. The estimates produced by this procedure indicate how individualswill adjust their work effort in response to changes in the amount of transfer payments they receive or in the size of the benefit reduction rates they face. The regression model that was used to obtain these estimates was developed by [6]. §The simulation methodology assumes that choices between the jobs program and alternatives to it are made on the basis of perfect information. However, unless persons are aware of the existence of a jobs program and know something about it, it is not a viable employment alternative for them. It is further assumed that an individual will participate in a work program whenever the job being offered is viewed by him as marginally superior to his best conventional job sector alternative. In actual practice, however, a substantial differential between public and conventionalemployment may be necessary, if only to overcome inertia. Nevertheless, many of the frictions that exist in labor markets would be reduced over the long run. For example, many persons may not actively consider voluntarily leaving thek present job to participate in a jobs program; but once they have been terminated or laid off they may seriously examine the program as a possible alternative to available regular employment opportunities. Thus, the methodology is best viewed as being based on a static model of economic behavior; the adjustments to the introduction of a work program would not take place instantaneously, but only over time. The larger the comparative advantage of the work program jobs, the more rapidly the adjustments would be expected to occur.
149
participate in the work program at all (the "private strategy").
Prediction of labor supply adjustments to implementation of the reform The third step consists of adjusting the values of the post-reform variables to account for labor supply responses to the changes in wage rates and disposable income that would occur under each of the strategies just listed. The values obtained from steps (1) and (2) are first used to calculate the changes in net wage rates and disposable incomes that would result from the welfare reform prior to any labor supply responses. Predictions of the effects on work hours of the reform are then derived by multiplying these calculated changes by labor supply parameters estimated from data obtained from the Seattle and Denver Income Maintenance Experiment.:~ Once these labor supply adjustments are computed, they are used to determine the number of hours individuals would work during the post-reform period. Given these estimates of the hours family members would work, household earnings, transfer payment receipts, and tax payments can then be recomputed.
Individual decisions on participation in public employment The first three steps of the simulation procedure provide estimates of post-reform income and hours of work for a sample of households. For those households in which a member is eligible for a job under a work program, it is necessary to compute what post-reform income and hours would be under each of the three alternative strategies listed earlier. The final step in the simulation involves using the resulting measures of income and hours to determine whether an individual who is eligible for a job under a work program will take the job whenever he is in the labor force, only when he is unemployed, or not at all. Since this is probably the most novel feature of the simulation methodology, it is discussed in some detail. It seems reasonable to view an individual who is eligible to participate in a work program as first engaging in a comparison between the jobs program and his best opportunity within the regular job sector, and then choosing the alternative that makes his family bes~ off. In general, one would expect that the chosen alternative will be the one that offers the higher income level at a fixed number of hours worked.§ As indicated earlier, however, individuals are not confined to an all or nothing choice between public and regular employment. They may also participate in the jobs program during their weeks of unemployment, returning to the regular job sector when the opportunity becomes available. Under certain circumstances, however, this "mixed strategy" may not be a viable alternative. Some unemployed persons may be unwilling to participate in a jobs program if the program wage is below their usual market wage or if they are required to relinquish unemployment compensation. Moreover, work programs may require a "waiting period" before unemployed persons become eligible for participation and this waiting period may exceed the length of their spell of unemployment. These considerations are explicitly treated by the simulation procedure. To determine whether or not various persons would participate in given work programs and whether they would select the pure or the mixed approach if they do
D. BETSONand D. GREENBERG
150
participate, it has been necessary to develop participation tests. These tests assume that individuals will choose the strategy that maximizes the expected value of their family's stream of future disposable income after all labor supply adjustments have taken place.f
Description o/ the simulated prototype programs Using the simulation model just sketched, three prototype transfer plans were simulated that rely on various combinations of direct transfer programs and work programs to raise the incomes of poor families. Although a wide variety of such programs can be simulated with the KGB model, we focus here on relatively simple programs to facilitate comparisons among the three simulated plans. As will be evident, however, the major conclusions we draw from our simulation findings are applicable to many other transfer policy configurations. The particular direct transfer program that we simulate is modeled on the negative income tax (NIT) plans frequently advocated during the past two decades. The specific work program we simulate would provide minimum wage, public service employment (PSE) jobs to persons unable to find conventional employment. Similar programs have been seriously considered from time to time in the United States since the end of World War II. Since most recently proposed PSE programs would be limited to families with children, the simulation findings reported in this paper focus exclusively on this group. The first of the three simulated prototype transfer plans, the "pure NIT plan," contains only an NIT component. This plan consolidates most existing Federal tThis procedure does not allow for the fact that individuals may not always be able to choose freely the total number of hours they work, at either a regular job or a work program job. In such cases, income might be higher if individualspick one strategy over the other, but only becausethey wouldwork longer hours. If so, these individuals must trade-off a higher family income against lower hours, and their choice will only be clear with knowledgeof their utility map. For this reason, we plan to implement shortly a procedure developed by [2] that utilizes income and substitutioneffect estimates, such as those from the Seattle-Denver Experiment, to derive the informationwe need about households' underlying utility surfaces. Preliminarytests of this utility technique suggest that it produces results very similar to those producedby the simplerprocedure we currently use.
