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June
1996
eCONOMIC
COMMeNTORY
Federal Reserve Bank of Cleveland
Welfare Refornt and the
Cyclicality of Welfare Progrants
by Elizabeth T. Powers
Congress, the White House, and the
nation's governors all seem to agree that
it's time for a dramatic overhaul of the
U.S. welfare system. What has been
harder to come by is a consensus on the
fairest and most politically feasible way
to implement that goal. President Clinton vetoed the welfare provisions in both
the budget reconciliation bill and the
Republican-sponsored Personal Responsibility Act of 1995, while the National
Governors Association continues to
stand solidly behind similar provisions
in its own reform initiative.
Although state and federal lawmakers
may approach welfare reform from different perspectives and with different
agendas, their most recent proposals
share at least five characteristics: 1) the
potential for huge reductions in expenditures, 2) heightened eligibility standards,
3) increased work requirements, 4) a
shift away from entitlement status for
benefits, and 5) a transfer of fiscal
accountability from the federal government to the states. Any successful
reform effort will likely incorporate all
of these basic features.
It is important to understand that the
nonwelfare elements of our social safety
net-unemployment insurance (UI) and
Social Security-have relatively strin- _
gent work and earnings history requirements. Thus, many households with a
weak attachment to the labor force either
are not eligible for these programs or
qualify only for minimal benefits.
Furthermore, Ul benefits do not fully
ISSN 0428- 1276
replace lost earnings and are time limited, meaning that even households
whose workers have strong earnings
records may tum to welfare programs
during tough economic times.
Current reform bills would do little to
address the cyclical variation in caseloads and expenditures. Because welfare
would be funded primarily through
capped block grants to the states, it
would fall to state lawmakers to cope
with increased program costs during
economic downturns. 1 Eliminating the
entitlement status of benefits means that
states would no longer be obligated to
expand programs in times of greater
need. Moreover, work incentives would
likely be of limited value when unemployment is high.
To understand how potential welfare
recipients would be affected by the proposed policy changes and to what extent
funding shifts would exacerbate states'
budget problems, it is first necessary to
examine the basic features of our current
welfare system. This Economic Commentary presents an overview of the
safety net's four main programs, analyzes the impact of business cycle fluctuations on caseloads and expenditures,
and reviews some provisions of the most
recent reform proposals.
•
The Programs
The federal government administers a
host of means-tested programs that pay
cash or provide in-kind assistance. This
article focuses on the most significant
-
Recent welfare reform proposals are
unanimous in calling for a reduction
in benefits and a shift in fiscal responsibility from the federal government to the states. However, none of
these proposals adequately addresses
the sometimes substantial impact of
business cycle swings on welfare
caseloads and expenditures. It is reasonable to expect that enactment of
such legislation will boost either the
volatility of state expenditures or the
income volatility of those households
least equipped to cope with economic
downturns-or both.
ones in terms of caseloads and outlays:
Aid to Families with Dependent Children (AFDC), Food Stamps, Supplemental Security Income (SSI), and
Medicaid. Figures 1 and 2 display historical trends in caseloads and total
spending by program.
With one important exception, these
programs do not even begin to match
the level of non-means-tested cash
transfers paid out through the Social
Security system. Excluding Medicaid,
combined state and federal welfare
transfers were only 23 percent as large
as Social Security payments in 1994.2
The exception, Medicaid, grew enormously in the past 10 years, with expenditures now nearly matching Medicare
outlays (each program paid out over
$140 billion in 1994).
One would not expect these programs to
experience the same cyclical swings,
since they target different groups of people. It is possible, however, to make an
informed guess about their cyclicality by
considering the features of each.
-
Millions of persons
40
.-~~~~~~~~~~~~~~~~~~~~~~---.
35
30
SSI: The SSI program provides cash aid
to both elderly and disabled Americans
who meet certain income and asset
restrictions. Eligibility and benefits are
based on federal poverty guidelines.
Benefits are indexed for inflation and are
the most generous of all the cash benefit
programs. In 1994, SSI paid out more
than $25 billion.
Participation in SSI expanded from
around 4 million people in 1974 to about
6.4 million in 1994. Recent caseload
growth stems entirely from an increase
in disabled recipients. Since the elderly
and disabled are presumably the least
active members of the labor force, a reasonable conjecture is that SSI is the least
cyclical of the welfare programs.
FIGURE 1 WELFARE RECIPIENTS
25
20
SSI • •• •• - ·- •• •• •• •• •• •• -· •• •• - -- ••
.... ....
...
