Ch12 Poverty Old and New Approaches to a Persistent Problem.docx

Chapter 12 Poverty Old and New Approaches to a Persistent Problem What's in This Chapter and Why Chapter 12 deals with the problem of poverty in the United States. It contains an unusually thorough integration of facts, analysis, institutional detail, and policy alternatives. The principal questions addressed are: (1) How many people are poor? (2) What is the shape of the long-run poverty trend? (3) How effective have government transfers been in reducing poverty? (4) What factors tend to increase poverty? (5) Do government transfers, in particular, increase poverty through their adverse effect on work effort and transition out of poverty? (6) What are the policy alternatives for dealing with poverty? Instructional Objectives After completing this chapter, your students should know: 1. How poverty is measured. 2. How the official poverty rate has varied over the last 30 years. 3. That government transfers have been responsible for much of the reduction in poverty that has occurred, especially among the elderly. 4. That poverty has become concentrated more in families headed by females, blacks, and Hispanics. 5. That discrimination plays a limited role in generating and maintaining poverty. 6. That the increasing incidence of unemployment has had a disproportionate impact on the poor. 7. How government means-tested transfers can affect work effort and transition out of poverty. 8. The policy choices for dealing with the problem of the "working poor," and how they work. 10. The policy choices for enforcing and ensuring child support payments. Key Terms These terms are introduced in this chapter: Poor person Official poverty threshold Gross money income Poverty rate Pre-transfer poverty rate Means-tested transfer Basic benefit Deduction for essential needs Benefit reduction rate Break-even gross income (BEGI) Target efficiency Suggestions for Teaching It is essential to begin a chapter on poverty with the issue of how to determine the number of people who are poor. To stimulate interest, remind your students that we must agree on the magnitude of the problem before we can generate the political will to do something about it. For example, the War on Poverty of the late 1960s was undoubtedly accelerated because of the facts brought to light in Harrington's The Other America and the initial estimates of poverty by the Council of Economic Advisors. The next thing to do is present data on the official measure of poverty for selected years. Do this to underscore two important points: (1) that poverty is persistent, but (2) that the level of poverty varies over time. This is followed in due course by a look at the composition of the poor where it is pointed out that the racial composition of the poverty population has been relatively constant, but that the age composition of the poor has varied considerably. Then examine the basic forces underlying the long-run trend. Economists really believed in the 1960s that poverty could be reduced effectively through real economic growth and investment in human capital. These factors are granted only a small role in poverty reduction. The three most common sources of support for poverty families, other than income from work, are food stamps, the EITC, and TANF payments. Each of these is a meanstested transfer. None is generous enough, by itself, to elevate very many families above the poverty threshold. Benefits from both the food stamp and TANF programs fall as income from work increases above a deduction for essential needs, raising the possibility that the loss of benefits discourages people from working. The EITC increases as AGI increases from $0 to $10,020, and remains constant from $10,020 to $13,090, encouraging work. Beyond that level, the EITC falls as AGI increases, discouraging work. The net effect of the three programs together probably does not discourage the poor from working at low wages but may adversely affect the transition from low to higher wages. The establishment of the TANF program is a clear signal that Congress wants to increase the percentage of income that the poor receive from work. Accordingly, this chapter reviews several programs or policies designed to achieve that objective. The examination of the relationship between unemployment and poverty suggests that policies to reduce unemployment are an important part of any strategy to reduce poverty. Data gathered to date on people who return to TANF after leaving TANF for work indicate that there is a need for more effective childcare assistance. It is believed that TANF clients are reluctant to leave TANF for work because of a fear that they will lose Medicaid benefits. This may be the case for adults, but not for children. The changing composition of the poor, especially the greater concentration of poverty in working poor