:~States assumed to supplement the federal benefit for singleparent familieswere Alaska,California,Connecticut,the District of Columbia, Illinois, Iowa, Kansas, Massachusetts, Michigan, Minnesota, New Jersey, New York, New Hampshire, Oregon, Pennsylvania, Rhode Island, Vermont, Washington and Wisconsin.
welfare programs (including AFDC, AFDC-U, SSI, the Earned Income Tax Credit, and Food Stamps) into a single negative income tax program that guarantees a minimum income of 75% of the federal poverty line to all households with children, but reduces transfer benefits at a rate of 50 cents for each dollar of earned or nonearned income. These program parameters are similar to those contained in many welfare reform proposals that were seriously considered during the 1970s. Since a number of states currently administer transfer programs that guarantee single-parent families more than 75% of the poverty line, many current single-parent recipients would be made worse off by the pure NIT plan unless the states supplement their benefits. Believing that the high benefit states would provide such supplements, we assume that single-parent families in states with high welfare benefits would be eligible for a combined federal and state income guarantee set at 100% of the poverty line. We further assume that transfer benefits for singleparents in these states would be reduced by 67 cents for each dollar of earned or nonearned income.~ The second of the transfer prototypes that was simulated for purposes of this paper, the "two-tier plan," places much more emphasis on encouraging work effort than does the pure NIT plan. Thus, the two-tier plan attempts to reduce work disincentives associated with the pure NIT by providing for both a lower guarantee level and a lower implicit tax rate for family units normally expected to work. Specifically, the plan maintains the provisions of the pure NIT for single-parent families, but reduces the income guarantee for twoparent families for 75 to 50% of the poverty line. Benefits received by two-parent families under the two-tier plan are assumed to be reduced by 33 cents for each dollar of earned or nonearned income. In addition to a NIT component that minimizes work disincentives, the two-tier plan also incorporates a PSE component that offers jobs that pay the 1975 minimum wage of $2.10 for up to forty hours of work per week. These jobs, which are assumed to be provided in sufficient numbers so that all qualified persons who want one can obtain one, are limited to primary earners who are in families with children and who have been without work for a minimum of five weeks. Each PSE participant can remain on the program for a maximum of one year, but then is required to take a five-week furlough, after which he may rejoin the program. To facilitate comparisons between the two-tier plan and the pure NIT plan, we have designed these two plans so that their net cost in terms of taxes are approximately equal. Consequently, a comparison of their effects should indicate some of the trade-offs between using all
Table 1. Number of persons participatingin the cash and jobs components of alternativetransfer plans (in 1000's) Pure NIT
Two-Tter Plan
High-Cost Plan
7,379
7,056
7,218
--
1,486
---
542 2,028
1,470 539 2,009
Number of Households Eligible f o r NIT B e n e f i t s Number o f PS( Parttclpants
NIT-Eligible NIT-Ineligible Tot.a1 Number of PSE Slots NIT-E119t bl • NIT- Ine1191 ble Total
---
804 224
794 224
--
1,028
1,018
Cash transfers versus job programs of a given amount of tax revenue to finance cash transfer payments or using part of the funds to provide jobs. The third of the simulated transfer prototypes, the "high-cost plan," consists of an NIT component that is identical to that provided by the pure NIT plan and a PSE component that is the same that is offered under the two-tier plan.t In terms of tax expenditures, the cost of this plan is about 40% higher than either of the first two plans we described.:~ Thus, comparing the high-cost plan with its two alternatives suggests the marginal effects of spending additional tax revenues in two different ways: comparison of the pure NIT plan and the high-cost plan indicates the value of adding a jobs component to a cash transfer program; a comparison of the two-tier plan and the high-cost plan suggests the implications of using the +In addition to the three transfer plans we describe in the text, we also simulated and will briefly report on a plan that would implement a PSE program identical to that provided by the two-tier and high-cost plans, but leave the existing welfare system intact. It would, of course, be possible to simulate transfer plans that relied even more on jobs programs and less on direct transfers. However, a transfer system that depends exclusively on jobs would be unrealistic to simulate, since some low-income families have no members who are able to work and must therefore be dependent upon direct transfers. ~The simulationfindings reported in the text of this paper are based on prototype assumed to be deficit financed, an assumption that is implicit in most previous simulations of various transfer program alternatives. However, we have also conducted a simulation that finances the high-cost plan by adding a surcharge to the