Structural Spending Reform, Part 6

In this the last installment of our series on structural spending reform, we will take a look at how a reform of the poverty concept would affect income-security spending. This analysis is theoretical in the sense that it focuses on the fiscal mechanics of these programs; it does not take into account the specific reforms needed to adjust the operations of each program.

However, the conclusion from this analysis is entirely applicable in policy reform: what matters in reforming entitlements is to change their purpose.

Here is what we said about this change-of-purpose reform back in Part 3 of this series:

Before the War on Poverty, the federal government used an absolute definition of poverty. It constituted the foundation for the welfare-program reforms under the Social Security Act of 1934. Figure 1a sketches the idea behind a return to this reform. The present trajectory in government spending (1) will continue unchanged (2) if no reform is made. If the definition of poverty is changed from relative to absolute (A) the trajectory of entitlement spending will change radically (3):

Figure 1a

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In Part 4 we saw what kind of policy thought needs to go into health-care reform in order to create the “kink” at (A) above. In Part 5 we learned how this can be done in Social Security. Here, we apply the same principle to programs that provide income security for the poor.

The idea behind the reform is to change the definition of poverty, from the relative definition we have today where the poverty limit is supposed to track median income, to a definition that defines a basket of benefits that remains unchanged over time. In practice, this means changing the method by which the poverty limit is calculated from year to year; technically, the poverty limit is no longer calculated with reference to overall income growth, but solely with reference to consumer prices.

This may seem to be a largely inconsequential difference, but it is not. When we upgrade the threshold for poverty with median income growth, we also take into account the qualitative rise in the standard of living that comes with a growing economy in general. When we use this relative definition of poverty, the purpose of income-security spending is no longer to provide for the poor. It is to redistribute the rising standard of living from households with higher incomes to those with lower incomes.

In order to remove the redistributive component, we – again – concentrate the calculation of the poverty limit strictly to inflation in consumer goods prices. This means that we keep constant the ability of the poor to buy a basic set of goods and services while on poverty relief. When the standard of living rises among the population in general, the poverty limit remains unchanged, thus keeping poverty relief programs confined to what they were originally meant to be: a dignified last-resort safety net for those who fall on hard times for no fault of their own.

Figure 2 applies this calculation method in a simulation over the period from 2002 to 2017. The poverty limit still rises each year, but at a lower trajectory:

Figure 2

Sources of raw data:
Census Bureau (Poverty threshold); Bureau of Economic Analysis (Inflation)

The impact of this new poverty-limit calculation method would be significant. First, it would show up in the growth of benefits per poor person:

Figure 3

Sources of raw data:
Census Bureau (Poverty threshold); Bureau of Economic Analysis (Inflation)

It is important to note that the change in benefits growth simulated in Figure 3 does not translate literally into a change in benefits for every poor person. Some of the difference would materialize when some programs deny benefits for those who earn more than the poverty limit.

With that said, since the poverty limit itself is changed, so will the number of poor. It is a bit dicey to estimate by how much, but Figure 4 presents a possible scenario. The technical difficulty lies in knowing where the poor are clustered: do most of them have an income just a hair below the poverty limit, or do they cluster far below the limit? Since we cannot say this for certain without highly sophisticated income data, the rational approach is to assume that they are evenly spread across the income spectrum below the poverty limit.

Given this assumption, an application of the new poverty limit reduces the number of poor as follows:

Figure 4

Sources of raw data:
Census Bureau (Poverty threshold); Bureau of Economic Analysis (Inflation)

And now for the grand finale. Let us multiply the new, lower benefits levels with the new poverty population. Figure 5 reports the results as the dashed line that slowly bends downwards; for comparison, the lower benefits levels are also multiplied by the actual number of poor (the dotted line). Compare these two functions to the solid line, which represents the actual cost trajectory, and then compare Figure 5 to Figure 1a above:

Figure 5

Sources of raw data:
Census Bureau (Poverty threshold); Bureau of Economic Analysis (Inflation)

Structural spending reform is not easy, but if it were easy it would have been done already. It takes courage, persistence and commitment to do reforms like these. Whoever steps up to the plate and does it, will save this country from fiscal ruin.

Whoever doesn’t, will keep rearranging the deck chairs on M/S Debt Crisis as she steams toward the iceberg.

There are a few more loose ends to tie up. The Addendum will follow in just a day or two.

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  1. Pingback: Structural Spending Reform, Part 5 | The Liberty Bullhorn