Thursday, November 7, 2013

Government Assistance and Backwards Incentives

The other day Stefanie, the author of a cool personal finance blog set in New York City titled "The Broke and Beautiful Life", wrote a post on unemployment and part time work. I loved the post because it was a detailed and transparent look at one woman's experience with government benefits. The part I found most interesting is how the system reduced her benefits ($251 a week, before taxes) by $63 in one week, as a result of earning just $40 after selling an article. In effect, by working, she actually reduced her income. Had she sold another article on another day that week, regardless of the amount paid for the work, her benefits would be reduced by another 25%. At that rate, the more she worked, the less she earned. This is a case of improper incentives: for every dollar Stefanie earned in this scenario, she lost more than a dollar in unemployment benefits. Rather than providing an economic incentive to work, the system is, in this case, ironically punishing the very behavior it wishes to encourage. So, unless employment with an income that significantly exceeds the weekly benefit becomes available (or if there is some other long term payoff, like a significant raise or health benefits), it makes little financial sense to accept the offer of work. It simply results in a lower income.


Before We Start, a Caveat:
The goal of this post is not to discuss politics, but rather, to discuss incentives. I'm not all that interested in the philosophical or moral arguments that typically surround discussions of social programs like unemployment, welfare and the like. It's all been said before. But I am interested in the idea of systemic incentives, and whether they are effective at driving beneficial behavior. Namely, how do you provide benefits to unemployed or underemployed citizens in a manner that effectively increases the desired behavior (i.e. - full, or fuller, employment)?

Do Incentives Even Work?
This is a thorny issue. Logically, incentives should have some impact on our behavior. Raise prices or provide discounts and spending behavior changes. Why can't the same logic apply to employment? Still, some people believe additional incentives are superfluous, since making more money is its own incentive: you don't need to convince anyone of that. Nearly all citizens would love to make more money, and the issue is not one of proper motivation. (The root cause is something else, like education, or macroeconomic conditions, social pressures, etc. etc.)

The problem with this issue (and with just about every other social issue that I find interesting) is that the discussion usually stays pretty academic. We exchange competing anecdotes and worldviews, but real data is hard to find because government entities are, for some reason, not keen on using their poorest citizens in social experiments.

An Experiment
But wouldn't it be great if some country, say, I don't know, Canada, did actually perform a randomized experiment using actual recipients of government assistance? And then published the results on the internet for free so that a frugal blogger could steal the information? Wouldn't that be neat?

Ask and ye shall receive. Let's go back to a simpler time. Let's go back to the days when I could wear baggy flannel shirts and torn jeans and part my wavy shoulder length hair right down the middle and somehow could think that I looked flipping awesome. Let's go back to 1996, and look at a study titled, "Do Financial Incentives Encourage Welfare Recipients to Work: Evidence from a Randomized Evaluation of the Self Sufficiency Project." (Another caveat: this experiment looks at welfare recipients, which is very different from those who receive unemployment benefits. Still, the programs are similar one respect: one of the stated goals of both programs is for recipients to find employment and, over time, no longer require benefits. So my interest is simply in seeing whether financial incentives are successful in achieving that goal.)
"ABSTRACT: This paper reports on a randomized evaluation of an earnings subsidy offered to long-term welfare recipients in Canada. The program -- known as the Self-Sufficiency Project (SSP) -- provides a supplement equal to one-half of the difference between a target earnings level and a participant’s actual earnings. The SSP supplement is similar to a negative income tax with two important differences: (1) eligibility is limited to long-term welfare recipients who find a full-time job; and (2) the payment depends on individual earnings rather than family income. Our evaluation is based on a classical randomized design: one half of a group of single parents who had been on welfare for over a year were eligible to receive the SSP supplement, while the other half were assigned to a control group. Results for an early cohort of SSP participants and controls suggest that the financial incentives of the Self-Sufficiency Program increase labor market attachment and reduce welfare participation."
Hooray for social experiments! Here is a quick rundown of the paper. The Self-Sufficiency Program was a new approach to welfare, in which an economic incentive (one-half of the difference between a single parent's actual earnings and a target earning level) was provided to long term welfare recipients who find employment for at least 30 hours per week. This was in contrast to the existing Income Assistance (IA) program, which reduced benefits dollar-for-dollar when income was earned, and provided "a strong disincentive to work for many IA recipients". (In contrast, the SSP only reduced the benefits by $.50 for each $1.00 in earnings.) Researchers followed the recipients in the program for 18-24 months.

