Welfare programs and black markets

There are lots of big questions about welfare programs and how to design them. I am not going to answer any of those questions here, but I am going to ask a few, specifically these two:

  1. Should receipt of welfare be means-tested for need (e.g. TANF) or universal (i.e. a minimum income for everyone)?
  2. Should receipt of welfare be conditional on employment?

The good arguments for means-testing usually boil down to maximizing impact. If we have a fixed amount of resources we can redistribute, then we can maximize the impact of those resources by directing them towards the people with the greatest need (rather than spreading it thinner across everyone). The good arguments against means-testing revolve around changing incentives at the margin. Even when designed with gradual phasing out as a person’s income rises, there remains the unavoidable reality that means-tested welfare reduces the value of every marginal dollar earned within the phase-out window.

The good arguments for requiring employment to receive a form of welfare are, again, incentives to work, this time at the extensive margin (i.e. how many people in the population choose to work at all). The good arguments against requiring employment are the obstacles that poverty places between people and finding work. It becomes a classic Catch-22 – you’re poor because you can’t find work, but you can’t find work because you are poor. Welfare unconditional of employment can help people get over the hump and into their next job.

None of these observations are new, and these very much remain hard questions. Yes, we should be concerned with incentives to work at the margin, but the fact remains resources are finite, and many people will, at some point in their lives, need a lot of help. The more we can give them the better. This pushes me towards means-testing. But then I remember that those marginal incentives to work at the intensive margin (how much to work) depend on phasing out of benefits with increasing visible income. For people living in poverty, there exist a number of viable earning options that are not visible to the institutions testing their means. A dollar earned in legal wages might reduce TANF benefits by $0.15, but a dollar earned in the black/gray market leaves those benefits untouched. Yes, illegal earnings come with risks, including future access to benefits, but the possibility remains that means-testing benefits could have the perverse effect of increasing the relative value of any and all “off-the-books” income, be it cash labor in the gray market or explicit criminal earnings.

Considering whether a source of welfare should be conditional on employment raises the question of wage subsidies versus cash welfare, but it’s really just the same question we were pondering previously, but with greater emphasis on incentives to work or not. These questions at the extensive margin, much like those at the intensive margin, become far more interesting when placed in the context of not just whether to work or not, but which market to work in. In a world of prohibitions scattered across a variety of extremely high demand (and high profit) markets, where licensing, educational norms, and discrimination all work to create a collage of cash opportunities outside of the well-lit protections of legal labor markets, there is no shortage of work that goes unseen. Welfare transfers conditional on legal labor can serve as incentive to pull people out of these market, and begin building a record of accomplishment that serve them going forward. This speaks in favor of conditioning welfare on employment, so long as everyone has access to employment.

This this thought experiment leaves me mostly where I started (no surprise, an hour’s reflection rarely changes my priors), namely that wage subsidies have a place in our welfare system, as does means-testing, but as welfare benefits rise, they should become more universal in their access across the income distribution, a lesson I expect we will learn in retrospect as we come out of “The Great Resignation”. A “universal basic income” need not be fully universal, but there are good reasons for it to reach well passed the median income. Or median voter, for that matter.

But maybe I repeat myself?

2 thoughts on “Welfare programs and black markets

  1. Zachary Bartsch November 30, 2021 / 10:48 am

    The ultimate stance is that wage subsidy draws more people into formal markets and that income-tapered assistance pushes people out of formal markets.

    Is there a welfare/utility argument for either? This also avoids the elephant of self-employment.

    It’s not clear to me that more formal results in more good.


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