In the war on poverty, cash assistance will fail

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Unemployed professionals take part in a back to work training program.

Fifty years have passed since President Lyndon B. Johnson declared an “unconditional war on poverty”. More recently, President Obama has declared a new war, this time on income inequality. This shift in focus is somewhat misguided. With 47 million individuals still living in poverty, the first war is far from over. Defining income inequality as “the biggest challenge of our time” further detracts attention from the poor since a change in the income distribution across all households says little about how people are faring in absolute terms at the bottom of the distribution.  In a recent testimony, I argue that the fundamental challenge facing this generation is the same one that faced President Johnson. The fundamental issue is about poverty, and not about whether incomes at the top are ten or fifteen times higher than for the bottom. While these latter statistics may serve a useful political end in stoking class wars, they do little to help people in need.

Aside from the fact that reducing income inequality per se is an ill-defined goal, a very basic issue with defining the problem of income inequality is the lack of a consistent measure of household income. Researchers have come up with different responses to the question “is income inequality trending up or down” on the basis of these different definitions of income. In a recent December 2013 report, the Congressional Budget Office divided all U.S. households into five groups of equal size (quintiles), on the basis of their before-tax income. The CBO definition of before-tax includes government transfers to these households. As per this report, in 2010, households in the lowest quintile (bottom 20 percent) received 5.1 percent of all before-tax income, or about $24,100 per household. Those in the middle fifth received 14.2 percent or $65,400 per household. Households in the top quintile received 51.9 percent or about $239,100 per household. In other words, households in the top income quintile received an income share that was ten times that for the lower income quintiles. The corresponding numbers for after-tax income are 6.2 percent for the bottom quintile, 15.4 percent for the middle quintile and 48.1 percent for the top quintile.

Trends since 1979 suggest that households at the very top of the income distribution have increased after-tax incomes at a much faster pace than households at the bottom. The much cited paper by economists Thomas Piketty and Emmanuel Saez confirms this trend, though it fails to account for taxes and transfers. Other economists however counter these results by using a different definition of income. In a 2013 paper, Richard Burkhauser and colleagues contend that using a broader measure of income, that includes accrued capital gains, income inequality has narrowed between 1989 and 2007.

The results for widening income inequality are further weakened when we use consumption as the measure of household welfare. In my own research co-authored with Kevin Hassett, we find that consumption inequality is a lot narrower than income inequality. Further, we document that there has been an increase in material standards of living even for low income households, resulting in a narrowing of inequality in terms of access to everyday household appliances and electronic devices. The percentage of low-income households with a computer rose to 47.7% from 19.8% in 2001. The percentage of low-income homes with six or more rooms (excluding bathrooms) rose to 30% from 21.9% over the same period.  Similar increases can be documented for appliances like air-conditioners, dishwashers, microwaves, cell phones and other household items.

However, despite these secular improvements in living conditions, the census bureau documents that more than 47 million people live in poverty in America today.  We are now in the fifth year of an economic recovery that does not seem like a recovery to most people in the labor market. There are more than 10 million unemployed workers, of which nearly 4 million have been jobless for longer than 27 weeks. In addition, there are another 10 million who are either in involuntary part-time jobs, or are too discouraged to look for work. Therefore, I would argue that the focus on income inequality is somewhat misplaced. This is essentially a problem of poverty. And when these high rates of poverty exist in an economy with low economic mobility as is true of the U.S., the problem is exacerbated.

What policies can we encourage in order to improve economic mobility and the access to high-wage high-skilled jobs that are one of the primary drivers of economic success? Access to high quality education and schools is extremely important as an investment into children’s futures. Poor quality schooling can limit an individual’s earning ability. Research has shown that the quality of local public education is improved in areas where there is more competition due to a large number of school districts or a greater availability of nonpublic education.

The labor market poses serious concerns about the future livelihoods of the millions of unemployed workers, particularly those who are long-term unemployed. One solution that is being proposed is the extension of unemployment benefits to the long-term unemployed. I believe that the unemployment benefit programs have to be supplemented by skills training and greater help with matching workers to jobs. It is simply not enough to keep extending benefits if at the end of the benefit period, the worker is still unemployed. The goal of any such program should be to train the worker to transition to a new job, rather than to simply provide cash benefits to allow them to meet their basic needs for a limited time period. For a worker who stays unemployed for more than six months, the likelihood of finding a job is extremely low and is unlikely to improve without active help. Towards this end, workers who have been long-term unemployed should be provided training and then placed in jobs through wage-subsidy programs that allow some share of the wages to be paid by the employer and the rest to be paid by the unemployment insurance program.[1] This would allow employers to test and see if the match with the prospective employee is a good one, while at the same time it would allow workers to receive on the job training and gain experience with the likelihood that they will be able to keep the job.

Raising minimum wages is a particularly bad idea when we think of high youth and teenage unemployment rates.[2] Workers under age 25 make up half of those paid the federal minimum wage (or less). Instead, research suggests that internship or apprenticeship programs may improve employment prospects and also boost college attendance.

Minimum wages are also not a tool to fight poverty. By some estimates, less than 25 percent of minimum wage workers live at or below the poverty line based on family cash income. An alternative to the minimum wage is the Earned Income Tax Credit program. The EITC arguably is one of the federal government’s most efficient means of encouraging work and fighting poverty. As per the Census Bureau, the EITC lifted 5.4 million people above the poverty line in 2010.While the EITC has some disadvantages, such as the significant tax penalties on earners in the phase-out range, it has been shown to encourage labor force participation for single mothers, and has lifted millions of adults and children out of poverty.

To conclude, the bulk of the evidence suggests that programs that enable people to work or transition to work are more effective at fighting poverty, than simple cash assistance programs. As such, wage-subsidy programs that combine skills training, and tax credit programs like the EITC are a better bet today to get the unemployed back in the labor market and improve the lives of low-income individuals.

 

Aparna Mathur is a Resident Scholar in Economic Policy Studies at the American Enterprise Institute.

 



[1] Katz (1998) presents evidence indicating that the Targeted Jobs Tax Credit, the major wage-subsidy program for the economically disadvantaged between 1979 and 1994, did boost employment of disadvantaged youths.

[2] Further, there is substantial evidence to suggest that there are negative employment effects, particularly for low-skilled workers of raising minimum wages. A recent 2009 paper by David Neumark suggests that employers often take back the increases that come with higher minimum wages in future years by forgoing the usual nominal wage increases that would have happened.

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About the Author

 

Aparna
Mathur
  • Aparna Mathur is an economist who writes about taxes and wages. She has been a consultant to the World Bank and has taught economics at the University of Maryland. Her work ranges from research on carbon taxes and the impact of state health insurance mandates on small firms to labor market outcomes. Her research on corporate taxation includes the widely discussed coauthored 2006 "Wages and Taxes" paper, which explored the link between corporate taxes and manufacturing wages.
  • Phone: 202-828-6026
    Email: amathur@aei.org
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