So, what happened? Here are some quotes that illustrate their findings:
"The patterns for the control group in Figures 5 to 8 reveal a more-or-less steady trend toward greater labor market activity in the months following baseline. This trend is clearly accelerated among the program group. The earnings impacts (Figure 5) are statistically significant from months 5 through 17 and increase gradually from about $40 in month 5 to a peak of about $140 in month 14. This is a sizeable impact (roughly 60 percent) relative to mean earnings of the control group in the same month...."
"Hours of work follow a pattern similar to earnings. The hours impacts (Figure 6) are statistically significant in months 5 through 17, and rise gradually from around 6 hours per month in month 5 to 21 hours in month 14. Again, this is a sizeable impact (about a 70 percent increase) compared to the mean hours of the control group...."
"The overall employment rate (Figure 7) follows a pattern similar to earnings and hours. The employment impacts are statistically significant from months 6 through 17 and rise gradually to a peak impact of 14 percentage points in month 14 before falling slightly. As shown in Figures 8 and 9, almost all of this impact is accounted for by a rise in full-time employment and a drop in non-employment." (Quotes are from pages 18-19 of the study.)
The incentives from the Self-Sufficiency Program resulted in greater labor market activity, more hours worked, and higher overall employment rate when compared to the baseline group in Income Assistance. Roughly twice the number of participants left welfare and found full time jobs when compared to the group in IA. Simply put, the incentives drove the desired behavior. However, the conclusions are not entirely rosy. It appears that those who left welfare took low wage jobs, roughly $1.00 to $3.00 above minimum wage. Unless wages increase over time for these recipients, the authors conclude that many of these recipients may go back to welfare if and when the incentives end.

Conclusions:
The thing that I take away from this study, and from Stefanie's story about unemployment benefits, is that people react well to proper financial incentives. While financial incentives are no silver bullet and do not apparently solve the issue of low wages, they can be effective in driving desired behavior. Additionally, the traditional model of taking away $1.00 in benefits (or, shockingly, more in Stefanie's case) for $1.00 of earned income is a misguided and sub-optimal approach. The desired outcome of increased employment is better achieved if some benefits remain, even when income is achieved, providing a clear financial incentive to work more hours and/or earn more dollars.

Thanks, as always, for reading.

Photo of carrots is from www.metamophoricalplatypus.com at Flickr Creative Commons.

42 comments:

  1. Wow. That's a fantastic way of looking at it, Mr. DoneBy40. Thank you for an objective perspective on, as you stated, a highly politicized issue.

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    1. Thanks, MSquared. I usually try to steer clear of stuff like that but thought it might make for a decent post. Glad you stopped by.

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  2. Great analysis! I wish part time earnings didn't affect unemployment benefits. That part time work could lead to more experience and a full time position in the future.

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    1. Stefanie, I'm so glad you liked the post. As I said in my email, I was worried the article might come off the wrong way. Your idea might even be a better option: simply allowing benefits to remain unaffected until full time work (either determined by a dollar amount or hours worked) is obtained.

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  3. Well... my cynical little brain has several responses to this. First of all, wouldn't it be wonderful if government programs actually employed logic in the decision making process? Unfortunately, I think that politics being what they are, logic generally takes a back seat to other considerations.

    The tragic flaw here is that in this example, as in countless others, better long term results are generally achieved by providing a bit more support up front. In this case it's by reducing benefits by half of the amount earned rather than the full amount, but a parallel could also be drawn to things like providing people with preventative medical care to keep them out of emergency rooms, or mental health care to keep them off the streets, and out of the corrections system etc.

    Unfortunately I think that there's a significant cultural impediment to this sort of program with at least a certain segment of our voting population. I mean look at all of the states that refused to expand Medicaid despite the fact that it would have saved them money!

    It just seems that there's a kind of moralistic self-righteous indignation that often accompanies any decisions on government assistance or social programs. Unfortunately certain politicians exploit this emotion for their own gain, and we're left with a situation where decisions are not based on creating programs that have the best results, they're based on a complicated set of political tactics and moral outrage.

    To make matters worse, there are certain political parties (which I will refrain from naming) that are opposed to social programs just on principle, and therefore really don't want them to succeed under any circumstance. So you've got a situation where certain lawmakers have a real disincentive to create successful social programs, and will actively work to sabotage them even if it means a negative financial and social outcome.

    Sorry for the downer comment, it's just an incredibly frustrating situation.

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    1. Hi Cat,

      I didn't really think it was a downer comment -- lots of good stuff there. I try to tiptoe around politics but perhaps a middle ground could be found on focusing simply on the policies that were most effective over a relatively short period of time (18-36 months).

      That is to say, if policies could reduce the number of recipients receiving benefits within a few years, even policy makers who might be philosophically against the program may provide greater upfront funding, in the name of a positive ROI.

      Maybe a bit naive on my part...

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  4. That's really interesting, and illogical, how the % reduction is set. If Stephanie had met a certain amount, and keeps meeting these incremental amounts, then perhaps that's when a sliding scale would/should work. That's gotta be frustrating for someone who genuinely wants to be productive, but would put oneself in a financially disadvantaged position to do so. So bass-ackwards.