Federal income tax. Under this plan, non-NIT recipients would face substantially higher tax rates, and in response to this change in work incentives, they would apparently increase their earnings. Indeed, this predicted increase in private sector earnings is about three times larger than the estimated reduction in the private sector earnings of transfer recipients. Although this result may appear surprising at first, it is quite consistent with the backward bending labor supply curves implied by the SeattleDenver work response parameters used in this study. At first, in fact, we thought that this result might merely have been a consequence of basing our simulation on these particular parameters. However, we have now conducted a number of sensitivity tests with labor supply parameters estimated with nonexperimentaldata and have consistently found that earnings increases among the higher income persons who would finance various income redistribution schemes, such as NITs, would more than offset decreases in earnings among recipients. One implication of this finding is that reductions in private sector output resulting from work disincentives are not a major obstacle to large-scalecomprehensive transfer programs--at least if these programs are financed through the income tax system. §In practice, receipt of cash transfer benefits would depend on how the plans were actually administered, but would undoubtedly be under 100%. Thus, the simulation estimates of the size and costs of the NIT components of the various plans contain an upward bias of unknown (but probably small) magnitude. IIln 1975, 150% of the poverty line for a family with two parents and two children corresponded to an annual income of $6183. ¶A comparison of the pure NIT with the high-cost plan implies that adding guaranteed jobs to the NIT program would reduce the number of households eligible for cash transfer payments by about 2% by enabling 161 thousand families to "work their way off welfare." ttAs described in t, in addition to the three prototypes discussed in the text, we also simulated a plan that would implement a minimum PSE program, but leave the existing welfare system intact. Interestingly, this plan was predicted to cause about as large a reduction in private sector earnings as the pure NIT plan.
151
additional tax revenue to provide more generous direct transfer benefits to two-parent families. Before presenting the results of simulations of the welfare reform plans described above, it is useful to clarify several additional points. First, it is assumed that all individuals eligible for transfer payments under the NIT components of these plans would actually receive them.§ Second, the breakeven levels of the NIT components of the simulated plans (that is, the income level at which eligibility for NIT benefits ceases) are consistently set at 150% of the poverty line.II Thus, a family that is eligible to receive NIT benefits under one prototype plan is usually also eligible under the other two plans. Third, it is assumed that any individual who is otherwise qualified can obtain a PSE job, regardless of his family income level. Hence, some PSE paritcipants will be from families with incomes that are above the NIT breakeven. 3. SIMULATIONRESULTS Table 1 reports simulation estimates of the number of families who would have been eligible for NIT payments and the number of persons who would have participated in PSE jobs during 1975 under each of the prototype transfer plans described above. Since many PSE participants----especially those following the mixed strategy-would not have remained at a public service job for the entire year, the number of full-time equivalent PSE job slots that would have been occupied are also reported. The estimates indicate that under any of the three plans more than seven million households with children would have been eligible for transfer payments during the year.¶ The estimates further imply that under either the two-tier or high-cost plans around two million households would have had a member employed at a PSE job at least sometime during the year. A little over one million job slots would have been required for these PSE participants, with three-quarters of the slots going to persons who also receive NIT benefits. Some perspective can be placed on these estimates by noting that in 1975 there were 31.2 m households with children. Thus, for example, had the high-cost plan been in existence in that year, about one-quarter (7.8m) of these households would have received either NIT benefits or PSE wages or both. The estimates in Table 2 show the predicted changes in earnings under each of the simulated prototypes. As may be seen, although the private sector earnings of persons ineligible for NIT payments slightly increase, earnings of NIT-eligibles are predicted to decline substantially, resulting in an overall reduction in private sector earnings. This reduction is attributable to both the NIT and the PSE programs.tt Private sector earnings decline under the NIT because of changes in work incentives that would induce many transfer recipients to reduce their hours of work. (These reductions by transfer recipients would be slightly offset, however, by increases in work effort by some families who receive benefits under current welfare programs, but who would no longer be eligible under the simulated NIT.) The PSE engenders a reduction in private sector earnings because some workers would leave the private sector jobs they currently hold to work at a PSE job. Thus, the program causes public work to be substituted for private work. Table 2 further indicates that the two equal cost plans (that is, the pure NIT and the two-tier plan) would be associated with virtually identical reduction in private
