Bryan Caplan  

Means-Testing is Awesome

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Name that Blip Redux... Market Failure in Education...
I'm against forced redistribution, even to help the deserving poor.  Still, unless you buy the whole libertarian package, I understand taxing the rich to help the poor.  What I can't understand is taxing everyone to help everyone.  Means-tested programs like TANF and Medicaid aren't crazy; they take from Peter to pay Paul.  Universal programs Social Security and Medicare are crazy; they take from Peter to pay Peter

Even if you're not into economics, universal programs should strike you as pointless.  But they're actually worse: When you tax Peter to pay Peter, you distort Peter's incentives along the way.  Of course, even means-tested programs require taxation.  But they require much lower taxation than universal programs.

The main economic argument against means-testing is that means-based benefit reductions, like means-based tax increases, distort incentives.  So they do.  But which is worse?  Heavily distorting incentives for the least productive segment of the population, or heavily distorting them for everyone?  In any case, once you accept means-testing, there are simple ways to reduce the distortion.  Most notably:

1. Phase benefits out gradually rather than discretely.  Don't give full benefits to everyone in the bottom 10% of the population, and zero benefits to everyone else.

2. Clearly distinguish between the deserving and undeserving poor.  Helping orphans and the severely handicapped is a lot less distortionary than helping able-bodied adults.  And of course "changing behavior in order to collect extra benefits" is part and parcel of being undeserving.

Just think about how small government would be if only the bottom decile got full Social Security and Medicare benefits, and these benefits were phrased out over the second decile.  Right now, these programs are about 35% of the budget and growing fast.  With this means-testing formula, they would shrink down to roughly 5% (or even less, since the richer live longer).

Admittedly, if we got to this point, I still wouldn't be satisfied.  The day we started means-testing all redistribution, I'd furrow my brow and ask, "So charity should be compulsory, but immigration restrictions are OK?"  But I'll take what I can get.


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COMMENTS (29 to date)
HispanicPundit writes:

Completely agree. Great post!

You really need to post more on fundamental stuff like this Bryan. The internet is full of moderates...the extreme statists are also represented. What we need more of, and explained in fundamental ways like this, is the extreme capitalist.

We lost Milton Friedman - and need others to help replace the void.

Mounir writes:

Isn't adverse selection an economic argument for universal programs?

lukas writes:

The downside of means testing is that it creates an immense intrusive bureaucracy tasked with enforcing it and doing the actual testing. Every little detail of a welfare recipient's life has to become the state's business in order to contain fraud.

For example, the German welfare state (which, unsurprisingly, is obsessive-compulsive about means testing) essentially ends up micromanaging transfer recipient's lives in order to dole out just enough for them to live in what we call "human dignity" (and not one cent beyond that, social justice oblige). Every expense that goes beyond an average person's average monthly basic needs has to be justified to a bureaucrat from social services, and if you are denied, you can call in the expert witnesses and sue. Fun times.

Believe me, having seen that a negative income tax doesn't look so bad any more.

hanmeng writes:

It's a good idea, but in practice, how do you "distinguish between the deserving and undeserving poor"? I'm an orphan (my parents died when I was in my fifties) and handicapped (I'm nearsighted, presbyopic, and astigmatic). Even aside from those who will try to game the system, people have varying ideas of what's "deserving", for themselves and others.

Indeed, the middle class seems to need a spoonful of sugar to swallow social programs aimed at the "deserving". So while Obamacare may have been intended to help the poor uninsured, the sugar was simultaneously selling it as cost-cutting for the middle class.

And finally, how much do "the deserving poor" need "to live in what we call 'human dignity'"? The bar keeps on rising. For example, I've lived without air conditioning, but apparently that's a basic requirement in hot weather now.