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    1. Hi Anna,

      That was my thought as well re: the 25% reduction in Stephanie's case, for any amount of work on any day. It's kind of a sloppy way to reduce benefits.

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  5. Sadly it's not just unemployment benefits that are structured with these crazy disincentive programs. There are many government programs of this form where the marginal income you make may be more than offset by a reduction in benefits, especially when taxes are taken into account. Some that I've heard about are housing benefits, child care benefits, etc.

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    1. Great point, Mrs. Pop. The dollar in benefits lost is just the tip of the iceberg. Like you noted, when you just consider the fact that income is taxed, the incentive to earn a low income is non-existent.

      The answer presumably is a job that pays significantly more than the benefits offered, but that's not a viable solution for the majority.

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  6. That's crazy to think about and such a hard choice for someone to make. I could try and work and or do nothing and make more money than I would trying to work. I think all of us would have a hard time living like that. I know I would hate being on any type of assistance but if working kept me from eating, it would be hard to go the honorable route.

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    1. Hi Micro. It really is a catch-22 for someone who's receiving benefits currently. I think the key is figuring out a way to properly encourage the right behavior, and to reasonably scale back benefits as that happens.

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  7. This is something that people should be thinking about and discussing more. The policy we choose has such a drastic impact on our society, but most people don't stop to think about it or voice their opinions on the issue (besides randomly complaining). This is so important -> "Additionally, the traditional model of taking away $1.00 in benefits (or, shockingly, more in Stefanie's case) for $1.00 of earned income is a misguided and sub-optimal approach. "

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    1. Thanks, DC! There was one policy in which I think our lawmakers got it right that I wanted to mention...but the post just ran way too long as it was. The Earned Income Tax Credit is a program I really love, as it provides increasingly larger tax credits to low earners as they progressively increase their income. Basic financial incentives, good results among low earners (as I recall). Maybe the subject for another post.

      Thanks for stopping by.

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  8. Some really strange things are happening in this world and sadly not all make any sense. In Germany, for example, people who have never worked in their lives are offered a home with garden by the government, a monthly assistance that is just enough to buy everything you need (and maybe even save very little if you're extremely frugal) and their only obligations are to take care of the garden and plant vegetables and not work. If they work for even an hour, all those benefits are taken away which, just as in Stefanie's case, makes no sense.

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    1. C, that is the most unique government assistance program I have ever heard of. They provide housing and benefits, but the conditions are to tend the garden and not work? Unreal.

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  9. I remember reading that blog by Stephanie too and imagine my disgust about the sorry situation. How come we can see this and the government doesn't? Don't they realize how very discouraging the scheme is?

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    1. Agreed, Jen. I think there probably are some situations in which it works out well (e.g. - when a day of work nets you more than the loss of benefits). But not all employment offers are going to fit that mold. Most might not.

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  10. Very interesting. I actually looked up the Massachusetts unemployment program in response to Stephanie's post and we seem to do it a little better. We can earn up to 1/3 of our benefit without any penalty, and then any earnings above 1/3 reduce your benefits on a dollar-for-dollar basis. That seems to be a much better system than what Stephanie described in NY. There's no penalty for earning more, but there is an incentive to do so.

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    1. That does seem like a better solution, Matt, than the one in NY. Still, I'd like to see governments remove the dollar for dollar reduction at any threshold, and instead retain some of the benefits as carrots.

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  11. That sounds like a much better system than we have here in NYC. I wonder how much variance there is in policies between states. Unfortunately, almost all of my work is NYC based. Even when I go on tour, the production companies are based here so I still have to file here.

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  12. Love the post and your focus on behavior modification. It triggered me to think how I am incentivizing behavior changes on a micro-scale - in my home!

    For me, I need to wake up earlier to take advantage of the day. But I currently have every incentive to lounge in bed. It's comfy, warm, and breakfast isn't going to be ready until 8 AM. I'm spoiled. Perhaps I can design an incentive to get my butt out of bed like a donut if I am working by 7 AM. Love donuts.

    My kids - their only incentive to make their beds is that I nag them once a week or so. Perhaps they need to get bed approvals in the morning before they can eat breakfast or they miss out on the sausage.

    Fun ideas!

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    1. I've personally used a dozen doughnuts as motivation for behavior in our house. My wife and I will sometimes use a dozen Bosa doughnuts as a reward if we clean the house on Friday evening, thereby freeing up our weekend to do fun stuff.

      Sausage may be an even better incentive though. There is something magical about that breakfast meat. It is unrivaled. (Though I will accept arguments for bacon, misguided as they are.)

