David R. Henderson  

Problems with Means Testing

From Poverty to Prosperity<... A Puzzle from the Blizzard...

Bryan posted earlier this week on why means testing is "awesome." While I do think that future budget deficits will push us towards some version of means testing, I can't agree that it's awesome. It just may be less bad than what he accurately characterizes as "taking from Peter to pay Peter."

Specifically, I see three problems with means testing. None of these problems necessarily means that means testing is worse than what we have now, but they are big negatives.

1. The phase-out issue.
Bryan recognizes that you wouldn't want to give benefits below income threshold x and then zero benefits to people above that threshold. It's important to say why. The reason is that when you earn the first dollar that puts you at $x+1, your implicit marginal tax rate on that $ could be hundreds of thousands of percent. I made that point earlier in discussing a proposal by Megan McArdle. So what's the alternative? Phase out the benefit over some income range, recognizing, as one of the commenters on Bryan's post pointed out, that the implicit marginal tax rate over that income range could be quite high. Take Bryan's proposal of giving a benefit to the bottom decile and then phasing it out over the next decile. Let's say the benefit is a $5,000 government check. Just eye-balling the data, I estimate that the bottom decile (about 8 million families) in 2008 had income between $0 and $17,500 and the second from the bottom decile had income from $17,500 to about $28,500. So that's $11,000 of income over which to phase out a $5,000 benefit. The implicit marginal tax rate from that phase-out alone is, therefore, $5,000/$11,000 or 45%. That's on top of other tax rates.

2. What are means?
Without exception, every time I've seen someone advocate means testing, he uses income as his measure of means. This completely ignores wealth. Although income and wealth are highly positively correlated, the correlation is not close to 1.0. Therefore means testing would discriminate in favor of wealthy people with low income. Because the most expensive programs for which means testing is advocated tend to be for the elderly, this is an even bigger problem. Among the retired population, the correlation between income and wealth is even weaker, I believe, than among the population in general.

3. The fairness issue.
Again, because the programs at issue tend to be for the elderly, there can be huge differences in income because one family saved a large percent over the years, and is earning interest and dividends on that income, and the other family saved 0 and relies on Social Security. This could be so even though the two families had a similar age-earnings profile. It's unfair. I know that the program per se is unfair, with or without means testing, but this one seems particularly unfair.

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CATEGORIES: Cost-benefit Analysis

COMMENTS (14 to date)
John T. Kennedy writes:

The relevant idoiom is "Robbing Peter to pay Paul" and it is an accurate description of Caplan's preference in this case. But then Paul has strong incentive to maximize such robberty. Politicians who can profit by serving Paul have similar incentives.

Robbing Peter to pay Peter is still robbery, but somewhat less dangerous since Peter has distinctly less incentive to maximize the robbery.

OneEyedMan writes:

A big part of this problem is the chunkiness of benefits like health care and food stamps. If we replaced the entire welfare state with cash transfers they the phaseouts would be relatively easy, all you have to do is combine the phase out rate with the marginal tax structure to keep incentives in line. For example, if the cash transfer is 10k per person per year and the flat tax rate is 20% (on all income), then everyone always has the same marginal tax on income but the subsidy is completely gone on everyone making more than 50k.

Mike Mathea writes:

OneEyedman sounds just like Bill Clinton when he was working for the McGovern campaign. His proposal sounds like a synopsis of the original McGovern proposal. Problem remains the political class hates this approach leads to smaller government. Won't happen.

OneEyedMan writes:

No doubt this is unlikely. Nevertheless, a guy can dream.

I just wanted to make a point about how it is the form of our benefits that makes this a problem, not the nature of government benefits in general.

floccina writes:

Mike and OneEyedMan
I think that part of the problem is that voters do not trust poor people with cash.

Daniel Lurker writes:

It is true that wealth and income are imperfectly correlated. But don't phaseouts count all income, not just wage income? Granted, the well off might have capital losses in some years. But those who don't have any other income would probably have sufficient income to disqualify them from means tested benefits.

David R. Henderson writes:

@Daniel Lurker. Good point, Daniel, but think on the margin. Think about the Pebble Beach retiree who owns her $2 million home free and clear. She could well be low-income.

Sharpshooter writes:

...from each according to his MEANS.

Bad idea. REALLY BAD.

Bill Conerly writes:

Some welfare programs in the past had wealth as a means test. A family on welfare that lived frugally and accumulated an emergency reserve savings account risked disqualification, whereas the family that spent every penny that came in were sure to continue.

Chris Koresko writes:

I think this debate illustrates two basic problems with government-based charity:

* It relies on broadly-applied formulas rather than individual judgement to determine eligibility and appropriate service.

* There's a disproportionate amount of funding available for the available pool of compassion, leading to a tendency to try to help people by blindly throwing money at them.

The White Detroiter writes:

Bill Conerly,

There still are some programs that include wealth as a means test. Supplemental Security Income (SSI) doesn't allow you to have more than $2,000 in savings and still receive benefits.

A few years ago I knew someone who was on SSI but had a part time low wage job. She lived in a very low rent trailer park and used the public bus system to get around (she was legally blind so she had no use for a car). Between the SSI and her part time income she was capable of building significant savings but if she did she would lose her SSI. So she spent everything she had on things like marijuana and never really got ahead in life.

The White Detroiter writes:

One form of means testing that has long bothered me is what you might call "negative means testing". Social Security retirement benefits are structured so that the higher your average earnings are during pre-retirement age are, the higher your benefits are. So someone who averaged a comfortable inflation adjusted income of $100,000 gets much more in retirement than someone who earned a modest $30,000 a year. Why not just pay all 65+ people the same flat amount every month? That is what Canada does through its Old Age Insurance Program.

The current US system causes total spending to be higher than if benefits were more flat. It also deludes many people to believe that when the government collects FICA taxes they put each person's "contribution" into a separate account for each person such as "John Smith's account". This is not how SS really works but because it vaguely appears that way to many people it makes many of them afraid of any changes to the system. Flattening benefits would expose SS for what it is and make controlling costs more politically feasible.

Sam Doctor writes:

One additional consideration regarding the unfairness of means testing for retirees: Some retirees in the middle to higher deciles (for their age group) have large pensions from their former employers. Usually, an equivalent withdrawal rate to match a pension is likely to rely partially on non-tax-deferred savings - more for older or current retirees, perhaps less so for younger workers.

Anyway, the accumulated wealth of someone with a good defined benefit may be much lower than one with defined contributions and/or personal savings, yet their "income" could be much higher - After all, any withdrawal from regular savings is not income.

Education Tay writes:

The concept and practices of means test in is not a matter of fairness, affordability and a few other ideas, as means testing is a complex issue. Not providing means testing finance to people that need the money for food, shelter and heating would cause many social problems. Means testing is social, ethical and a good thing for a community to gain access to required income based on what they have.

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