Lukas, I think Bryan meant the phrase "means testing" in the broad sense, which includes mechanisms such as the negative income tax.

ehager writes:

In the 1999 study "Social Security and Poverty Among the Elderly--A National and State Perspective" (http://www.cbpp.org/archiveSite/4-8-99socsec.pdf) the authors find that Social Security reduces the poverty rate among the U.S. population over 65 from 47.6% to 11.9%. They do not account for the changing incentives Social Security may cause stating "Measuring the extent of poverty without the benefits of government programs is not the same as saying that if these programs did not exist, this number of people would be poor." (page 19 of 56)

In their 2004 paper, "Social Security and the Evolution of Elderly Poverty" (http://urbanpolicy.berkeley.edu/pdf/Ch6SocialEG0404.pdf), Gary Engelhardt and Jonathan Gruber do take into account changing incentives Social Security may cause and still find "a major causal role of Social Security in driving these time series patterns. Increases in Social Security generosity over time are strongly negatively associated with changes in poverty." (page 4)

Particularly striking in the Engelhardt/Gruber paper is the graph on page 32 showing the elderly poverty rate decreasing from nearly 30%(!) in 1967 to just over 10% in 2000 and how this mirrors Social Security expenditures over the same period.

The large proportion of elderly who would otherwise be in poverty may help explain why the majority of people favor Social Security (interesting poll here http://www.pollingreport.com/social.htm which shows that 80% of people believe it is "the government's responsibility to provide a decent standard of living for the elderly").

Pat writes:

You would have really high marginal rates if you phased out Medicare and Social security between the 10th and 20th percentile - so high that people would probably rather be at the 10th percentile than the 20th.

Giving it to everyone doesn't distort as heavily as phasing out out that fast.

Lode Cossaer writes:

Universal programs are bad economically, but are great politicly, for obvious reasons. You can gain support - especially when you pay by increasing the debt and taxing the rich - for it when you can also promise the middleclass that there is something in it for them.

Ryan Vann writes:

This is definitely one of the better posts I've seen from you in awhile Prof Caplan. I think your rhetorical mode of questioning is quite poignant

matt H writes:

Sorry Caplan people are idiots, its forced savings or no savings. There are better ways to do it, but there is no way around it. This kind of opinion tends to be held by those surrounded by other smart people. I grew up in a housing a project, let me tell you people like my parents can't be given too much choice or freedom with how they deal with their finances. If you think they saved no money in their lives because of incentives from social programs, you really need to spend a few hours with them, they just score low on contentiousness. Since people are bad at planning, means testing something like social security or medicare will not save us that much money.

fmb writes:

Isn't taxing peter to pay peter less distortionary than an ordinary tax?

Basically, you should not look at your S.S. tax as pure loss, but as partially going towards increasing your eventual S.S. benefit. While there are many imperfections (e.g. risk of govt not delivering on its promised benefits, many scenarios where add'l taxes have no effect on benefits, etc), the point stands that in a number of cases there is a partial correspondence that should reduce distortion. Don't assert "since the govt can take it away it's worth 0" -- you wouldn't sell your expected benefits for $1.

In the extreme case, imagine that all of your SS taxes went into a personal retirement account. Then it would only be distortionary to the extent that this forces you to save more than you otherwise would. If you could withdraw without penalty, it basically wouldn't be distortionary at all. Our current program is like this to some degree.

The key, of course, is that your benefits depend on some formula linked to your payments, so paying more often increases your benefit.

In practice, I suspect low earners in fact accrue benefits worth more than their tax. In their case, the tax may actually be an incentive to work. Clearly not distortionary in the ordinary sense.

Floccina writes:

I understand taxing the rich to help the poor. What I can't understand is taxing everyone to help everyone. Means-tested programs like TANF and Medicaid aren't crazy; they take from Peter to pay Paul. Universal programs Social Security and Medicare are crazy; they take from Peter to pay Peter.

Well said! can I quote you on that?

I have been telling people for a while that "you cannot subsidize the middle class" and "if everyone is subsidized no one is subsidized".

I would extend your comments to Government education. The rich and middle class should pay one a sliding scale to send their children to Government schools.

Also consider my suggestion for healthcare that subsidizes the poor encourages the competent to shop for price and value, and avoid huge marginal tax rates near the point where medicaid eligibility ends.


