Why In-Kind Benefits?

Janet Currie, Firouz Gahvari 17 December 2007

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Economists have long been concerned with the state’s role in bringing about a just distribution of income. The fact that many governments choose to conduct significant redistribution through in-kind rather than cash transfers is an enduring puzzle. Economic theory suggests that the recipients of in-kind transfers would generally be at least as well off and often better off given the equivalent amount in cash.

Table 1 provides some evidence regarding the percent of GDP that is devoted to five types of in-kind programs in OECD countries. The largest share of public in-kind spending concerns health care, followed by education. But child care, housing, and active labour market programs are also important. Most countries have some form of food subsidy program (such as a school lunch program) as well, although the OECD does not track public expenditures on these programs so they are not included in Table 1.

Table 1: Public Expenditures on Five In-Kind Programs, Selected OECD Countries  
  Health   Housing   Child Care   Education   Active Labour Market  
  %GDP 2002   %GDP 2001   %GDP 2003   %GDP 2003   %GDP 2001  
Australia 6.1   0.1   0.4   4.7   0.1  
Austria 7.6   0.1   0.6   5.1   0.1  
Canada 6.7   ..   0.2   5   0.4  
Denmark 7.3   0.7   1.6   7.3   0.2  
France 7.9   ..   1.2   5.2   0.4  
Germany 8.4   ..   0.4   4.2   0.3  
Ireland 5.4   0.5   0.2   4.3   0.4  
Japan 6.5   ..   0.3   3.3   0.1  
Netherlands 5.6   0.4   0.5   4.7   0.4  
Portugal 6.5   ..   0.8   5.3   0.1  
Spain 5.2   0.2   0.6   3.8   0.4  
Sweden 7.7   ..   1.2   7   0.2  
United Kingdom 6.4   1.5   0.6   5      
United States 6.6   ..   0.6   5.3   0.2  

Notes: Dots indicate share is less than .1% of GDP. Child care also includes pre-primary education. Education includes primary, secondary, and tertiary. Active labour market policies include, but are not limited to job training and search assistance. See Currie and Gahvari for sources.

Separation device

A popular economic justification for in-kind transfers is based on the idea that governments want to target transfers to the needy for efficiency reasons, but that they cannot accurately identify the poor. Hence the government must rely on individuals to self-identify as needy. If cash is offered, all individuals have an incentive to claim they are poor, making cash subsidies an inefficient tool for targeted transfers. In-kind transfers can serve as a separation device. This is the so-called "self-targeting" property of public provision. Nichols and Zeckhauser (1982) were the first to apply this idea to the provision of in-kind transfers.

But it is difficult to find with examples of large-scale transfer programs that are purely self-targeted. Although many programs have elements that are designed to get recipients to self-select , the authorities still expend considerable resources determining eligibility, and most recipients are required to document their eligibility at regular intervals. Moreover, attempts to differentiate between the needy and others by imposing transactions costs that only the needy will bear run the risk of screening out many truly deserving recipients.

A second potential explanation for in-kind transfers views them as a way of improving the efficiency of the tax system. The idea is that taxes distort labour supply, but that the provision of in-kind goods that are complementary to labour might mitigate this distortion. In Currie and Gahvari (2008) we argue that this is unlikely to be the main motivation for most of the programs we consider. For one thing, many programs count the elderly as their primary beneficiaries, even though most elderly are no longer participating in the labour market. And there are many examples of in-kind programs that discourage labour supply by creating large “notches” in budget constraints. At a notch, a household that increases earnings by $1 may lose much more than $1 in benefits when the value of in-kind benefits is correctly accounted for (see Blundell and MaCurdy 1999 for some important examples).

Samaritan's dilemma

A third explanation for in-kind programs is the Samaritan's dilemma, introduced in the literature by James Buchanan (1975). Bruce and Waldman (1991) provide an illustration in which current transfer recipients are entitled to receive benefits as long as they are poor. This undermines their incentives to invest in activities that will raise their income since they bear the costs of such investments, but not the benefits. It is assumed that the government cannot credibly commit to end benefits for poor who do not invest, so the equilibrium is one in which the poor do not invest and the government continues to support them.

One way out of the dilemma is to invest directly in the education of the poor in an attempt to enhance their human capital. Cash aid can also be tied to other benefits that will improve the human capital of the recipient. The conditional cash transfer programs that have become popular in many developing countries can be seen as a response to the Samaritan's dilemma. In these programs, parents are usually required to consume another benefit, such as sending their children to school or to medical clinics, in order to receive their cash benefits. Still, while these programs are gaining a foothold in OECD countries, they are still the exception rather than the rule, so that the Samaritan’s dilemma cannot be regarded as a general explanation for in-kind transfers.

A fourth explanation involves pecuniary effects. The government can lower the price of the publicly-provided good by pushing up its supply. The government might wish to do this in order to achieve a policy objective in addition to redistribution. Public housing policies that aim to preserve low or moderate income housing in expensive urban areas can be seen as one example. However, government programs may also raise prices. Programs that purchase food and redistribute it may be seen as a form of agricultural price support. Finkelstein (2007) provides evidence that the introduction of the US Medicare program (public health insurance for the elderly) has driven up medical costs by making the elderly, who are the largest consumers of medical care, insensitive to price.