families and in families headed by females, is noted. Some of this trend is attributed to discrimination, but factors that encourage work and a transition out of poverty are also explored, such as unemployment policy, childcare assistance, medical protection, minimum wage, wage subsidies, and labor market discrimination policies. The final programs considered are government efforts to assist single mothers with collecting child support payments from absent fathers. Efforts to date have resulted in significant increases in the amount of child support collected. Some believe, however, that the government should assure or guarantee child support payments while making further efforts to get fathers to pay. Hopefully a relatively complete and up-to-date discussion of the principal poverty programs and options under consideration is presented. Still, it is difficult to keep up with the literature on this topic. Additional References In addition to the references in the text, instructors may with to read or assign one or more of the following: 1. Committee on Ways and Means, U.S. House of Representatives, Background Material and Data on Programs within the Jurisdiction of the Committee on Ways and Means (Washington, D.C.: U.S. Government Printing Office). An annual publication that may be referenced in your library simply as The Green Book. 2. Thomas Corbett, "Child Poverty and Welfare Reform: Progress or Paralysis?" Institute Research on Poverty: Madison, Wisconsin Focus 15 (1) (Spring 1993). 3. David T. Ellwood, Poor Support: Poverty in the American Family (New York: Basic Books, 1988). 4. Bradley R. Schiller, The Economics of Poverty and Discrimination, 6th ed. (Englewood Cliffs, N.J.: Prentice Hall, 1994). 5. Michael Wiseman, "How Workfare Really Works," Public Interest (Fall 1987), pp. 36-47. 6. Edward N. Wolff, Poverty, Inequality and Discrimination, (Mason, OH: SouthWestern, 1996) Outline I. THE SCOPE OF THE PROBLEM A. Measuring Poverty 1. The official poverty measure is one possible measure of poverty. a. According to this measure, a person is poor who lives in a family whose gross money income is below the official poverty threshold. 1. Gross money income includes earnings before taxes, interest, dividends, and private and government cash transfers. 2. The official poverty threshold is the cost of a nutritionally adequate diet multiplied by three. The official poverty line is based on the idea that the poor should not have to spend more than one-third of their income on food. b. The official poverty measure is adjusted for inflation and family size. B. The Number of People in Poverty 1. From 1959 to 1969 there was a significant decrease in poverty. 2. From 1979 to 1993 there has been a general increase in poverty. 3. After 1993 the poverty plummeted, however, it increased again in 2001. 4. The poverty rate for people age 65 and older has declined dramatically since 1967. Since 1982 the poverty rate for the aged had fallen below the allages poverty rate. 5. There has been a significant reduction in the poverty rate for persons living in femaleheaded families. 6. Although the poverty rates for people living in black and Hispanic households are much higher than the poverty rates for people living in white, non-Hispanic families, they fell both absolutely and relative to the poverty rate of the latter group in the 1990s. II. ANTI-POVERTY EFFECTIVENESS OF GOVERNMENT TRANSFERS A. Official versus Pre-Transfer Poverty Rates 1. The official poverty rate reflects the number of people who are poor after they receive various government cash transfers. Government cash transfers reduce the number of people who are poor according to the official measure of poverty. 2. The pretransfer poverty rate is an estimate by the Census Bureau of what the poverty rate would be without the income provided by the cash transfers except the Earned Income Tax Credit (EITC). 3. Government cash transfers reduced the average poverty rate by 7.5 percent, or nearly 36 percent of the pretransfer level. 4. Taxes, increase the poverty rate, the EITC and noncash transfers reduce it. The net effect of the adjustment for taxes, the EITC, and noncash transfers has been to reduce the poverty rate below the official poverty rate throughout the period 19792001 by an average of 2.8 percent per year. III. MEANS-TESTED TRANSFERS AND WORK INCENTIVES A. The meanstested transfers are those in which the transfer falls as a recipient's means or income increases. They provide incentives to the poor to do less to earn their own way out of poverty. Meanstested transfers include temporary assistance for needy families (TANF), food stamps, the EITC, Medicaid, and federal housing assistance. 