Home Business & Finance Principles of Public Finance
Private agents may behave rationally or myopically. It is important to know the degree to which people consider the future. If people are myopic and do not pay much attention to the future, they consume a great deal in the present and save little. By so doing, they may become poor in the future. Then, they may become recipients of social welfare programs.
If they are rational and have perfect foresight and expectations, they save for the future; hence, they do not become recipients of social welfare programs.
The government cannot know who is really poor and needs a subsidy from them. If a social welfare program is too generous, it may benefit those who should not be eligible. However, if it is too strict, it may not help the poor who really need the subsidy. It is often said that reported income does not necessarily reflect true income.
Income is defined by revenue minus cost. For employees it is easy to distinguish revenue from income since the earning cost is clear for then. However, for selfemployed people, earning costs are closely related to living costs, so that tax authorities have difficulties identifying true earning costs. If earning costs are over-reported, reported income is underestimated. In such a situation, the government cannot identify true income and hence the true poor.
When society has a culture of shame attached to becoming a subsidy recipient, the poor do not like to receive the subsidy. Then, redistribution tends to be too small. However, if society has a culture that promotes the right to become a subsidy recipient, many people are content to receive the subsidy. Thus, redistribution becomes too great.
It is important to terminate the period of benefits in order to avoid a moral hazard problem. A typical example is unemployment insurance. When an agent is unemployed and does not find a new job for a long period, it may be hard to terminate the benefit simply because the payment period is due to end. Politically, the government may extend the period of termination. If so, people may not have an incentive to seek a new job.
Without commitment, those who could have found a job may not do so and may continue to receive unemployment benefit in the long run.
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