Fifth, the policy literature often discusses politics as a reason that transfers are supplied in-kind. For example, in the debate over welfare reform in the US, there were proposals to "cash out" the Food Stamp Program (FSP). However, these proposals were resisted by an unlikely coalition of agricultural interests (who have always supported the program) and advocates for the poor, and the program escaped the radical restructuring that befell cash transfer programs. By focusing on particular goods, in-kind programs can create political constituencies in addition to those who are the recipients of the transfers. Political arguments are also used to justify the appeal of universal in-kind transfer programs.

Unfortunately, most theoretical treatments do not explicitly distinguish between cash and in-kind transfer programs.

Paternalism

With the possible exception of political economy arguments, it seems unlikely that any of the explanations given above provides a sufficient justification for the wide variety of benefits that are offered in kind. The traditional justification for in-kind transfers has been "paternalism." Paternalism has different formulations in the literature. One useful example involves inter-dependent preferences. If members of society care about the consumption patterns of the poorest rather than their utility, then the unconstrained choices of the poor may create negative externalities for those who care about them. “Specific egalitarianism,’’ the idea that while income inequality per se may be acceptable, all individuals should receive adequate food, medical service, and housing, is also a form of paternalism. Paternalistic arguments assume particular force when the intended recipient is a child but the transfer goes to parents. Parents may not take full account of the utility of their children when making decisions, or they may neglect to factor in externalities. For example, suboptimal spending on children's education may lead not only to poorer prospects for children and their parents, but also to slower future economic growth.

A related hypothesis that has received little attention is that in-kind transfers are an attempt to redistribute from parents to children within the family. This can be done by transferring items that benefit children in amounts greater than those that would have been purchased by parents out of the equivalent cash transfer. Why would the government try to override the parent's preferences? A classical utilitarian answer could be that the kids enter separately into the objective function of the social planner and do not simply enter through their effects on the parent's utility functions, which is of course consistent with paternalism.

Alesina, Glaeser, and Sacerdote (2001) argue that racism is an important reason for the relative lack of political support for cash transfers in the US since transfers go disproportionately to black families. They argue that while many European countries also have sizeable minority populations, US blacks are more disadvantaged relative to the average citizen than most European minority groups. They also argue that political institutions in the US (such as the primacy of the courts), as well as features such as a relatively dispersed population, have diluted the political power of the poor in the US relative to Europe. The idea that racism is central to the way that the US transfer system has evolved, suggests an interesting twist on paternalistic arguments about the role of transfers—perhaps the US system’s reliance on in-kind transfers reflects a sense that the poor cannot be trusted with cash. The US experience with a large, persistently underprivileged minority may be salient for a Europe facing the rise of an immigrant underclass.

Finally, social insurance constitutes an important element of government redistributive programs. They are often justified on the basis of failures in markets dealing with risk due to the asymmetric information between agents. However, social insurance does not have to take the form of in-kind benefits, so that this literature is largely silent on the question of why benefits are delivered in-kind rather than in cash.

Economists appear to feel that paternalism is either too simple or too unattractive a rationale for large scale government programs. Hence, they have expended considerable creativity positing other explanations. A hard look at existing programs suggests that many of these alternative explanations have merit in particular cases. But it is hard to escape the conclusion that paternalism remains a fundamental underlying rationale for in-kind transfers. It is likely that in this far from perfect world, there is a legitimate role for in-kind transfers. If that role is largely paternalistic, then it brings three policy questions sharply into focus: When, and for which groups, is paternalism justified? Who decides on the bundle to be delivered in-kind? And how can we know when the efficiency costs of in-kind transfers outweigh the benefits of ensuring that the chosen groups receive the chosen bundle? The answers to these questions are key to improving the equity and efficiency of the in-kind transfer system.

References

Alesina, Alberto, Edward Glaeser, and Bruce Sacerdote. 2001. Why Doesn't the U.S. Have a European Style Welfare State?Brookings Papers on Economic Activity, Fall, 187-278.

Blundell, Richard and Thomas MaCurdy. 1999. Labor Supply, Orley Ashenfelter and David Card (eds.) The Handbook of Labor Economics (Amsterdam, North Holland).

Bruce, Neil and Michael Waldman 1991. Transfers in kind: Why they can be efficient and nonpaternalistic. American Economic Review, vol 81, 1345-1351.

Buchanan, James M. 1975. The Samaritan's dilemma. In Edmund

Phelps, ed, Morality, and Economic Theory. New York: Russell Sage, 71-85.

Currie, Janet and Firouz Gahvari. 2008. Transfers in cash and in-kind: Theory meets the data. The Journal of Economic Literature, forthcoming.

Finkelstein, Amy. 2007. The Aggregate Effects of Health Insurance: Evidence from the Introduction of Medicare, Quarterly Journal of Economics, 122 #1, 1-37.

Nichols, Albert L. and Richard J. Zeckhauser. 1982. Targeting transfers through restrictions on recipients. American Economic Review, vol 72, 372-377.

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Topics:  Welfare state and social Europe

Tags:  Inequality, Poverty, Government Assistance

Henry Putnam Professor of Economics and Public Affairs, Princeton University

Professor of Economics at the University of Illinois at Urbana-Champaign