1. Food Stamps a. Under the food stamp program, households are given ATM-like debit cards that are accepted as payment by grocery stores for food purchased. b. Monthly food stamp benefits vary with gross income. The basic benefit is the amount received when gross income is equal to or less than the deduction for essential needs: $134.0 in 2002. c. The ratio of the decrease in benefits to the increase in income is called the benefit reduction rate. The level of gross income where benefits are equal to zero is called the breakeven gross income. d. The breakeven gross income is an indicator of the target efficiency of a transfer programthe degree to which program benefits are confined to the poor. In general, the lower the breakeven gross income relative to the poverty threshold, the greater the target efficiency. 2. Earned Income Tax Credit (EITC) a. The federal tax code has provided an earned income tax credit (EITC) since 1975. This is a credit against income tax liability for taxpayers with dependents and a relatively low adjusted gross income (AGI). The credit is refundable; taxpayers may receive a credit even if their tax liability is less than the credit. b. Nine states have also adopted EITCs in the last 5 years. 3. Temporary Assistance for Needy Families (TANF) a. TANF is the nation's safety net program for lowincome families. TANF is financed by the federal government through bloc grants to the states. The amount given to each state is based on how much the state received from the federal Aid to Families with Dependent Children (AFDC) program in the middle 1990's, just before TANF was established as a replacement for AFDC. b. Each state is allowed to design and implement its own TANF program, including benefit levels and criteria for eligibility. c. TANF households are limited to 5 years of support in a lifetime, but states may impose shorter lifetime limits. TANF recipients are required to engage in work or "work activities," such as job training, looking for work, or schooling. States may refuse to provide additional benefits to families who have additional children while on TANF assistance. 4. TANF + Food Stamps + EITC a. The core antipoverty programs probably do not discourage heads of lowincome households from working at least, not at minimum wage jobs. They may, however, discourage them from seeking work at higher pay. Whether the net effect of these incentives increases or decreases poverty in the United States has not yet been determined by empirical studies. IV. MAKING WORK PAY A. AFDC was transformed into TANF in an attempt to increase the degree to which the poor work their way out of poverty by gainful employment. TANF does this by requiring single mothers to find a job and by establishing a lifetime limit on the duration of TANF benefits. This strategy is a necessary but not sufficient condition for reducing poverty because: 1. The economy must generate enough jobs for TANF clients 2. TANF clients appear to need help in order to successfully transition from welfare to work, especially with childcare and medical expenses. 3. The jobs that TANF clients get must pay an adequate wage. Data suggest that poverty, to some extent, may be caused by discrimination. B. Unemployment Policy 1. Since the establishment of TANF there has been more than a 25 percent increase in the percentage of single mothers who are working. TANF was established in the midst of the longest peacetime economic expansion in the last century so it is arguable whether the precipitating factor behind the rise in employment rates of single mothers was TANF or the economy. 2. Empirical data shows that: a. The variations in the pretransfer poverty rate virtually mimic the unemployment rate over time. This relationship strongly suggests that the ability of the economy to generate jobs is an important determinant of the poverty rate. b. The persistence of the pretransfer rate also suggests that the market can solve only part of the poverty problem by generating jobs. C. Childcare Assistance 1. The lack of affordable childcare can significantly hinder the labor market participation of adults in poor families. Both the federal government and state governments have programs that provide some form of childcare assistance. The most prominent of these are a. The Child and Dependent Care Tax Credit b. The Child Care and Development Fund c. The Dependent Care Assistance Program d. The Child Tax Credit D. Medical Protection 1. The potential loss of Medicaid benefits may deter families from leaving welfare for work. Congress, under the Family Support Act of 1988, required states to expand Medicaid coverage for up to 12 months for families leaving AFDC for work. Under waivers, some states have expanded coverage for up to 24 months. E. Minimum Wage 1. Poverty among the working poor is partly due to very low wages. Interest exists, then, in policies that increase the rewards that workers realize from their efforts. The three mostdiscussed policies are: a. Expanding the EITC b. Raising the minimum