(This essay was published in Hong Kong Economic Journal on 22 May 2013)

 

I know of no modern society that claims it is unwilling to alleviate poverty and assist the poor. Yet very few have succeeded in doing so. The greatest effort applied by a government to alleviate poverty in its own society was made by US President Lyndon Johnson (1963-69). He launched the Great Society Programs to restructure American society, with the ultimate goal being, in a nutshell, to assist the poor and create a more egalitarian society.

 

Half a century later, most observers and analysts would consider the accomplishments of the Great Society Programs to be at best very modest; many would call them an outright failure. The late Professor Peter Drucker, widely acknowledged as the world’s leading management guru until his death in 2005, considered their failures as inevitable. He believed most governments could not alleviate poverty for a variety of reasons. One was that government was already doing too many things and so a poverty alleviation program would accomplish nothing except the expenditure of money.

 

To have any impact at all, such a program requires the hard work and dedication of a small number of first-rate people. Such people are always in short supply and there may be enough first-rate people for only a very few social programs at any one time. Drucker endorsed the opinion of two of the most successful entrepreneurs of social programs – Arthur Altmeyer the father of America’s Social Security Program and David Lilienthal the builder of the Tennessee Valley Authority – that there were at most enough first-rate people available at any one time in any one country to launch one major social program. Under the Johnson Administration the US in four short years tried to launch half a dozen schemes while it was also fighting the Vietnam War.

 

Unbundling a Hard Problem

 

Drucker’s wisdom in management matters should not be ignored or dismissed. To take poverty alleviation seriously, Hong Kong must correctly define the poverty problem that it wishes to address Today there is no lack of politicians and interest groups who proclaim they are eager to help the poor. Each of them advocates a few favorite projects and supports the pet projects of other like minded politicians and interest groups. One approach would be to accept their arguments for addressing the poverty problem. This would be a huge mistake.

 

The temptation for government is to support a large collection of these advocated projects by providing some financial support to each of them. The aggregate amount of funding spent on all the programs taken together could be quite impressive. The government could then claim it had tackled the problem of poverty in a major way with a huge commitment of resources. This would be the politically astute thing to do if the government were looking for immediate short-term results, but it would be almost destined to fail as a public effort to alleviate poverty.

 

Poverty is a hard problem to tackle. If it were easy it would have been solved a long time ago. In this essay I highlight a few main thoughts about how to approach the problem of poverty and its alleviation. In subsequent essays I shall consider a fuller set of strategies to alleviate poverty.

 

Poverty studies are so numerous that one cannot hope to read even a small fraction of what has been published even in an entire lifetime. Most poverty studies try to explain what causes poverty. The not-so-surprising finding is that there are many causes. This naturally leads to multiple programs to attack each of the causes. My colleague at the University of Hong Kong told me he recently counted 221 government programs in Hong Kong providing different benefits to people who are presumably in need of assistance. Inevitably there will be overlap among programs. Since programs once created by government seldom if ever die, the number of programs will continue to multiply over time.

 

Program Overlap Reduces Efficiency

 

The growth in programs will naturally lead to a growth in the overlap of benefits. Attempts to reduce the overlap will result in increasing regulatory and bureaucratic complexity and costs. A growing share of the resources that go into poverty alleviation and other social programs is absorbed by the cost of administering and regulating these programs. As the programs expand in scale and scope, the fraction of resources that is actually received by the client as benefits often becomes smaller over time.

 

Poverty alleviation programs may adopt different approaches to tackle the problem. Some try to be preventive, others curative, and some aim to be remedial. A program to promote workplace safety could reduce crippling worker accidents that are often a cause for a family to sink into poverty. A program to subsidize education is curative if it helps members in a poor family to augment otherwise unaffordable human capital. A program to subsidize expenditures can provide remedial support for poor families that cannot afford expensive housing and medical expenses.

 

These different approaches attack different aspects of the causes of poverty and some deal with its consequences. Some produce immediate short term results, but others will not yield any results until the very long-term, often only in the next generation. A government that wants immediate results is not keen to wait for long-term solutions. Unfortunately the track record shows the introduction of more new programs does not yield better results.

 

The Negative Income Tax Solution

 

It was against this background many economists endorsed a proposal by conservative free market economist Milton Friedman to introduce a negative income tax scheme. They believed this would be a much more cost effective scheme to assist the poor than the plethora of government-administered, overlapping programs that exist in a modern society. Even economists like Paul Samuelson, Robert Solow and James Tobin, who strongly disagreed with Milton Friedman on almost all other policy issues, openly endorsed the negative income tax.

 

The scheme is primarily a remedial scheme (although there may be some preventive and curative elements as well) to provide poor individuals with monthly income support. Its goal is to guarantee a minimum level of income for everyone, which is financed through taxes.

 

Friedman’s negative income tax proposal can be explained using a simple example. Suppose a government with the support of society sets a minimum level of guaranteed income for each individual at $5,000 per month. A family of four would therefore be entitled to income support of $20,000 per month. If this family has no earnings at all the government would provide this level of income support.

 

If the family earns some income then it would be expected to contribute a percentage of that earned income to offset the income support provided by the government. Let us assume that the government with the support of society sets this percentage at 50%. Income from the ownership of assets, with the possible exception of self-occupied homes, would be treated as contributing to earned income and factored into the calculations to offset government provided income support.

 

So if the family earns $10,000 per month then the government would deduct 50% of its earned income from the entitled income support and provide only $15,000 per month. The family’s total income would be $25,000 = $10,000 (earned income) + $15,000 (government income support). Table 1 below illustrates the amount of government income support and the resulting total family income that would be received by the family at different levels of earned income. When a family of four earned $40,000 per month the government would no longer provide income support.