Below is and excerpt from my blog post on a healthcare compromise.

The state would provide insurance to all Americans but the annual deductible would be equal to the family’s trailing year adjusted income minus the poverty line income (say $25,000 for a family of 4) + $300. So a family of 4 with a trailing year adjusted income of $30,000 would have a deductible of $5,300. A family of 4 with a trailing year adjusted income of $80,000 would have a deductible of $55,300. Middle class and rich people could fill the gap with private supplemental insurance but this should be full taxed. This would encourage the middle class and rich, who are generally capable people, to demand prices from medical providers and might force down costs. They could opt to pay for most health-care out of pocket while the poor often less capable would be protected.

Devin Finbarr writes:

The government is going to tax to the Laffer curve maximum and spend it all anyways. Therefore, might as well get as much as the money come back to the tax payer anyway. It may be crazy, but it's how politics works. The money will be spent, might as well lock up the spending on your preferred policy.

For instance, look at Medicare/Medicaid. The two programs only cover 1/4 of the population. Yet the programs spend more than most universal healthcare programs. If they had been designed as universal healthcare from the start, they probably would have grown to the same budget, but at least everyone would have gotten healthcare.

floccina writes:

Here is my plan for SS:


Everyone gets the same payout.

http://un-thought.blogspot.com/2009/10/welfarize-and-minimize-social-security.html

1. End the charade of the separate SS tax and fund the program from general revenue. It is not now nor ever was a retirement plan, it has always been a pay as you welfare program.

2. Make the pay out (the check recipient receive each month) the same for every one, currently the more money you made in your work years the more SS you receive.

3. End the charade of the “trust fund” a “trust fund” never existed and cannot really exist (apart from the US government buying foreign bonds which would be politically unpalatable and somewhat risky) because when you are the source of all money as the federal government is it impossible to save up money for later use. Again the program has always been pay as you go where the money the young people pay goes to current recipients.

4. Increase the age one needs to reach to start collecting SS. When FDR started the program the average life expectancy was 62 years and to start collecting SS you had to be 63 years old. People today are much healthier at 63 than people were in the 1930s and most jobs are less taxing .

Yancey Ward writes:

No one joins a Ponzi Scheme if you tell him up front that he might not qualify to get his money out.

aretae writes:

I agree with many of the commenters here in a response post. The idea is great; the reality is that politics and public choice say you can't actually get much good support on a program that only helps the poor.

Maximum Liberty writes:

matt H:

It isn't quite forced savings, because enough people know that the link between the amount taken from them and the amount they ultimately get is tenuous at best. I think that, since it is too complex for most folks to figure out, most working folks figure they are getting screwed somewhere. I certainly think that.

So, if it were truly a forced savings program, it would be transparent to the payers. I would get an account statement showing how much is in my account, instead of this impenetrable estimate of how much I will get per month if the law does not change between now and then.

Such a program would be possible. Congress could say "everyone younger than 15 on the date of this bill will have their social security taxes directed to an account at a financial institution, from which they cannot make withdrawals until they reach age 65 (or whatever) and which can't be taken away in bankrptcy." Presumably they would also limit those individuals' participation in social security benefits (maybe by making it means-tested).

fmb:

I can't see how the social security tax that I pay today is less distortionary than an income tax without all the crazy deductions, credits, and penalties would be. I still pay some amount of my earnings today in exchange for glorious government benefits at some point. If the claim is that I am buying social security benefits, so that should be less distortionary, I don't see how it is less so than income taxes buying me student loan availability, insurance against pverty (through welfare), and protection from terrorists. It's not like there is a discernable link between what I pay and what I get. I'm sure that there is some kind of very rough linkage in the calculation, but I doubt it is anything approaching "if you pay in $1 of taxes, you get out $X in benefits."

Max

ab writes:

Social Security would take a long time to phase out, but until then, it would be nice to have more control over my allotted social security funds. I can think of at least one guy who pushed for a private option in Social Security (it was one of the few things he had right), and wonder if the same idea could be applied to medicare. That way those who want to continue robbing Peter to pay Peter can do so, and those who accurately see that system as pointless can at the very least control their portion of the pie. It wouldn't be perfect, but would be a step in the right direction.

