The Safety Net Isn't Free

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Benefit payments by government safety net programs, like unemployment insurance, help the people who receive those payments. But government officials, politicians and journalists sometimes go another step and assert that everyone benefits when the poor and unemployed receive payments from the government, because that “puts money in the hands of consumers,” and consumer spending is said to stimulate employers to hire.

I explained last week that the “hands of the consumer” theory ignores the hands of the people who pay for safety net benefits. For example, because of the extra taxes needed to help pay for the unemployment insurance program, a taxpayer may no longer be able to afford to make an addition to his house.

Thus, while jobs will be needed to serve the unemployed people as they spend their benefit payment, there will be no need for the construction workers and others who would have helped with the taxpayer’s home project.

Dean Baker of the Center for Economic Policy and Research disagreed, in a post on the center’s Beat the Press blog, saying that, for now, unemployment insurance benefits do not cost us anything because they are not financed with current taxes:

At the point in a business cycle where large numbers of people are receiving benefits (like now) the U.I. system will be running a deficit. This allows unemployed workers to receive benefits, which they will overwhelmingly spend, without an offsetting current payment from other workers.

I agree that unemployment benefits and other safety net benefit payments are many times financed with taxes in the future or taxes in the past. But that “financing channel” still does not make the payments free from the perspective of today’s economy.

Suppose the government has been borrowing the money to pay for unemployment benefits. It borrows money by selling bonds. The purchasers of those bonds have less to spend on something else.

As I explained last week, government borrowing to pay for safety net benefits may increase consumer spending and reduce investment spending, because it does put money in the hands of consumers.

But that could either increase or reduce employers’ need to hire, depending on, among other things, whether the consumer goods purchased are more or less labor-intensive than investment goods not purchased (see last week’s discussion of liquidity considerations).

Last week I noted that I was holding constant the amount that safety net beneficiaries (“the poor”) work and earn, so that more safety net income for the poor means more total income for them, which permits them to spend more. But the safety net causes some beneficiaries, or their spouses, to work less.

Unless the safety net replaces all of the income lost from reduced work time – it typically does not – then the families who reduce their labor in response to the safety net expansion will spend less as a result of the safety net, and the amount less could be many times more than the amount that the safety net expanded.

Now the “hands of consumers” theory is turned on its head: at the same time that the poor spend most of whatever income they have on consumer items, the safety net’s redistribution reduces their total spending because it reduces their total family income.

Benefit payments by government safety net programs help the families who receive those payments. But it is inaccurate to ignore that fact that those payments hurt the rest of us.

Unemployment Benefits, the Unemployed, and the Rest of Us

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As politicians have debated expansions and contractions in the unemployment insurance program, many commentators, as well as reports by the Congressional Budget Office and other government agencies, have asserted that the unemployment program increases aggregate spending, and by that channel even helps people who are not unemployed. However, that proposition has so far been the subject of few direct, empirical investigations.

Studies find that, with labor income held constant, the recipients of unemployment insurance and other transfer payments from the government tend to use those resources to consume, rather than invest or purchase liquid assets. As news articles often say, government transfers such as unemployment compensation “put money in the hands of consumers.”

That unemployed people tend to spend their benefits when they receive them is important, because it tells us that the benefits are important for maintaining their living standards. Even if unemployment benefits reduced employment as a consequence of paying people not to work, the fact that the beneficiaries’ living standards depend so much on them helps make the case that the program’s benefits outweigh their cost.

But editorial writers and commentators go too far when they jump from the consumer-spending observation to the assertion that unemployment insurance actually stimulates employment by increasing the number of people whom employers are willing to hire.

It’s true that the businesses serving unemployed people will need more employees when the unemployed spend more, but unemployment insurance is not free. The benefits are financed by taxpayers, the owners of government debt or the beneficiaries of other government programs (which cannot grow because of the size of the unemployment insurance budget).

The businesses serving those who pay for the unemployment insurance program — whether they make consumer goods or investment goods — are likely to hire less, because their customers are dedicating some resources to pay for the program.

Even if unemployment insurance did not discourage a single person from working, the net effect of the program on hiring can be positive or negative, depending on the labor intensity of the goods and services that the unemployed buy, compared with the labor intensity of the goods and services that those who pay for unemployment do not buy.

The obvious, and critical, empirical question is whether the unemployed really do spend a larger fraction of their income on labor-intensive items, and I am not aware of any empirical studies on that topic. The answer is far from obvious, For example, some of the most labor-intensive industries are hotels, coal mining and restaurants, while farming commodity crops and providing cellphone services are some of the least labor-intensive.

If the unemployment insurance program redistributes resources from people who spend a relatively large fraction of their resources on restaurants and hotels toward people who spend a large fraction on groceries and cellphone services, the redistribution may well reduce national labor demand rather than increase it.

New Keynesian models of the business cycle offer a coherent theory about how the composition of the demand for final goods might be affected by unemployment compensation that has little to do with the distinction between consumption and investment. That theory emphasizes a third spending category: the accumulation of liquid assets.

It is usually assumed that liquid assets are not produced with labor (in fact, it is assumed that they are not produced at all but rather are in fixed supply). Thus, more demand for consumption and investment goods rather than liquid assets might mean more demand for labor, especially when, as New Keynesian models assume, market prices do not adjust very well.

But that still does not tell us whether unemployment benefits increase the demand for labor, unless the unemployment program can somehow be connected with the demand for liquid assets, which empirical studies have not done yet.

An unemployment insurance program can provide some real help for the unemployed. But there is no proof that the program is good for the rest of us.