D. BETSONand D. GREENBERO
152
Table 2. Aggregatechanges in earnings under alternativetransfer plans (in $billions) Pure NIT
Two-Tier Plan
High-Cost Plan
-1.9
-1.9
-2.7
.3
.2
.2
-1.7
-1.6
-2.5
NIT Eligibles
3.5
3.5
NIT-Ineligibles
1.0
1.0
Total
4.5
4.5
-I .9
1.6
.8
.3
1 .Z
I .Z
-I .6
2.8
2.0
Change in Total Private Sector Earnings NIT-Eliglbles NIT-Inellglbles Total
PSE Earnings
Change in Total Earnings NIT-Eligibles NIT-Ineligibles Total
sector earnings. However, earnings from the PSE component of the two-tier plan would be almost three times the size of this reduction in private sector earnings, and consequently, total earnings in the economy would actually rise under this plan. By contrast, the pure NIT plan, as anticipated, causes a reduction in total earnings in the economy. Table 3 provides a somewhat different perspective on the work incentive effects associated with the simulated welfare reform plans. The table suggests that NIT-eligibles would make substantial proportional adjustments in their total hours, total earnings, and private sector earnings in response to the simulated plans. However, because families eligible for NIT payments comprise only a minority of all families, the proportional effects on total hours and earnings in the overall economy are relatively small. tThe net cost to the governmentis equal to the PSE wage bill plus the sum of the changes in direct transfer payments,tax revenues (including Social Security taxes), and unemployment compensation. Neither the cost of PSE inputs nor the value of PSE output--two factors that will be briefly considered later-are included in these costs estimates.
Table 3 also implies that incentives to work tend to be minimized by transfer plans that provide relatively generous direct payments and do not emphasize jobs, such as the pure NIT, and maximized by reform plans that stress jobs and provide relatively ungenerous payments, such as the two-tier plan. However, all the simulated plans are predicted to cause declines in participant's private sector earnings, suggesting that such declines are inevitable, regardless of the mix between direct transfers and jobs. The loss of private sector production associated with declines in private sector earnings, however, will be at least partially offset under plans with PSE components, if output produced under these components is valued more highly by society than the physical capital and administrative inputs required to operate them. This issue will be further discussed later. The estimates reported in Table 4 indicate how direct transfer payments and disposable incomes would be changed by the simulated plans and what the net cost to the government of the simulated plans would be.i" It is interesting to note that although the pure NIT and the high-cost plans contain identical NIT components, the net outlay in direct transfer payments is smaller under the latter. The reason for this is that PSE earnings under
Table 3. Percentagechanges in hours and earnings under alternativetransfer plans Pure NIT
Two-Tier Plan
High-Cost Plan
Total Hours Worked NIT-Eligibles NIT-Ineligibles Total
-7.4 .0 -.7
5.0 .7 1.1
1.3 .7 .8
Total Earnings HIT-Eligibles NIT-Ineligibles Total
-8.8 .1 -.4
7.4 .3 .7
3.7 .3 .5
Private Sector Earnings NIT-Eligibles NIT-Ineligibles Total
-8.8 .1 -.4
-8.8 .1 -.4
-12.4 .1 -.6
Cash transfers versus job programs
153
Table 4. Aggregate changes in net transfers and disposable incomes under alternative transfer plans (in $billions) Pure NIT
Two-Tier Plan
High-Cost Plan
Change in Transfer Payments NIT-Eligibles NIT-Ineligibles Total
6.32 -.40 5.92
2.55 -.48 2.07
4.91 -.46 4.45
Change in Disposable Income NIT-Eligibles NIT-Ineligibles Total
4.72 -.39 4.33
3.98 .18 4.16
5.62 .17 5.79
Total Net Cost
5.97
5.83
8.26
.73
.71
.70
Efficiency Ratio
the high-cost plan are "taxed" by the NIT program. In other words, the cost of the public service jobs would be partially offset by reductions in transfer payments to PSE participants. It is evident from Table 4 that the high-cost plan produces a considerably greater increase in disposable income than either of the two equal cost plans. The total net cost of this plan, however, is also considerably higher. To normalize for variation in program costs among the three prototype plans, we have divided the change in disposable income associated with each plan by the plan's net cost. The resulting "efficiency ratio", which is reported on the last line of Table 4, suggests that per dollar of expenditure, the three simulated plans are about equal in their effectiveness in raising participants' incomes. This finding may appear surprising at first. It is well known that reductions in earnings that result from the work disincentives associated with pure NITs mean that a dollar of transfers will