Redbud writes:

Regarding the proposal in earlier comments that everyone get the same benefit, how does one account for varying costs of living?

Also, it is my understanding that one must work 10 years (or 40 quarters) to earn SS benefits. So only those who worked, or married someone who worked, are covered.

It would be nice to have smaller government, but means testing is essentially punishing the ant and rewarding the grasshopper, right?

Bill writes:

One of the pros of having social security and medicare, in my mind, is fixing a floor to income for seniors to the power of the government to tax and spend.

Especially now, where I would argue 401Ks create inflated demand for the purchase of securities, but not because the securities themselves justify the entire purchase price, but rather because people want stocks and bonds for their 401Ks.

Even when and if all that goes south (I have an IRA purchased in September of 1999 that returned -1% as of January 1, 2010), you can at least figure on getting enough money from social security to buy some food and other necessities. Lose all your money with Madoff? At least you won't starve. Invested your money in California municipal bonds and AIG stock? At least you won't starve. It's an expensive program granted, but I don't know if it is much worse than a -1% return over ten years.

Dan Weber writes:

As others have said, the problem with means testing is that it's a marginal income tax.

What I would like to see is Medicare locked into its current budget [1], but open to anyone who wants in. If you are poor and want Medicare, you have it. If you are rich and want Medicare, you have it.

The expectation is that most rich people and many middle-class people will take themselves out of it (and we will give them a small tax credit for their trouble), but that is a "tax" that you choose when to pay.

[1] Modulo inflation and size of the US population. Medicare should also be freed from politicians similar to the way the Fed is. The people in charge decide what is covered and not covered. If you as a participant don't like this, remember it was free, and buy your way out.

fmb writes:

Max says (in response to me):

I can't see how the social security tax that I pay today is less distortionary than an income tax without all the crazy deductions, credits, and penalties would be. I still pay some amount of my earnings today in exchange for glorious government benefits at some point. If the claim is that I am buying social security benefits, so that should be less distortionary, I don't see how it is less so than income taxes buying me student loan availability, insurance against pverty (through welfare), and protection from terrorists. It's not like there is a discernable link between what I pay and what I get. I'm sure that there is some kind of very rough linkage in the calculation, but I doubt it is anything approaching "if you pay in $1 of taxes, you get out $X in benefits."

Most govt programs are not linked to tax payments at all -- you get them either way. So those payments are fully distortionary.

In contrast, there is in fact a "discernable link" between what you pay and what you get. It is a "rough linkage", and there are a lot of scenarios where the linkage is zero (and so fully distortionary), but it is much more of a linkage than most govt programs. So, it is (or should be) less distortionary than it otherwise might be.

If you're single and work for only 10 years at a moderate wage, the correspondence between your taxes and your benefit are pretty high, so there are cases where the distortion is potentially very low. Public school teachers, who aren't part of the social security system (they have some other system), often get other jobs as they approach requirement in order to pay enough ss tax that they can collect two govt retirement benefits. If anything, they're responding to the "tax" as a subsidy.

I'm not saying it's a good idea, just that a universal program such as ours is less distortionary per dollar raised on average than a means-tested program or a fixed-benefit program. Of course, making the link more transparent and less susceptible to congress changing it later would make this more true.

I don't have a strong opinion on the degree, but I think it's material and generally ignored.

Ano writes:

I'm against forced redistribution, even to help the deserving poor.

How do you feel about forced contributions to other parts of government, such as collective defense?

lukas writes:

Jacob Wintersmith, if a NIT (basically flat income tax + refundable tax credit) is to be considered "means tested", why not Medicare (which also provides fixed benefits financed by a flat income tax)?

Nick writes:

Aren't the people that die before drawing out the ones subsidizing the others?

Also a NIT seems like it would be rife with fraud. I've heard something like 30% of EITC payouts are fraudulent, that is probably a conservative estimate. Much of the new homebuyer credits were fraudulent as well.