~~65:-'-..................1~97_0..........................19~7-5........._._....._
19~80....._........._._1~98~5..._........._._1~
99_0........._._....L...11995
-
FIGURE 2 WELFARE EXPENDITURES
Billions of 1993 dollars
180
Billions of 1993 dollars
30
90
AFDC 3: Since 1935, this program has
provided cash assistance to single parents (usually women) meeting certain
income and asset eligibility standards.
Funding is provided by the federal government and the states, with eligibility
and benefit levels varying significantly
across state lines. Benefits are not indexed to inflation. In 1994, AFDC
served about 5 million families (approximately 14 million people) and paid out
almost $23 billion.
Although caseloads (measured as number of persons) expanded 43 percent between 1979 and 1994, real expenditures
changed little over this period. AFDC
caseloads and outlays are expected to rise
during recessions for three reasons: female heads of household frequently participate in the labor force, unemployment
appears to contribute to family breakups,
and AFDC-UP benefits are contingent on
unemployment However, a sizable fraction of AFDC recipients are known to
depend on the program regardless of the
economy's health.
Medicaid: Although the latest reform
efforts would change this, AFDC and
SSI recipients are now automatically
enrolled in the Medicaid program. In
SOURCE: U.S. Department of Health and Human Services.
most states, other individuals may be
granted eligibility if their resources have
been nearly exhausted by medical bills.
In 1994, after a decade of explosive
growth, more than 35 million people
were covered by Medicaid for a total
program cost of $143.5 billion. Variation
in caseloads and expenditures over the
business cycle should mimic those of
AFDC and SSI (since these recipients
account for most of the Medicaid caseload), but may be further influenced by
economic conditions in states that extend eligibility to other groups.
Food Stamps: Founded in the early
1970s, the Food Stamp program is the
only welfare program whose eligibility
requirements are solely financial. Benefits are indexed, funded totally by the
federal government, and uniform nation-
wide. In 1994, about $24 billion worth
of benefits was paid out to about 27 million individuals. Because Food Stamps
can be collected by all types of families,
and because income-eligibility requirements are the least stringent for this program, one would expect caseloads and
outlays to have the strongest association
with cyclical swings in business activity.
• Measuring
Welfare Cyclicality
It is reasonable to expect welfare expenditures and caseloads to move in tandem
with business cycles, since no program
perfectly insures workers and their
dependents against recessions. As mentioned above, UI is time limited, does
not fully compensate for lost earnings,
and excludes workers who do not have
qualifying work and earnings histories.
In addition, potential welfare recipients
may be dependents (such as a child or
elderly parent) of an unemployed worker
who is either underinsured or lacks
insurance altogether.
The strength of cyclical variation in welfare spending depends on several factors. First, Medicaid is an unusual case
because many new enrollees come
through the AFDC program and are presumably not ill. Therefore, caseloads
may grow without a commensurate rise
in expenditures. In other programs, it is
likely that enrollees who sign on during
a recession will receive a below-average
payment, which means that spending
will grow less quickly than the number
of cases. The reason is that people with
earnings records (that is, job losers) are
more likely to receive other types of
income that reduce their welfare benefits
(Social Security, UI, alimony, and child
support). Finally, at least for programs
that are indexed, nominal expenditures
must rise with inflation, so the response
of nominal benefits also depends on the
relationship between inflation and unemployment over the period of study.
Using standard methodology, I estimated the effect of higher unemployment on caseload and expenditure
growth for each of the four major welfare programs. 4 Although my approach
has several limitations, evidence from
other studies (discussed below) suggests
that, overall, my methodology is conservative in that it tends to understate the
relationship between economic conditions and welfare programs. 5
First, consider the relationship between
unemployment and caseload growth for
the various programs. Caseload growth
accelerates during recessions and slows
during expansions, as expected. My findings confirm the intuition based on the
individual programs' features. A!percentage-point rise in unemployment
would add 0.39 percentage point to the
growth rate of SSJ caseloads, 1.88 percentage points to Medicaid, 2.52 percentage points to AFDC, and 4.54 percentage
points to the Food Stamp program. 6 Put
another way, if the 1994 jobless rate had
been 1 percentage point higher, more
than 1.2 million people would have been
added to the Food Stamp rolls, 620,000
to Medicaid, 200,000 to AFDC, and
23,000 to SSI.
The relationship between nominal spending growth and unemployment follows
much the same pattern. An additional !percentage-point rise in 1994's jobless
rate would have contributed 0.97 percentage point to the SSI expenditure
growth rate, 2.05 percentage points to
Medicaid, 3.00 percentage points to
AFDC, and 4.84 percentage points to
Food Stamps. In each case, nominal
spending growth seems to respond more
strongly to unemployment changes than
do caseloads. These figures suggest that
an additional percentage point of unemployment would have boosted annual
expenditures by more than $3.3 billion in
the case of Medicaid, over $1 billion for
Food Stamps, nearly $235 million for
SSI, and about $0.7 million for AFDC.