raise disposable income by less than a dollar. But since public service jobs are associated with increases in earnings, it might appear that adding a PSE component to an NIT program should raise efficiency ratios. However, as a comparison of either the two-tier plan or the high-cost plan to the pure NIT plan indicates, this does not occur. In fact, the ratio slightly falls ! The explanation for this finding resides in the fact that PSE programs cause some persons to substitute public work for private work. To see this, consider a worker who leaves a private sector job that pays $2 hr for a PSE job that pays the 1975 minimum wage of $2.10hr. The efficiency ratio associated with the PSE program for this +The degree of substitution of PSE for private sector employment could potentially be reduced by increasing the relative attractiveness of low wage private sector employment through provision of wage or earnings subsidies. A simulation analysis of income maintenance systems that combine public sector employment with private sector wage or earnings subsidies is an important topic for future research. :~Theterm "pre-transfer poor" refers to households that would be counted as poor in the absence of either the existing welfare system or the simulated plans. §The numbers of households made worse-off are at first blush surprisinglylarge. These estimates, however, merely indicate that it is difficult,if not impossible, to construct an NIT program of moderate cost that does not make some households worse off. liThe high-cost plan is predicted to have a larger impact on income inequality and poverty than either the pure NIT or the two-tier plan, but this merely reflects the fact that the net cost of this plan is considerably larger.
particular worker is only 0.05 (i.e. at a net cost to the government of $2.10 the individual's income only increases by a dime). Given the large estimated amounts of substitution of public for private work implied by Table 2, it is hardly surprising that PSE programs do not succeed in raising efficiency ratios.? Table 5 reports several indices that measure the effects of the simulated plans on the income distribution and poverty. The measures of target efficiency, which are reported in the first two columns of the table, indicate the percentage of PSE earnings and NIT transfers that would be received by the pre-transfer poor.:~ Thus, these measures are intended to reflect the extent to which public expenditures on the PSE and NIT components of the various plans would be concentrated on households with the greatest needs. As is evident, there is very little variation among the alternative plans in terms of the target efficiency of either their NIT or PSE components. However, it does appear that target efficiency is considerably higher for direct transfer expenditures under any given plan than for PSE wage expenditures. The relatively greater target efficiency of transfers occurs because, by design, the size of payments received under an NIT is inversely related to income levels. By contrast, some payments under a PSE program will inevitably be received by relatively high income persons who are temporarily unemployed. The remaining five columns in Table 5 present several measures that may be used to assess the extent to which the simulated plans reduce income inequality and poverty. The first of these measures indicates the number of households whose annual disposable incomes would be increased or decreased by a minimum of $240 were each plan implemented.§ The next measure is an estimate of the percentage decrease in persons below the poverty line that would result from implementation. The final two measures are based on a proportion known as the welfare ratio, which is computed by dividing a household's disposable income by its poverty line. The mean of the logarithm of the welfare ratio is reported in the sixth column of Table 5 and the variance of the logarithm of the ratio, which indicates how the plans affect the size distribution of disposable income is reported in the seventh. The most interesting implications of Table 5 are suggested by comparing the pure NIT and two-tier plans-the two equal cost alternatives. This comparison implies that poverty and income inequality can be moderately more reduced by a welfare reform package that does not include a PSE component than by an equally expensive package that doesll a finding that reflects the fact that
D. BETSONand D. GREENBER6
154
Table 5. Effects of the alternative transfer plans on the income distribution and on poverty
Simulated Plans
Target Efftctenc~ of PSt Transfer Earntngs P~ments
Number of Households (in lrOOO's wtth Higher LOwer Incomes Incomes
Percent Change in Povert~y Popu|atton
Mean Log of Welfare Ratto
Yartance of Log of Welfare Ratto
Pure NIT Plan
--
88
4,772
],368
-37.1
.694
.21 8
Tio-Tler Plan
74
91
4,471
1,365
-27.5
.691
.231
High-Cost Plan
75
88
5,374
1,223
-49.2
.704
.210