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  13. That's an interesting debate for sure. Stefanie was very much in a catch 22 situation. In fact I emailed her and said that personally I wouldn't report it because it's not worth it. But I guess she had to fill out a w-9 so there ya go. Yes it's going behind the system's "back," but that just seems ridiculous.

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    1. I agree, Tonya. In a way, that is the behavior the system is nudging people towards: to simply not report the income.

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  14. It's hard to judge if we aren't in someone's shoes. However, it makes perfect sense to act in a financially rational manner.

    I think government incentives will continue to grow, and we should look at the positive side of things: no longer a need to work as hard or as long for our money any more. The ACA subsidies are awesome for early retires!

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    1. That's a clever point, Sam. Maybe it's better to just accept the incentives as they are, and to benefit from them, rather than hoping the system will be changed.

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  15. ahh, you mention EITC but I was going to talk about that! EITC actually WORKS. I wish the government would do more things like EITC to get people motivated to earn MORE.

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    1. Hi Tara,
      I'm glad you're an EITC supporter, too. I think that's the subject of a future post. One of these days I'll actually have to write about personal finance, rather than these random tax/benefit programs.

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  16. I have to agree with EcoCatLady that there are strong political forces at work that prevent scientific knowledge from being used in a good way for social and fiscal engineering.

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    1. You're probably right, Bryce. I don't want to admit that these programs are political footballs, but I'd be pretty naive to think otherwise.

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  17. Well articulated Done By, I think in the US, the incentives have been misplaced by dependency. Why work 40 hours per week for minimum wage when you could just stay home in your Sponge Bob P.J's watching Jerry Springer and collect a minimum wage check. The more dependent you are the more they have your undivided attention.

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    1. Hi Jim,

      I agree that the benefits themselves ironically provide a disincentive to work for a low wage job. The authors noted that since most of the jobs being taken by recipients were just a dollar or three above minimum wage, there was a good chance they'd return to traditional welfare once the SSP incentive went away. It might be more beneficial to keep the incentive to place longer (or indefinitely, depending on the wage), from a bottom line perspective.

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  18. I read that post, too, and loved it. Like many others, I think this system is flawed in this way for this program and across others. The Canadian study shows what behavioral psychologists have been saying for years: positive reinforcement is almost always going to yield better results that negative punishment.

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    1. Hi femmefrugality,
      I am intrigued by behavioral psychology and try to write about it when I can. But I am still pretty ignorant of the subject, unfortunately.

      More carrots, less sticks, sounds like a good approach.

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    2. That's pretty much exactly it haha.

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  19. Thank you for the detailed analysis on the unemployment benefits. I am officially unemployed today, so I filed for those benefits. We will see how the system works. I do agree that many of the benefits offered out there by the government are not necessarily encouraging the behavior in the right direction. Same goes for food stamps. I have seen people buying a cart load full of junk food with the card rather than real food (bread and milk). I assume the assistance program was created to feed people with food, not junk that can give them a heart attack.

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    1. Hi Mrs. Y,

      It's great to get the perspective of someone utilizing the benefits. I'd love to hear about your experience with the system.

      The program of food stamps is another tricky one. What's the incentive to buy the right food (or, to stop receiving benefits)?

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  20. Wow, that's a rather interesting study. At a basic level, I like to believe that incentives like that do work, so it's encouraging to see empirical evidence that it does. I wonder what we could apply from this sort of study to the average Canadian/American. Is there a better way to incentivize the average individual to save more money and use less high interest credit? It opens up a world of possibilities...

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    1. Hi Cash Rebel,

      I wonder the same thing. I do think that in the realm of retirement planning, the government has tried to give some pretty strong incentives to save: the 401k and IRA programs provide potentially huge incentives over time. I don't think the average American really understands the impacts of those incentives fully though. Additionally, since compounding interest provides a terribly long timeframe until the saver sees the real benefit of tax free or tax deferred growth, it may not be as effective at driving behavior.

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  21. Fascinating study and post. I've always thought that financial incentives and motivations played a large role in determining the behavior of someone. With benefits such as welfare and unemployment, I do feel that people need to be encouraged to work and discouraged from not working. My co-workers have stated things like, "why would someone just want to be unemployed, of course they're trying to improve their lot in life." I might be cynical, but I tend to disagree. There really needs to be financial incentives and disincentives worked into our social benefits program to prevent abuse.

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    1. I think your skepticism might be warranted, Andrew. Especially since the jobs these individuals might be able to obtain in the short term may not pay that much more than the benefits themselves. That is to say, in the traditional system in which a dollar gained reduces benefits by a dollar, the worker would need to find income well above the level of the benefits before it's worth his or her time. If you can only earn an extra $40 per week over your benefits, the delta means that you'd be only gaining an extra dollar per hour of full time work. That's a terrible ROI...I'd be tempted to just do nothing and keep getting benefits.

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