wage c. providing wage subsidies 2. Some economists argue that raising the minimum wage increases the unemployment rate. A further difficulty with a higher minimum wage is its target inefficiency. F. Wage Subsidies 1. In a program of wage subsidies, lowwage workers would receive a subsidy for each hour worked. The wage subsidy would equal some percentage of the difference between a designated maximum wage and the worker's wage. 2. A wage subsidy can be more effectively targeted to the poor than can the minimum wage, provided it is restricted to principal family workers. Unlike the minimum wage, a wage subsidy probably would not reduce employment. Paradoxically, it does not guarantee increased work effort, as one would expect a higher effective wage to do. G. Labor Market Discrimination Policy 1. The fact that poverty rates are higher in families headed by females, blacks, and Hispanics than in families headed by nonHispanic whites, suggest that poverty may be, to some extent, caused by discrimination. 2. Evidence shows that unexplained differences in pay do exist between apparently identical white and black workers, between male and female workers, and between Hispanic and nonHispanic white workers. However, the unexplained pay differences is no larger than the 13 percent penalty paid by blacks, and they are probably less for both females and Hispanics. 3. These differences should be viewed as upper limits. 4. There are several reasons the authors do not believe discrimination is a major contributor to poverty. a. 48 percent of the poor live in families headed by white males. b. There is some evidence that suggest that the earnings differential between white males and others is smaller for lower-paying occupations than it is for higher-paying occupations. c. There is evidence that the earnings differential between white males and others is less among individuals with less education (individuals who are more likely to be poor). d. Poverty rates have persisted even though earnings differentials have narrowed over time. e. In many cases, the earnings penalty imposed by discrimination would not be large enough to cause poverty. 5. Authors suggest that rather than discrimination, a stronger link is probable between poverty and occupational segregation, and some hope that reducing the latter will also lower the poverty rate. V. MAKING FATHERS PAY A. Child Support Assistance 1. The increase in femaleheaded families has focused attention on the poor record of absent fathers in supporting the children they leave behind. 2. Child support is an important strategy in making work pay because it increases and stabilizes the income of lowincome working adults. Legislation and enforcement mechanisms to this end include: a. The Child Support Enforcement program b. The Family Support Act of 1988 c. The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 B. Child Support Assurance 1. Some believe that government should go beyond simply collecting money from absent fathers; that child support assistance should become child support assurance (CSA). 2. New York has run a CSAlike program successfully for more than a decade. Other states are considering similar programs. Answers to Review Questions 1. Currently, in-kind transfers are not included in the official measure of resources that individuals have available to meet their basic needs. Do you believe these transfers should be included? Defend your answer. The official poverty measure uses money income; however, money income fails to include relevant, and important sources of income. Further, money income does not adjust for the impact of taxes on income. The antipoverty effectiveness of government cash transfers can be determined by comparing the pretransfer poverty rate with the official poverty rate. The pretransfer poverty rate is an estimate by the Census Bureau of what the poverty rate would be without the income provided by the cash transfers, except the Earned Income Tax Credit (EITC). Government cash transfers have been a uniformly important factor in reducing poverty throughout the period 19792001. In the absence of income from government cash transfers the poverty rate would have averaged 21.1 percent; with the income from government cash transfers, the poverty rate averaged 13.5 percent. Government cash transfers reduced the average poverty rate by 7.5 percent, or nearly 36 percent of the pretransfer level. 