Welfare: More a Band-Aid than a Solution

_When Sir Bob Geldof berated the New Zealand government a year ago for its ‘pathetic’ contribution to alleviating world poverty, he overlooked the fairly generous amount of government assistance to New Zealand’s own poor. Our governments have a long tradition of attempting to address inequality and relieve poverty by redistributing national income. Some regard this as a primary means of helping the less well off: it’s as if there were a giant, government-baked pie that, sliced up and dished out fairly, could in the end eliminate poverty.

But there is no giant government pie. In reality we are talking about money earned by some and taken as tax to be given as income to others. And both the acts of taxing and giving affect the incentive to earn income in the first place, reducing the size of the pie.

Proponents of redistribution usually have the very best of intentions Local supporters of Geldof’s campaign Make Poverty History, for example, urge New Zealanders to email their politicians asking them to “consider bringing an end to child poverty in New Zealand”. Similarly the Child Poverty Action Group argues that child poverty figures remain “needlessly high”, and that through redistribution, the government could “eradicate child poverty by 2010”.

But such proponents of redistribution programmes seldom question their effectiveness and their costs and consequences.

A new study released this month by the New Zealand Business Roundtable looks at these issues empirically. The Outcomes of Income Transfers, by economist Mark Harrison, concludes that income redistribution is not only a relatively ineffective strategy for lifting people out of poverty, but it is also costly, and has many disincentive effects.

As an example, the study points out that transferring just 1% of income to the bottom 20% of households from the other 80% of households would involve a $900 million transfer, would require an increase in the average tax rate of 6.5 percentage points, and would only increase incomes in the bottom 20% by $3000 a year – and that doesn’t take account of the impact of higher taxes and welfare payments on work effort.

In another example, the study looks at what would happen if the government’s goal were to raise all incomes to the commonly suggested poverty line of 60% of median income. It finds that this would require everyone’s effective marginal tax rate to rise by 47 percentage points. The bottom tax rate would rise from 19.5% to 65.5%, while the top rate would go up from 39% to 86%.

This example again assumes raising the necessary tax is costless, but this is far from the case. High tax rates reduce work incentives and decrease national income. There are also high administration and compliance costs involved in raising tax revenue and redistributing it.

In this regard, the study cites the enormous efficiency costs of the Working for Families package, which largely redistributes income from single people and couples without dependent children to families with dependent children, many of them on relatively high incomes.

Proponents of redistribution not only understate its costs; they often overstate its benefits. The study finds that while welfare programmes have a role, they have little impact on the distribution of income from a lifetime perspective – the same people often end up paying as much as they receive. Furthermore, they do not address the underlying causes of poverty and indeed may exacerbate them: by discouraging recipients from working and gaining experience, welfare programmes may create dependency and a so-called underclass.

We need to recognise the limits of income redistribution as a means of alleviating poverty. Dr Harrison concludes that a much more powerful strategy is to adopt policies that create wealth and increase living standards, such as pursuing sound macroeconomic policies, reducing economic distortions, establishing flexible labour markets that generate jobs for people willing to work, and providing opportunities to the poor through good education and training policies. Any meaningful approach also needs to focus on non-monetary factors, such as encouraging self-reliance and personal responsibility, and supporting the family and marriage.

Economist Tyler Cowen, writing in his blog Marginal Revolution last week, put the issue as follows: “We don't take steps to redress inequalities of looks, friends, or sex life. We don't grab a kidney from you to save someone's life, even though that health difference was unfair brute luck. Redistribution of wealth has some role in maintaining a stable democracy and preventing starvation.

But the power of wealth redistribution to produce net value is quite limited. The power of wealth creation to produce net value is extraordinary. Most of America's poor are already among the best-off of all humans in world history. We should be putting our resources, including our advocacy and our intellectual resources, into wealth creation as much as we can”.

Roger Kerr is the executive director of the New Zealand Business Roundtable.

ENDS

© Scoop Media