Means Testing
First warnings — as usual I am writing on a topic discussed by many experts and I am not an expert. It is very often debated whether social welfare programs should be means tested (available only to people with low income or to people with low income and low wealth). An alternative is universal programs which are provided also to high income people (Medicare, Social Security old age and survivor pensions, K-12 public school, police protection, fire department putting out fires — most programs)
In particular, the topic of the week is Biden’s student debt forgiveness plan, which forgives $10,000 of student debt only if income is less than $125,000 per year. I do not want to focus on this particular program (because it has been discussed a lot and many many people know more about it than I do).
I want to start with a theoretical discussion of the general issue in public economics (a large literature with many researchers vastly more expert than me). I start here, mostly because the viewpoint is strange and not familiar to most normal people (the discussion will be of little practical use, because the viewpoint is strange, not familiar to most normal people, and not connected to actual policy making in the actual real world).
This means I will pretend I am advising a social planner, philosopher king, benevolent dictator. That is I will discuss policy ignoring politics (at first). In this fantasy world, there is a case against means testing. The argument is simple — if you are worried about income distribution, handle it with an income tax, if you are worried about wealth distribution handle it with a wealth tax. If you have optimal income and wealth taxation, you shouldn’t care about the marginal effect of programs on the distribution of income and wealth.
This is standard economics 101. It very much appeals to the policy with no political limits (if you have optimal — then you are not on this planet). The logic is largely based on models in which market outcomes are Pareto efficient, so the only thing wrong with them is that the distribution of income and wealth is not optimal. There are two real world based arguments for universal benefits. First assessing income for the income tax and then again for program eligibility implies duplicating income assessment and un-necessary administrative costs. Second, and more important, the costs are partly born by people eligible for the program and many eligible people do not, in fact, participate. This means that programs for needy people do not reach those who are unable to handle applications or are too busy surviving to spend the time. So any complication prevents a program from helping some of the people who need it most.
There are two very bad arguments against universal benefits and progressive taxation. They are very bad arguments against progressive taxation. The first is that marginal tax rates other than zero distort incentives. This is a reason that optimal taxation and redistribution definitely does not imply perfect post tax equality — optimally managing the tradeoff between equality and undistorted incentives is the original meaning of “second best.” Straw man might argue that means testing benefits is a way to achieve more equality given the limit on taxation due to its effects on incentives. Straw man is made of straw (I won’t google but I might not be able to find anyone making this silly argument). The reason is that means tests also affect incentives. In theory it doesn’t matter whether we take from those with high income with a high income tax or by cutting off benefits. Also in practice. Straw man then argues that the problem isn’t simple incentives but tax evasion and tax avoidance. Again the argument is that increasing taxes and reducing benefits are the same (have the same effect on household budgets) so have the same effect on cheating or legally avoiding.
I think a benevolent planner would use highly progressive taxes to fund universal benefits.
Now politics. One very strong argument for universal benefits is “programs for poor people are poor programs”. Means tested programs are generally stingy. There is one huge exception — Medicaid. I think a key reason is that many Medicaid recipients are needy because they are sick and had previously been middle or working class. A related issue is that participation in means tested programs is stigmatized. The strange ratio of hatred of welfare to dollars spent on AFDC then and TANF now are key illustrations.
On the other hand, there is anger at benefits going to rich people totally out of proportion with the cost in dollars. This is one example of how stories beat numbers and accounting is alien to most people (I am trying to avoid typing the word “innumerate”).
On the other hand, there is also a strange focus on the Federal Budget and Federal Government employment. This means that there is a political difference between a cash benefit and a tax credit. To a certain extent, I think that Straw man (above) is actually influencing people. It is certainly true that Democrats put huge efforts into describing new welfare programs as tax cuts.
I think that, so far, consideration of politics vastly increases the strength of the case for universal benefits and against means testing. Here “politics” is public opinion and elite rhetorical strategies.
But then there is congressional politics. It is silly to consider optimal income redistribution and then optimal other programs. In practice the one thing we all agree on is that the progressivity of the income tax is all wrong (the problem is most of us think that it is not progressive enough but the minority who think it is too progressive are relatively rich and powerful). In the real world, the effect of policy on income distribution always matters a lot, because the progressivity of taxation is hard to change, because the law is hard to change.