2. "Instead of enacting new transfer programs to eliminate poverty, we should concentrate on policies that would reduce unemployment." Do you agree or disagree with this statement? Defend your answer. Reducing unemployment can reduce poverty. As a group, the poor lack the skills and patterns of work force attachment that employers demand. Because of this, increases in unemployment tends to hit the poor harder than other groups in society. Since the establishment of TANF there has been more than a 25 percent increase in the percentage of single mothers who are working. TANF was established in the midst of the longest peacetime economic expansion in the last century so it is arguable whether the precipitating factor behind the rise in employment rates of single mothers was TANF or the economy. Empirical data shows that:(1) the variations in the pretransfer poverty rate virtually mimic the unemployment rate over time. This relationship strongly suggests that the ability of the economy to generate jobs is an important determinant of the poverty rate; (2) The persistence of the pretransfer rate also suggests that the market can solve only part of the poverty problem by generating jobs. In sum, policies designed to reduce unemployment would have a significant impact on poverty. It should be borne in mind, however, that the poor also need to acquire skills necessary to fill available jobs. Thus, training programs might be combined with policies to decrease unemployment. 3. What government program or programs has (have) been the most effective poverty-reducer(s)? Justify your answer. Various government transfer programs have been responsible for reduction of poverty over the past 40 years. The main categories of government transfers that benefit lowerincome families are cash and non-cash transfers. These programs are as follows: Cash transfers include: Social Security Supplemental Security Income (SSI) Earned Income Tax Credit (EITC) Temporary Assistance for Needy Families (TANF) which consists of: Federal Government Bloc Grant State Government Funds Noncash transfers include: Medical Care, which consists of: Medicaid Federal Gov. Medicaid State Gov. Food Assistance, which includes: Food Stamps Women, Infants, Children (WIC) & Child Nutrition Housing Assistance Child Care and Child Support Energy Assistance The antipoverty effectiveness of government cash transfers can be determined by comparing the pretransfer poverty rate with the official poverty rate. The pretransfer poverty rate is an estimate by the Census Bureau of what the poverty rate would be without the income provided by the cash transfers, except the Earned Income Tax Credit (EITC). Government cash transfers have been a uniformly important factor in reducing poverty throughout the period 19792001. In the absence of income from government cash transfers the poverty rate would have averaged 21.1 percent; with the income from government cash transfers, the poverty rate averaged 13.5 percent. Government cash transfers reduced the average poverty rate by 7.5 percent, or nearly 36 percent of the pretransfer level. The poverty-reducing impact of Government noncash transfers and the EITC are stronger than the povertyincreasing impact of taxes. The net effect of the adjustment for taxes, the EITC, and noncash transfers has been to reduce the poverty rate below the official poverty rate throughout the period 19792001 by an average of 2.8 percent per year. 4. The average female earned 78 percent as much as the average male in 2001. Explain why this comparison overstates the degree of labor market discrimination against females. This comparison may overstate the degree of labor market discrimination because earnings differentials can arise from several sources. For example, differences in education, training, work experience, occupation, location, hours worked, work effort, industry, marital status, verbal skills, and intelligence all impact earnings differentials. In order to determine the amount of the differential attributable to discrimination, the effects of the various factors impacting earnings differentials must be identified. 5. Evidence indicates labor market discrimination against blacks, Hispanics, and females, but such discrimination has little to do with poverty. Explain why. Evidence indicates that there are unexplained differences in pay between apparently identical white and black workers, between male and female workers, and between Hispanic and non-Hispanic white workers. Black males appear to pay a 27 percent earnings penalty for being black, white females appear to pay a 22 percent earnings penalty for being female. This implies that the earnings penalty imposed by discrimination is typically not large enough to lower a family's income from above the poverty threshold to below the poverty threshold. Other factors also suggest that discrimination has little to do with poverty. For example, 48 percent of the poor live in families headed by white males. Thus, nearly half the poor could not be adversely affected by labor market discrimination. A second factor is evidence indicating that the earnings differential is smaller for lower-paying occupations. There is also evidence that the earnings differential between white males and others is smaller among the less educated. It is the less educated who are more likely to live in poverty. Finally, poverty rates have persisted over time even though earnings differentials have narrowed. These arguments indicate that labor market discrimination has little to do with poverty. 