Jim Glass writes:

Universal programs Social Security and Medicare are crazy; they take from Peter to pay Peter.

Glenn Hubbard made exactly this point to Krugman in a discussion in Harpers (of all places) a few years ago.

I.e.: These social spending programs have a funding gap. It's certainly progressive to cut the benefits of the better off to close that gap. Instead you want to raise taxes on these people to pay the very same money back to them -- increasing the "govt share" of the economy, the deadweight cost of taxes and all. Why??

Krugman: "I believe in the social-insurance paradigm".

But it's a lot easier to believe in that model when it is cheap -- before the final bill arrives.

For instance, today the idea of "defaulting" on the Social Security trust fund bonds (even though such a thing is totally impossible, even if they are never paid off) is an unimaginable, shocking idea to the left. But today, when the TF's operation is actually giving the govt money, instead of costing it money -- this is a very cheap belief to hold.

Come the 2020s TF operations are going to require a near 15% across-the-board income tax hike on everyone from today's level. Including, of course, on seniors -- and on all their retirement income from pensions, investments, and yes, Social Security!

Then, I guarantee you, a whole lot of people are going to be saying, "by means-testing the rich out of some of their benefits, we won't have to use those bonds ever." Avoiding that tax will look pretty nice to them (especially considering the bill arriving at the same time for Medicare).

In fact, if you tally up by self-interest, "Who will want to renege on the SS trust fund bonds?", it's hard to find anyone who won't want to -- starting with the senior lobby!

Krugman's going to be sorely disappointed. Wait long enough and you'll be seeing means-testing arriving in a big way.


Jim Glass writes:

reality is that politics and public choice say you can't actually get much good support on a program that only helps the poor.

This is why the Earned Income Credit was stillborn and has been diminishing ever since.

Jim Glass writes:

people are idiots, its forced savings or no savings.

The thing is, there are no forced savings in SS or Medicare. The taxes collected for them are all immediately consumed.

If they were saved to fund future benefits for those who paid them, these programs wouldn't be on course to drive a 50% across the board income tax increase by 2030, as per CBO , to cover them.

About 15% of that 50% tax increase is to service the SS trust fund, which buries the myth of it holding "savings" available to finance SS. As to Medicare, they don't even pretend.

the problem with means testing is that it's a marginal income tax.

And the problem with no means testing is that it results in higher marginal income taxes (see the "50% increase" above).

Isn't taxing peter to pay peter less distortionary than an ordinary tax? ... In the extreme case, imagine that all of your SS taxes went into a personal retirement account.

In that case Peter wouldn't face a big income tax hike in the nearing future to be able to withdraw his funds from his own personal account.

And how are income tax increases that drop on Peter to finance Medicare not supposed to be distortionary just because they pay for Peter's Medicare?

If that 50% tax increase when it arrives drives Peter to quit working for taxable wages, and to put his investments in offshore tax shelters, that's not distorting?

Steve Roth writes:

Bryan, you ignore what I think is the strongest argument for (progressive) taxation and redistribution: it's necessary for a highly-productive technological economy to thrive.

Technology and corporate capitalism are spectacularly efficient pumps driving the flow of the economy.

But they inevitably pump the wealth up. Eventually the bottom reservoir runs dry, and the pump sucks air. And the upper reservoir overweights, collapsing the whole structure.

The only solution I see is sluices (redistribution) from the upper reservoir to the lower. This can be in the form of education, health care, infrastructure, and transfers.

Evidence for this necessity: there is no thriving, prosperous, modern economy that does not include massive doses of redistribution.

On the nature of those transfers vis-a-vis means testing, two thoughts:

1. Lane Kenworthy's recommendation for a major increase in the Earned Income Tax Credit. (Yes, he deals with the gradual phaseout means-testing issue.)

2. I've been tending more and more toward thinking like Steve Randy Waldman's:

http://www.interfluidity.com/posts/1232166069.shtml

"Transfer flat": Fixed payments to every adult citizen. We could call it the Alaska model.

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