PRINCIPLES OF PUBLIC ECONOMICS
Lisanne Callewaert 1
,PUBLIC EXPENDITURES (PART II) (CH 15-16)
SPECIFIC GOVERNMENT PROGRAMS: SOCIAL INSURANCE
- Growing importance of the social insurance role of govts in the post-war period
- Social security differs from most govt programs, having its own payroll taxes (=met hun eigen
loonbelasting)
- Social insurance = insurance, provided by the govt, contract that transfers consumption from low
marginal utility status to high marginal utility status
- Why the growth of public social insurance programs?
- Market failure = the economic situation defined by an inefficient distribution of goods and services in
the free market → administrative costs, social risks (inflation), adverse selection issues and differential
risks
- Social security as a 3-in-1 program: a mix of a (forced) savings plan, social inflation-indexed annuity
and redistributive plan
- main criticism: low rates of return, inequities, fiscal burden, crowding-out (= verdringen) of private
savings, reduces work incentives → poverty traps (= a situation where someone or a country starts
poor and remains poor)
SOCIAL INSURANCE PROGRAMS IN PRACTICE
- social insurance programs: non- contributory pensions (= premievrije pensioenen), family allowances
(= gezinstoelage), unemployment benefits, guaranteed income programs,…
- government programs ensuring ‘minimum standards’:
fixed subsidies/benefits, matching subsidies, decreasing /progressive subsidies, hybrid solutions
- the case of a negative income tax:
o = a way to provide people below a certain income level with money. In contrast to a standard
income tax, where people pay money to the government, people with low incomes would
receive money back from the government
o In addition to specific social insurance programs, govts have other tools for intervention
o Suggestion that govt can do more about poverty alleviation (= armoedebestrijding), instead
of having myriad (=ontelbare) govt programs
Taxes = t*y – D
D = distance between income line and T
Lisanne Callewaert 2
, - The case of a negative labour income tax:
o Simplest version: proportional income tax combined with an unconditional transfer of
amount D (= proportionele inkomstenbelasting in combinatie met een onvoorwaardelijke
overdracht van bedrag D) → universal basic income (“social dividend”)
o Total taxes paid by individual i: T(y) = ty – D
o t = tax rate paid by each individual
o important properties:
1) universal coverage → ensures equal conditions for everyone at same poverty
level
2) individuals’ after-tax/transfer income: y – T(y) = D + (1-t)y → ensures everyone
has a level of income at or above this level
3) each increase in y implies a (1-t) increase in net income → poverty traps and
disincentives to work disappear
o why don’t we observe a widespread use of this type of social insurance scheme?
Even moderate levels of D imply large increases in govt budgets
SOCIAL INSURANCE PROGRAMS: POVERTY TRAPS AND DISINCENTIVES TO WORK
- fixed govt subsidies = provide a consistent level of financial support from one period to the next.
- Matching subsidies (difference between income and minimum threshold level)
- Marginally decreasing subsidies
- “progressive” subsidies = one where the subsidy has less and less impact based on the recipient's
income / those where subsidies are paid to rich at a lower rate and the poor at a higher rate.
If you receive less than B’ :
govt gives complement for
consumption until M’
For each euro they earn,
they need to receive 1 euro
less from the govt
Lisanne Callewaert 3
, - Problems with welfare programs: adverse incentives (“moral hazard” = a situation in which one party
gets involved in a risky event knowing that it is protected against the risk and the other party will incur
the cost)
o Welfare programs as “safety net” programs
o Yet poverty rate has increased in US
o Basic criterion to determine eligibility (=geschiktheid): personal income
o Do welfare programs discourage work?