6. Congressperson Smith argues that government transfers have worked to alleviate poverty. Congressperson Jones argues that these transfers have worked to increase poverty. Who is correct? Defend your answer. Congressperson Jones argues that transfers have worked to increase poverty. Her argument is based on the adverse effect that transfers have on work effort. The five major programs aimed at the poor are all means-tested programs. This means that as the recipient's income rises, benefits from these programs fall. The basic transfer and the transfer reduction rate are two features of means-tested programs that may adversely influence recipients' willingness to work. The basic transfer is the amount received if the recipient's income is zero. The transfer reduction rate is the rate at which benefits fall as income rises. It is often equated to a marginal tax on earned income. The basic transfer gives the individual more income with which to purchase more goods and services. One of the things that the individual will "buy" more of is leisure. Because there are a limited number of hours available each day, when the individual consumes more leisure they work less. The transfer reduction rate will cause the transfer to fall as the recipient works and earns more. The authors argue that this should have a negative effect on the individual's work effort with the effect becoming larger as the transfer reduction rate increases. Considering the fact that many of the poor receive benefits from more than one program and therefore face transfer reduction rates greater than one, Ms. Jones argues that government transfers could have very serious adverse effects upon work effort and hence poverty. Congressperson Smith claims that evidence from the real world does not support Ms. Jones's argument. Evidence does not indicate that transfers have significantly increased poverty rates. Mr. Smith states that studies show that means-tested transfers have had a relatively small impact in terms of increasing poverty rates. For example, in the absence of income from government cash transfers the poverty rate would have averaged 21.1 percent; with the income from government cash transfers, the poverty rate averaged 13.5 percent. Government cash transfers reduced the average poverty rate by 7.5 percent, or nearly 36 percent of the pretransfer level. Furthermore, the EITC, and noncash transfers have reduced the poverty rate below the official poverty rate throughout the period 19792001 by an average of 2.8 percent per year. If present programs were removed, the number of poor would significantly increase. Based on these arguments it does appear that transfers have slightly increased the poverty rate. Further, it is likely that a significant expansion of programs could be associated with a much larger increase. It is possible, then, that significant additional assistance would have a high marginal cost in terms of poverty created. 7. Using the benefit equations for food stamps and TANF, solve the following problem for each program considered separately: Suppose the basic benefit is $500 per month and the deduction for essential needs is $150, what is the benefit that will be received? The food stamp benefits (B) at each level of gross income (GI) greater than the deduction can be determined by solving the benefit equation: B = BB - BRR (GI - D) Where BB is the basic benefit, BRR is the benefit reduction rate, and D is the deduction for essential needs. Benefits would run out when GI=$1816.67. The following table shows the benefits schedule for various gross incomes where, BB=500, BRR=0.3, and D=150 Determination of Food Stamp Benefits Family of Three in 2002 Gross Income Deduction Benefits Change in Benefits Change in Gross Income Benefit Reduction Rate 1 2 3 4 5 6 $0.00 $150.00 $500 150 150 500 $0.00 $150.00 0 200 150 485 -15 50 -0.30 300 150 455 -30 100 -0.30 400 150 425 -30 100 -0.30 500 150 395 -30 100 -0.30 1000 150 245 -150 500 -0.30 1816 150 0 -245 816 -0.30 TANF benefits would run out when GI=$983.33. The following table shows the benefits schedule for various gross incomes where, BB=500, BRR=0.6, and D=150. Determination of TANF Benefits Family of Three in 2002 Gross Income Deduction Benefits Change in Benefits Change in Gross Income Benefit Reduction Rate 1 2 3 4 5 6 $0.00 $150.00 $500 150 150 500 $0.00 $150.00 0 200 150 470 -30 50 -0.60 300 150 410 -60 100 -0.60 400 150 350 -60 100 -0.60 500 150 290 -60 100 -0.60 983 150 0 -290 483 -0.60 8. Suppose that a person works 1,800 hours a year at the minimum wage. How large will this person's EITC be? Assume that total income from wages