•
Current Proposals
Although President Clinton recently
vetoed HR 4, the Republican-sponsored
welfare reform bill, its fundamental features have resurfaced in a proposal
backed by the nation 's govemors.7 Both
proposals emphasize capped block
grants for the major welfare programs.
Although states would have the option to
spend more on welfare, they would also
be allowed to slash payments up to 25
percent without penalty.
Contingency funds for recessions, emergencies, and population growth are probably unrealistically modest in their scope
and funding. The governors' plan would
set aside $2 billion, allocated over seven
years, for states experiencing increased
unemployment-well below the needs
suggested by recent experience. Furthermore, a state would become eligible for
this money only after a substantial rise in
its jobless rate. Even the very conservative estimates presented here suggest
that moderately high but sustained
unemployment could exhaust the contingency fund well before its seven-year
horizon is reached.
Both proposals also place five-year limits on lifetime cumulative welfare
receipts and eliminate entitlement status
for groups currently served by Food
Stamps and AFDC. Presumably, many
who apply for aid during a recession will
be turned away, particularly considering
the block-grant nature of welfare funding. All of these changes would serve to
severely limit access to welfare, exacerbating households' financial difficulties
during economic downturns.
Finally, the proposals emphasize the
welfare-to-work philosophy by 1) financially rewarding states that effectively
move people off public assistance and
onto private payrolls, 2) increasing funds
for child care and other work-related expenses, and 3) requiring able-bodied
adult recipients to work (in public jobs
if need be). However, these incentives
and requirements would do little to control caseload growth during recessions,
since many of those coming into the system would be unable to find work.
•
Conclusion
The degree of caseload and funding cyclicality across the nation's welfare programs varies in ways that can be logically anticipated. SSI, serving the elderly
and disabled, is the least sensitive to
business cycle conditions, both in program use and outlays. Medicaid is moderately sensitive. AFDC, which mainly
serves female-headed households, is
somewhat sensitive, and Food Stamps,
which bases eligibility primarily on
financial need, is highly sensitive. According to the findings of other researchers using state-level data, even SSI participation and expenditures would rise
significantly during a recession.8 Thus,
the degree of cyclicality suggested in this
Commentary is a conservative estimate.
It is safe to say that shifting funding
responsibilities from Congress to the
nation's statehouses will impose formidable cyclical burdens on the states.
With entitlement status for benefits
gone, state lawmakers could react to a
recession-induced fiscal squeeze by
tightening standards or reducing benefits , which would pass cyclical income
risk down to households. Without compensating changes in other programs
(most obviously, UI), reduced payments
and decreased opportunities for participation will inevitably worsen the impact
of a faltering economy on the wellbeing of the poorest Americans.
•
Footnotes
1. Block grants are funds distributed to states
to spend on certain items as they see fit. Many
of the current welfare reform proposals fix (or
"cap") the amount of money that will be
granted over a five-year horizon.
2. This is the most recent year for which data
are available. More than $73 billion in welfare benefits (AFDC, Food Stamps, and SSI)
was paid out, while the Social Security system provided over $312 billion in old age,
survivors,' and disability insurance.
national data may obscure the relationship
between unemployment and welfare expenditures and caseloads, because national
trends are not equally distributed on an interregional basis.
6. Caseloads are measured by the number of
persons served, with the exception of AFDC,
which refers to the number of families.
7. The new bill is currently scheduled for
consideration by the House Ways and Means
Committee.
-
Elizabeth T. Powers is an economist at the
Federal Reserve Bank of Cleveland. The
author thanks Michael Bryan for helpful
comments and Kristin Roberts for excellent
research assistance.
The views stated herein are those of the
author and not necessarily those of the Federal Reserve Bank of Cleveland or of the
Board of Governors of the Federal Reserve
System.
3. AFDC figures include the relatively recent
AFDC-UP ("unemployed parent" ) program,
which allows two-parent families meeting
certain requirements to receive cash benefits.
4. Caseload and expenditure growth rates
were regressed on a constant and on the
change in the unemployment rate.
8. One recent study estimates a 2 percent
increase in SSI awards for every 1 percentage point increase in unemployment. See
David Stapleton and K. Dietrich, ''The
Effects of the Business Cycle on Disability
Applications and Awards," Lewin-VHI,
mimeo, January 1995.
Economic Commentary is now available
electronically through the Cleveland Fed's
home page on the World Wide Web:
http://www.clev.Jrb.org.
5. These limitations include ignoring nonemployment factors and using national rather
than regional data. The former may have
important effects on welfare caseloads and
expenditures, some of which may be incorrectly attributed to unemployment. Using
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