Supporting Bad Habits With Public Money

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Florida and a few other states are considering additional restrictions on food stamp and welfare payments to the poor, such as prohibiting the purchases of snacks and sweets with food stamps and prohibiting withdrawals of welfare cash at casinos and strip clubs.

Economists have two basic principles they use in these cases: fungibility and screening, and both point to unintended consequences of the sin-based restrictions.

The principle of fungibility says that dollar bills are equivalent, regardless of their source. If a customer brings in his wallet $100 he received from the government and another $100 from a job, the cashier at the store cannot tell whether the customer is spending his government money or his employer money.

For many years, the Department of Agriculture tried to affect this situation by making the government “money” a different color – that’s why they were called food stamps – and merchants were not permitted to accept food stamps for alcoholic beverages, tobacco and other prohibited items.

But there is hardly any difference between giving somebody $20 to buy beer and giving that same person $20 earmarked for food, because the earmarked funds allow her to spend $20 less of her own money on food, leaving $20 left to buy beer, if she wants. Earmarked funds can be as good as unrestricted money.

The only situation when food stamps could really increase food purchases is when the value of stamps exceed what beneficiaries would be willing to spend on food on their own. The Department of Agriculture, which runs the food-stamp program, estimates that only 30 percent of beneficiaries are in this situation.

The same analysis applies to proposed restrictions on snacks and sweet foods. A family receiving a $200 monthly food-stamp benefit that spends $300 a month in total on all food – $200 of food stamps plus $100 of its own – can still buy its usual monthly amounts of snacks and sweet foods under the more restrictive rules, as long as the snacks and sweets part of the monthly food bill is no more than $100.

Perhaps a few food-stamp beneficiaries, absent restrictions, spend a large fraction of their food budget on snacks and sweets (I am not aware of any U.S.D.A. analysis of the frequency of such cases). They would find the food-stamp program less attractive and might even let some of their food stamp benefits go unused.

The U.S.D.A., or specific states like Florida that put additional restrictions in place, could respond by increasing the total food-stamp benefit, but that brings about another unintended consequence, counterproductive screening.

The principle of screening recommends introducing program attributes that are more attractive to the target population than to the rest of the population or attributes that are less unattractive to the target population than to the rest of the population.

For example, a public housing project intended for poor members of a particular ethnic group might be built in the poor part of that group’s neighborhood, even if there might be other places to build more efficiently, so that the project is more accessible to the target population and less accessible to others.

The food-stamp program, like much of the social safety net, is intended for the poor. Most Americans, even many whose incomes are temporarily low, are not poor. As a result, the program needs methods for distinguishing households that are truly poor from households that are not. It used to have an “asset test” – people with money in the bank and other non-trivial financial assets were not eligible – but most states have eliminated that test in the last few years.

If it were true that preference for snacks and sweets are correlated with poverty – that people who are not poor allocate more of their food budget to “healthy” foods – then the snacks and sweets restriction tends to make food stamps less attractive for the poor, but not less attractive for those not poor. The result could be that the snacks and sweets restriction increases the fraction of beneficiaries for whom the program is not intended.

By definition, the economic principles of fungibility and screening do not account for an important political principle – that the food-stamp program and other safety-net programs must continue to have political support, so that Congress and the states continue to be willing to allocate tax dollars to them. That’s the only justification I see for taking aim at the poor with restrictions on purchases of snacks, sweets and other items thought to be bad for you.

Will the IRS be Busy Next Year?

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Republican and Democratic presidents are quite different in their enforcement of tax laws and their administration of the Internal Revenue Service.

Republicans are constantly telling us how different they are from the Democrats, and vice versa. But in many ways Republican and Democratic politicians are a lot like Coke and Pepsi – very different marketing but essentially made of the same chemicals.

President Obama, for example, has retained the Republican policy of keeping prisoners at Guantánamo Bay. And as Massachusetts governor, Mitt Romney put into place a state health insurance plan that in many ways resembles the federal Affordable Care Act enacted by a Democratic Congress.

Economists have studied the history of policy making by Republican and Democratic presidents. They find a few differences here and there, but for the most part both types of presidents play to the same middle of the country and to many of the same interest groups.

But one significant difference between the two parties had been their administration of the Internal Revenue Service, the agency of the United States Treasury that enforces tax rules.

A dissertation written in 2005 by Valentin Estévez at the University of Chicago found that:

¶ “Under Democratic presidencies the audit rate of income tax returns is higher than under Republican presidencies even after the inclusion of various political and economic controls.”

¶ “During Democratic presidencies the I.R.S. tends to audit fewer individual returns and more corporate returns than during Republican presidencies.”

¶“Parties may be in fact resorting to more subtle redistributive policies, such as the likelihood of an audit, to favor their constituency.”

I.R.S. data released since Mr. Estévez’s dissertation have confirmed the tendencies of Democratic and Republican presidents to use I.R.S. audits differently. Twelve percent of millionaire earners were audited in 2011, when Barack Obama was president, compared with 5 to 7 percent audit rates for 2004-9 (George W. Bush was president most of that time). Among people earning less than $200,000, a far lower percentage of returns are audited (about 1 percent in 2011).

Steven Miller, deputy I.R.S. commissioner for services and enforcement, told The Associated Press, in reference to the recent audit rates, that “I.R.S. officials said the high ratio was part of an effort to demonstrate that tax laws are applied fairly.”

If these past audit patterns continue, whether or not millionaires can expect to meet I.R.S. auditors in 2013 and beyond depends a lot on whether President Obama defeats the Republican nominee.