and AGI are equal. Show your calculations. The federal minimum wage is currently $5.15 per hour. Assuming that total income from wages and AGI are equal, AGI = 1,800 x $5.15 = $9,270. For a worker with two or more children in 2001, the federal credit was 40 percent of AGI over a phasein range from $0 to $10,020. $4,008 for AGI over a maximum payment range from $10,020 to $13,090, and $4,008 minus 21.06 percent of AGI over a phaseout range for AGI greater than $13,090. Thus, the benefit for the person considered is $3,708 B = 0.40 (AGI) = 0.4 (9,270) 9. Repeat question 8 for someone who earns $10 per hour. Assume again that total income from wages and AGI are equal. AGI = 1,800 x $10 = $18,000. Given the formula in question 8, the EITC for this person would be $4,008 minus 21.06 percent of AGI over a phaseout range for AGI greater than $13,090. Thus, B = $4,008 - (0.2106 x ($18,000 - $13,090)) = $2,973.95 10. Congress is currently debating the pros and cons of the various methods of increasing the earnings of the poor: increasing the minimum wage, expanding the earned income tax credit, and granting wage subsidies. You are called before the House to testify. Briefly outline your views on these various programs. Increasing the earnings of the poor is often used as a justification for increasing the minimum wage; however, it is doubtful that this policy does much to help the poor. Empirical studies show that increases in the minimum wage result in increased unemployment in low-wage industries and among teenagers. Since the working poor are likely to be concentrated in low-wage industries, raising the minimum wage will lower the employment prospects of the working poor. Increasing the minimum wage is also target inefficient. Of the 3.9 million workers who earned the previous minimum wage of $3.35 per hour, less than 10 percent were household heads of poor families. Thus, much of the benefits associated with increasing the minimum wage will go to the non-poor. Under a program of wage subsidies, low-wage workers would receive a subsidy equal to some percentage of the difference between a designated maximum wage and the worker's wage. By restricting the subsidy to one principal earner per family, this program could be more effectively targeted to the poor than a minimum wage policy. There is no guarantee that the program of subsidies will not affect employment. On the one hand, the wage subsidy does not force employers to pay workers more than they are worth as employees, and therefore should not cause employment to fall. On the other hand, because government is picking up part of the tab for labor, employers may have an incentive to reduce the wage they are willing to pay for low skilled labor. This amounts to understating their demand price for low skilled labor, which would cause a drop in employment. Finally, there is no guarantee that the subsidy would increase work effort. The higher wage does increase the opportunity cost of leisure, inducing more work; however, the higher wage also enables individuals to maintain a given standard of living by working less. The earned-income tax credit provides a credit against the income liability of the poor. The budget law passed in 1990 expanded the credit and adjusted it for family size. The three components of the earned-income tax credit are: the basic earned income credit, a supplemental young child credit, and a supplemental health insurance credit. The credit is phased in at a rate of 29.4 percent on earned income up to $7,520 and phased out at a rate of 20.995 percent on income in excess of $11,840. The maximum credit, the phase-in rate, and the phase-out rate were all increased in 1990 legislation. The increase in the credit will enhance the poverty-reducing potential of the earned-income tax credit. The increase in the phase-in rate should slightly increase the incentive of the poor to work; however, the increase in the phase-out rate may have the opposite effect on work effort. Thus, the impact of the earned-income tax credit on work effort is ambiguous. Surveys indicate that many women in poor households would seek work if they could obtain adequate childcare. Currently, the Child and Dependent Care Tax Credit provides a credit against tax liability equal to thirty percent of employment-related child care expenses for taxpayers with adjusted gross income up to $10,000. The credit is reduced for higher-income taxpayers. Because eligible expenses are limited to $2,400 per child for the first two children, the maximum credit a household can receive is $1,440. The only way the credit can be claimed is if both parents (in a two parent household) are working. As it now stands, the poor benefit very little from this credit. One reason for this is the fact that the credit is not refundable for couples with no taxable income after exemptions and deductions. Another