 

Table 1:       Total Family Income and Government Income Support under a Negative Income Tax – An Example

 

Earned income Government provided income support Total family income
$0 $20,000 $20,000
$10,000 $15,000 $25,000
$20,000 $10,000 $30,000
$30,000 $5,000 $35,000
$40,000 $0 $40,000

 

Milton Friedman and other economists were well aware that a negative income tax scheme would have some disincentive effects on work effort and reduce the total economic pie. But they considered its simplicity and low administration cost to be superior to the large multitude of overlapping poverty alleviation programs and were willing to tolerate the disincentive effects.

 

They also believed that one of the huge costs of having a large multitude of social programs is the wastage of administration manpower. For them, hiring an increasingly large number of people to administer poverty alleviation programs in both government and non-government organizations was an important inefficiency. The saved manpower could be more gainfully employed in economic activities to increase the economic pie and therefore make a direct contribution to poverty alleviation in another manner.

 

Despite widespread support among economists the negative income tax has not been adopted in the US. Strangely, the concern about the disincentive effects on work effort was put forward as the main reason for not adopting it even though economists were much less concerned about this. Some observers believe this was an excuse and the real reason was that many social service providers feared that their programs would be threatened.

 

High Tax Burden of the Universal Social Pension Scheme

 

The US has instead introduced a modified version of the negative income tax – the earned income tax credit scheme. The two schemes are essentially the same except under the earned income tax credit scheme, the government provides income support contingent on the person receiving an income. The recipient therefore has to be employed in order to benefit from the scheme. The limitations of this are obvious. It fails to provide adequate support to many families who need support – namely those that have members who do not work including children, women who are homemakers, and the retired elderly.

 

A means-tested old age allowance is similar in spirit to the negative income tax proposal, except that it applies only to the elderly population who are mostly retired and without earned income, except for those with asset income. A universal social pension scheme with payouts for everyone, on the other hand, does not target its payments to the poor. It is designed to give money indiscriminately to everyone regardless of whether they are poor or not. As a measure to alleviate poverty among the elderly it is wasteful.

 

A universal social pension scheme funded through taxation can of course have population wide income redistribution effects. Presumably those who pay taxes will fund the scheme and those who do not pay taxes will become net beneficiaries. However, tax induced population wide income redistribution has well known disincentive effects on work effort similar to the negative income tax.

 

Moreover, funding a universal pension scheme through taxes has spillover effects to the rest of the economy.  A well-known result from economics is that higher tax rates have larger disincentive effects, create bigger economic distortions and lead to a smaller economic pie. The amount of damage to the economy rises exponentially with increases in the tax rate, so when the tax rate doubles the cost to society rises by more than double.

 

Funding a universal pension scheme is many times more expensive than funding means-tested old age allowances. Not only are there more individuals to support, but the larger numbers will mean higher tax rates, which in turn has serious impacts on work incentives and distorts economic activity. More importantly too many people are helped who are not poor. All of this leads to a smaller economic pie. Given these circumstances, there is little justification for introducing a universal pension scheme.

 

From Social Burden to Opportunity

 

Coming back to the negative income tax, it is worth noting that although it was intended to alleviate poverty without having to rely on a large plethora of social programs, it was not intended to replace them totally. There will always be a demand for specific curative and preventive programs to alleviate poverty. These usually are offered on a sustained basis or only yield results over the long-term. In many societies housing, education and medical care often require very expensive subsidies in one form or another to help the poor cover expenses not adequately supported through a negative income tax scheme.

 

Some economists have proposed offering housing, education, and medical care vouchers directly to the poor to further enhance their purchasing power. Unfortunately in Hong Kong, these services are largely funded by providing subsidies to service providers rather than to selected clients. As a consequence, everyone in society has access to these services at the same subsidized prices. This  funding approach is a historical legacy and it naturally leads to an explosion of demand because the services are open to all and not sufficiently targeted at the poor.

 

Meeting the demand for these heavily subsidized services requires a major public expenditure and leads inevitably to the rationing of access. The demand therefore is unsatisfied and this fuels political discontent over time.

 

Reforming the social sector, however, is difficult and politically divisive. There will inevitably be an increasingly huge burden on society in the decades ahead as the demand for social programs continues to grow. If things remain in their present form, the additional resources shifted into publicly funded social programs will mean that the economic pie will contract at an even faster rate. Our ability to pay for these social services will become increasingly challenged.

 

A negative income tax provides a good solution for Hong Kong to address its poverty problem in an efficient and less costly way. It provides immediate political support for government to find breathing space to negotiate difficult-to-reform social programs, and to devise and implement new approaches to funding and organizing social programs that is sustainable in the long run.

 

Unlike Macau’s economy we cannot pay everyone income support every year. Macau’s solution does not work well either, even if they can afford it, because it lacks essential social programs to assist the poor that cannot be helped by government provided income support alone. Targeting assistance specifically to the poor is important in every society. This is the only way it can be economically sustained in the long-term. Long-term political support for alleviating poverty can only be found provided it is economically sustainable. Alleviating poverty needs to give priority to long-term solutions that do not necessarily produce immediate results.

 

In my next essay, I shall consider a framework for funding and organizing social programs and services that can be economically sustainable. This will supplement a negative income tax scheme and the two together will provide both short-term and long-term solutions that are economically and politically sustainable for alleviating poverty in our society.

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