expenditures on direct transfer payments are relatively more target efficient than expenditures on jobs. Thus, it appears that welfare expenditures on public service jobs must be justified on grounds other than their effectiveness as anti-poverty tools.# We shall discuss such justifications in the following section. 4. CONCLUSIONS In the previous section, we compared the simulated effects of a prototype transfer plan based solely on a NIT program with transfer plans that incorporate a PSE component as well as a NIT. Our findings imply that redistribution schemes that rely entirely upon direct transfer payments are in certain important respects equal or slightly superior to more complex schemes that couple direct transfers with job programs. For example, the pure NIT we simulated would diminish poverty and inequality by somewhat more than an equal cost plan that combined a PSE program with a NIT. Moreover, a redistribution scheme that is based solely on direct transfers is at least as effective per dollar of tax expenditure in raising incomes as a combination of direct transfers and jobs. In addition, job and direct transfer combinations would apparently cause reductions in
tResults from simulatingthe plan that would implementa PSE program identical to that provided by the two-tier and high-cost plans but leave the existing welfare system intact suggest that by themselves minimumwage public service jobs will make only a very modest contribution towards reducing income inequality or poverty. The simulated "pure" PSE plan, for example, would only pull about one-quarter as many persons out of poverty as the simulated pure NIT. ~:For example, a recent study by [7] of an experiment in supported work, a job program concept that places particular emphasis on the production of socially useful output, estimated that the average annual value of output per supported work participant was between $3298 and $6018. (The $3298 value represents a lower bound estimate based on the average amount paid in the market for output produced under the program; the $6018 value is based on an estimate of the average alternative supplier's price.) The annual cost of inputs used directly in the production of this output was estimated to equal $3797 and the annual cost of office space, staff salaries, and other administrative, management,and support services required by the supported work program was estimated at $3379. Thus, it can be seen that production cost substantially offset the value of the program's output. §The numerous studies of the post-program value of work experience and job training that have been conducted since the mid-1960s vary considerably in their results--depending on program characteristics, the characteristics of program participants, the state of the labor market, and the research methodologyand data that were used in the study. These studies have indicated a number of instances in which the work experience and job training received under particular programs was of considerable value to program participants and many other instances in which the experience and training was of little or no value.
private sector earnings that are as large, if not larger, than those resulting from comparable schemes that utilize only direct transfers. These findings suggest that job programs offer little advantage over direct transfers unless they satisfy objectives beyond merely redistributing income. One such objective, for example, may be the production of socially useful goods and services. However, the value that society would place on the goods and services produced under a large-scale PSE program is virtually impossible to predict at the present time. Furthermore, it is important to recognize that the cost of the physical capital, supervisory personnel, and other inputs required to produce such goods and services may exceed their social value.¢ Another potential benefit of a job program is that it may provide valuable work experience. However, if the work performed in the program has little transferable value, a worker's stock of human capital could actually deteriorate while he is participating in a jobs program. Moreover, some employers may be reluctant to hire job applicants who previously participated in a work program, thereby giving rise to a stigma effect.§ Perhaps, the case for utilizing job programs for redistribution purposes must ultimately depend on a value judgment, rather than on simulations and other forms of quantitative estimates. As indicated earlier, such programs tend to increase total work effort in the economy, while direct transfer programs cause decreases in overall hours of work. Indeed, although our findings suggest that a pure NIT and a transfer plan that incorporates both PSE and NIT components would result in similar private sector earnings reductions and would be about equally effective in raising the incomes of beneficiaries, it may be very important to many tax payers that increases in income that ensue from participation in PSE are in the form of earnings exchanged for labor service. Consequently, the decision on whether job programs should be an important part of the nation's income transfer system perhaps ultimately rests on the value society places on PSE output and in the work ethic.
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6. M. C. Keeley, P. K. Robins, R. G. Spiegelman and R. W. West, The estimation of labor supply models using experimental data. Amer. Econ. gev. 68, 873-887 (1978). 7. P. Kemper, D. Long and C. Thorton, The supported work evaluation: final benefit--cost analysis. Mathematica Policy Res. Paper, Princeton, NJ (1979).