reason is that there are many poor two-parent families in which only one parent works. Paradoxically, the high costs of childcare may prevent one parent from working. Making the credit refundable would help the poor relative to the non-poor. Expanding the percentage of childcare expenses covered by the credit would also help the poor; however this would be target inefficient. As an alternative, Congress might consider providing grants to states for child care services to the poor. Employment and training assistance could also help increase the earnings of the poor. While the government provides numerous programs aimed at increasing employability of individuals, restrictions on the uses of these funds ensure that few dollars are spent on providing services to the working poor. Removing restrictions that bias the use of funds against the working poor and expanding the reformed programs may go far towards increasing the skills, and hence earnings, of the working poor. It should be noted that in addition to pursuing these training programs, the government should ensure economic stability. It will do the working poor little good to acquire skills if the state of the economy means there will be no demand for their labor. 11. The prospect of paying childcare expenses and the fear of losing Medicaid are both barriers to leaving TANF for work. Which of these two is really the bigger barrier? Explain. Female-headed families have the highest poverty rate. Over 20 percent of the mothers who leave the TANF rolls for work return to TANF within 2 years. Although they encounter a variety of obstacles while working, two of the more prominent are the costs of childcare and loss of Medicaid benefits. Both the federal government and state governments have programs that provide some form of childcare assistance. The most prominent of these are the Child and Dependent Care Tax Credit, the Child Care and Development Fund, the Dependent Care Assistance Program, and the Child Tax Credit. Both the federal government and about half of the state governments have a Child and Dependent Care Tax Credit (CDCTC) that provides a credit against income tax liability for childcare expenses for working taxpayers. Eligible expenses for the federal credit are limited to $2,400 per child under age 13 for the first two children. The credit is equal to 30 percent of eligible expenses. The maximum credit is $1,440. The credit can be claimed by working heads of oneparent families or by families in which both parents are working. The law that established TANF broke the direct link between eligibility for cash assistance and Medicaid. Families who leave TANF for work are still eligible, however, to receive 12 months of Transitional Medicaid Assistance (TMA). And once transitional Medicaid benefits are exhausted, Medicaid now provides coverage to all children younger than six living in families with incomes below 133 percent of the federal poverty level. If the parent in a family of three worked 35 hours a week and earned $9 per hour, the family's earnings would still fall below 133 percent of the poverty threshold, and any children ages 6 and younger would still be covered by Medicaid. Given this coverage, it is unlikely that Medicaid regulations should deter a parent from moving from no work to at least a parttime job. The bigger problem is that the parent would need to find health insurance for herself before the end of the first year of employment when TMA runs out. It is hard to determine which of the two is the bigger barrier since the poverty rate of the female-headed families is very high and it appears that childcare expenses would be a serious barrier if the heads of the families are relatively young and healthy. 12. What factors would you consider in designing a child support assurance program? Explain why. Some believe that government should go beyond simply collecting money from absent fathers; that child support assistance should become child support assurance. In a child support assurance (CSA) system, a family would be guaranteed a certain amount of child support regularly and on time each month. To fund the guaranteed payment, the state would collect the child support owed by the noncustodial parent. If it were unable to collect, the state would still provide child support to the family at the guaranteed level and continue to pursue collection. If a lowincome noncustodial parent paid support but the amount were less than the guaranteed level, then the state would supplement that parent's payment up to the guaranteed level. New York has run a CSAlike program for more than a decade. The New York Child Assistance Program (CAP) began as a demonstration project to test CSA as an alternative to welfare. The project was judged to be so successful that any county that wishes to do so can now offer CAP as an alternative to TANF.