How Do Government Transfers Influence Economic Well-Being?

Governments have long manipulated fiscal policy to address their country’s problems. Using tax revenue to intervene in the economy to promote good outcomes has been a staple of economic policy since the days of Keynes, and one clear example of this is the modern welfare state. From Franklin Roosevelt’s New Deal to Lyndon Johnson’s Great Society, the United States government has created sprawling new federal programs to address the crisis of poverty in America. These programs typically deliver aid to individuals through transfer payments, which deliver income from governments to individuals without any services being rendered. 

However, the efficacy of these payments has been brought into question, specifically whether they actually improve the poor’s long-term economic well-being. Proponents note the dramatic reduction in poverty since the introduction of federal welfare programs. Poverty fell from 19.0% to 14.8% between 1964 and 2014, and the poverty rate now fluctuates far less during recessions and periods of high unemployment. Alternatively, opponents contend that these programs create a strong disincentive to work, which decreases the long-term economic prosperity of transfer recipients. Researchers found that when young uneducated men aged into eligibility for French government assistance at 25, that group experienced a 7-10% drop in labor force participation. In this case study, you and your classmates will adjudicate between these competing perspectives using data from the DemCap Analytics (DCA) tool to decide whether government transfer payments actually improve the economic well-being of the poor. You will also discuss related questions, such as the government’s role in alleviating poverty and whether governments should condition transfer payments. 

Understanding how these programs work will help us evaluate their economic impact. Typically, welfare bureaucracies disperse their aid through something called a transfer payment. A transfer payment is a payment, cash or otherwise, from the government to an individual or business with no expectation that a service be rendered in return. Essentially, it is a donor-receiver relationship wherein the government redistributes tax revenue to individuals. Transfer payments are an integral tool of any anti-poverty program, and in many high-income countries their impact is widely felt. In the United States, 4 in 10 seniors rely on Social Security payments for over 50% of their annual income. Additionally, over 41.2 million people are enrolled in the Supplemental Nutrition Assistance Program (SNAP) to help increase their monthly food budgets. The list of transfer programs is long, and this is reflected in their cost. Over 62% of the United States budget in FY2022, equivalent to 16.3% of GDP, was spent on transfer payments.

The ubiquity of government transfer programs coupled with their cost makes them a common subject of spending debates in the United States. Indeed, a 2023 report by the House of Representatives Budget Staff decried “a growing culture of government dependency” in a working paper on transfer payments and called for the Biden administration to rein in spending to pre-COVID 19 pandemic levels. But what effect would a decrease in spending have on the economic health of transfer payment beneficiaries? 

Advocates of government transfers argue that these payments are an effective way to reduce poverty, and that the effect transfers have on labor force participation is small if not negligible. A 1981 study commissioned by the Department of Health and Human Services appraised the effect of Great Society-era expansions in the welfare state, and found that income transfer payments had caused a 75% reduction in poverty compared to the counterfactual where they had not been introduced. Similarly, a United Nations note on the effect of conditional cash transfers on poverty in Latin America found that “national poverty rates would be 1 to 2 percentage points higher—about 13 percent higher relative to average baseline rates—in the absence of CCTs.”

In and of themselves this decrease in poverty rates is laudable, but transfer programs also improve other outcomes for their recipients, dramatically increasing their long-term economic well-being. A study on the impact of the Mother’s Pensions, a WWI-era cash transfer program, on life outcomes found that, among child recipients, the payments  “reduced the probability of being underweight by half, increased educational attainment by 0.34 years, and increased income in early adulthood by 14 percent.” Cash transfers to Colombian families via the Familias en Acción, a cash transfer program to at-risk youth, decreased arrest rates among beneficiaries by 2.7%, decreased pregnancy rates by 2.3%, and increased college enrollment by 1.7%. So in addition to reducing poverty, transfers help improve other facets of recipients’ lives that contribute to sustained well-being.

Despite these results, other researchers have questioned whether government transfers are the most efficient way to reduce poverty, and worry that transfer programs will discourage work, limiting their recipients’ long-term economic prospects. Government transfer programs take up a substantial amount of their budgets, and one key reason for this is administrative and overhead costs. Edwards notes that “public income redistribution agencies are estimated to absorb about two-thirds of each dollar budgeted to them in overhead costs, and in some cases as much as three-quarters of each dollar.” In contrast, this figure is only one third on average for private charities. So while transfer programs have had a positive effect on poverty, taxing less and leaving anti-poverty efforts to private charities might allow more people to get more help.

Additionally, some researchers find that transfer payments only elicit short-term economic benefits for recipients. In their study about the effects of government transfer payments in rural China, Yan Maio and Zheng Li find that while the money improved “basic living security needs of poor residents,” in the long run it led to a “decrease in labor supply among rural poor residents who receive such payments.” This tradeoff ultimately limits the lifetime earnings of poor Chinese by discouraging entry into gainful employment. Indeed, a 2001 study on the earning potential of women who left welfare found that they earned $2.63 more for each hour of work effort than when they did on welfare (about $3.99 in 2018 dollars). So if transfers actually discourage work, they may hurt recipients’ economic welfare.

Some governments condition aid on recipients meeting certain requirements, typically either income or employment-based. For example, SNAP benefits are only available to families earning up to 130% of the poverty line for their household size. By targeting aid more narrowly to populations that need it, policymakers hope to decrease the cost of programs while ensuring that vulnerable populations are not deprived of aid.

The problem with means-testing is that it requires an “administrative mechanism for measuring need,” i.e. expensive bureaucracies, which substantially increase the cost of benefits per recipient. Additionally, the red-tape and paperwork necessary to demonstrate eligibility can be time-consuming to produce, which can discourage recipients from pursuing aid that they need.

While it is easy for developed countries with robust tax bureaucracies to means test transfer payments based on individual incomes, this type of targeting can be much more difficult in developing countries where most citizens, especially the poor, work in the informal sector. This has motivated calls for a universal basic income (UBI), which affords every citizen within a country a flat transfer payment irrespective of income. Though very costly, UBI makes government payments much more accessible and ensures a basic standard of living for everyone in a country.