- Poverty traps and disincentives to work
o As income rises, individuals stop progressively to meet eligibility criteria → benefits reduced
o This means that total income or poor individuals rises much more slowly than their before-
subsidy income
o Lower marginal returns to work → less incentive to work
o Another issue: informal work (unreported income = income that someone illegally does not
include in their tax return)
Lisanne Callewaert 4
Lisanne Callewaert 1
,PUBLIC EXPENDITURES (PART II) (CH 15-16)
SPECIFIC GOVERNMENT PROGRAMS: SOCIAL INSURANCE
- Growing importance of the social insurance role of govts in the post-war period
- Social security differs from most govt programs, having its own payroll taxes (=met hun eigen
loonbelasting)
- Social insurance = insurance, provided by the govt, contract that transfers consumption from low
marginal utility status to high marginal utility status
- Why the growth of public social insurance programs?
- Market failure = the economic situation defined by an inefficient distribution of goods and services in
the free market → administrative costs, social risks (inflation), adverse selection issues and differential
risks
- Social security as a 3-in-1 program: a mix of a (forced) savings plan, social inflation-indexed annuity
and redistributive plan
- main criticism: low rates of return, inequities, fiscal burden, crowding-out (= verdringen) of private
savings, reduces work incentives → poverty traps (= a situation where someone or a country starts
poor and remains poor)
SOCIAL INSURANCE PROGRAMS IN PRACTICE
- social insurance programs: non- contributory pensions (= premievrije pensioenen), family allowances
(= gezinstoelage), unemployment benefits, guaranteed income programs,…
- government programs ensuring ‘minimum standards’:
fixed subsidies/benefits, matching subsidies, decreasing /progressive subsidies, hybrid solutions
- the case of a negative income tax:
o = a way to provide people below a certain income level with money. In contrast to a standard
income tax, where people pay money to the government, people with low incomes would
receive money back from the government
o In addition to specific social insurance programs, govts have other tools for intervention
o Suggestion that govt can do more about poverty alleviation (= armoedebestrijding), instead
of having myriad (=ontelbare) govt programs
Taxes = t*y – D
D = distance between income line and T
Lisanne Callewaert 2
, - The case of a negative labour income tax:
o Simplest version: proportional income tax combined with an unconditional transfer of
amount D (= proportionele inkomstenbelasting in combinatie met een onvoorwaardelijke
overdracht van bedrag D) → universal basic income (“social dividend”)
o Total taxes paid by individual i: T(y) = ty – D
o t = tax rate paid by each individual
o important properties:
1) universal coverage → ensures equal conditions for everyone at same poverty
level
2) individuals’ after-tax/transfer income: y – T(y) = D + (1-t)y → ensures everyone
has a level of income at or above this level
3) each increase in y implies a (1-t) increase in net income → poverty traps and
disincentives to work disappear
o why don’t we observe a widespread use of this type of social insurance scheme?
Even moderate levels of D imply large increases in govt budgets
SOCIAL INSURANCE PROGRAMS: POVERTY TRAPS AND DISINCENTIVES TO WORK
- fixed govt subsidies = provide a consistent level of financial support from one period to the next.
- Matching subsidies (difference between income and minimum threshold level)
- Marginally decreasing subsidies
- “progressive” subsidies = one where the subsidy has less and less impact based on the recipient's
income / those where subsidies are paid to rich at a lower rate and the poor at a higher rate.
If you receive less than B’ :
govt gives complement for
consumption until M’
For each euro they earn,
they need to receive 1 euro
less from the govt
Lisanne Callewaert 3
, - Problems with welfare programs: adverse incentives (“moral hazard” = a situation in which one party
gets involved in a risky event knowing that it is protected against the risk and the other party will incur
the cost)
o Welfare programs as “safety net” programs
o Yet poverty rate has increased in US
o Basic criterion to determine eligibility (=geschiktheid): personal income
o Do welfare programs discourage work?
- Poverty traps and disincentives to work
o As income rises, individuals stop progressively to meet eligibility criteria → benefits reduced
o This means that total income or poor individuals rises much more slowly than their before-
subsidy income
o Lower marginal returns to work → less incentive to work
o Another issue: informal work (unreported income = income that someone illegally does not
include in their tax return)
Lisanne Callewaert 4