I can predict my position on policy issues basically almost always by considering their effect on the income distribution. In theory that should be one issue separate from all the others, In practice it is one issue connected to all the others.
OK so just about student debt relief. There is no way a philosopher king would even consider Biden’s program. Nor would Biden if it weren’t for the detail that it is one of the few things he can do without Congress.
I can’t say I understood a word of that. But if you base your policy preferences entirely on “equality” or “progressive (tax)” or any other single parameter, you will always have bad results: the world (even economics) is complex, and simple solutions don’t work.
Social Security is not exactly provided to high income people. Social Security is an insurance program paid for by the worker-beneficiaries themselves. High earners pay the same percent of their income from wages as low earners…up to the point where what they pay would be an unreasonable cost of the insurance they get. Benefits are figured in a way that very low earners get a higher percent “return”, just like people who have a fire get a higher “return” on their investment than people who don’t have a fire.
I find that I am not terribly distressed that taxes on tobacco are “regressive”…that is, poor people pay a higher percent of their income on cigarette taxes than high income workers. As far as I know a rich man pays the same price, including tax, for a cigartte as a poor man.
A progressive tax on income is easy to justify in that a poor person needs much more (as a percent) of his income for real needs than a rich man, leaving him with less money to pay taxes….etc. you get the idea. or don’t. Social Security, Income, and cigarettes are different things and a one size fits all policy for taxation won’t work.
Since Mrs Fred and I became Soc Sec recipients (and the monthly checks are much of our income) I guess I am less of a believer in means testing for such benefits. Pure self-interest at work.
Could means testing be employed, for folks like us. Well it is already, in the sense that because of our other income, most of what we receive from Soc Sec is treated as taxable income. Lets keep that in mind.
Dobbs
if we are going to keep it in mind we ought to understand it. you are not being means tested.
social security is insurance. in order to keep the cost of the insurance low it needs to adjust payouts to the level of damage suffered. (the damage of earning too little over a life time to save enough for basic needs in retirement).
an ordinary worker collects enough in benefits to keep him out of poverty by providing an effective interest of about 5% on his FICA “contribution” (call it a tax, or savings, or investment, or insurance premium…it is what it does). Ordinary investment gains or interest is taxed. Social Security gains are not taxed. But for people who have (relatively) high incomes in retirement, part of their Social Security income is taxed…no means testing involved… just file your tax return, pay the tax on your income, some or all of which is Social Security income not taxed.
I wouldprobably choose to do this a different way if it was up to me, but right now I can’t think of a way that would accomplish the purpose of first paying Social Security the benefits they paid for, including the boost for low income over a lifetime, paid for by a lower “return” to those “who did not have the fire”…that is earned over a lifetime enough to not need the “boost” to stay out of poverty … this is how insurane works. and second, taxing the income of those with high enough incomes during retirement not to need the tax exemption given to people whose incomes during retirement are so low that taxing that income would defeat the purpose of Social Security.
I hope that this is clear enough…and not seen as special pleading…that it will at least suggest that the various tucks and tweaks in the Social Security code are not “means testing”… the are automatic, apply to everyone, without having to show up at the welfare office to prove you “need” “welfare.”
and please note the difference between what you earned over a lifetime, and what you are earning during retirement….they are different things having different effect for different situations…it does not help understand them by calling them means testing….no more than calling various exemptions on your income tax “means testing.”
btw the 5% is very approximate and about half of it is just keeping up with inflation…but any investment or interest income has to first keep up with inflation….automatically keeping up with inflation (and the growth in the real economy) by pay as you go financing is one of the pillars that make Social Security an essential part of protecting your retirement savings in a modern economy.
One way to reduce (the cost of) my benefits is to do means testing and determine that I am entitled to less (due to additional income.) Another way to do the same is to increase my income tax payments by taxing a larger portion of my income. Please just don’t do both.
BTW, I realize that ‘what they are doing is not means testing’, because they don’t DO means testing. They are just making me pay more in income taxes by other means.
I do not object to paying a higher level of income taxes than I would otherwise (on social security benefits) because of what Oliver Wendel Homes Jr said.
Oliver Wendell Holmes, Jr: “Taxes are the price we pay for civilization.”
glad you got to that last line, but complexity in taxation is what we pay for a society that tries to make taxes “fair” in spite of what special interests or think.
you could pretend that you are not paying “more tax” but that the other guy is paying less…because he has less, but that still does not make it means testing.