Book Review: The Redistribution Recession

The Redistribution Recession: How Labor Market Distortions Contracted the Economy by Casey Mulligan, an economist at the University of Chicago, looks at the extent to which Americans will withdraw from the work force if you pay them to stay home and not work. This is kind of a companion piece to my review of Peter Wallison’s book on what caused the Collapse of 2008. Wallison asks “Why did things fall apart?” and Mulligan asks “Why can’t Americans put their economy back together [in less than 7 years]?”

The book is written for professional economists but readable for anyone with an undergraduate Econ 101 background.

If you live in an expensive city and are acquainted with families collecting welfare the book confirms what you might have noticed, i.e., that it would be irrational for the adults in the family to enter the workforce. Here in Cambridge, Massachusetts, for example, the welfare families that I have spent the most time with occupy apartments with a market rent of about $4,500 per month ($54,000 per year in post-tax income) in a building with a swimming pool, two gyms, and a variety of other luxurious facilities. Their health care is free through some combination of Medicaid, Obamacare, and a city-run health system. Their food is mostly free through food stamps. They can get cash from TANF and some similar programs. They would need to earn at least $160,000 per year pre-tax to obtain the same standard of living at market prices. However, even if someone were to offer the adults in the family a $160,000 per year job it would not be rational for them to accept it. If they were ever to lose that job it would take many years of paperwork, bureaucracy, and waiting lists to get back to their current welfare lifestyle.

Able-bodied American adults who live off alimony and child support, as chronicled in Real World Divorce, face a similar situation and, according to the attorneys we interviewed, respond similarly. If an adult tapping into a former spouse or sexual partner gets a high-paying job there is a risk of the defendant going to court and getting the payments reduced due to a lack of need. If the job were lost for some reason it is possible that the original cash flow might never be reestablished.

Mulligan makes some attempt to model these high switching costs and long switching delays with (a) a “model of take-up” of government benefits (Appendix 3.2), and (b) program participation weights, which make a dollar of assistance worth less to the recipient than a dollar of cash picked off the sidewalk. But the core of Mulligan’s analysis is that income-based government handouts function as a high marginal tax rate in that if the low-income person earns a bit more he or she qualifies for fewer government benefits and therefore has only slightly more spending power than before. Mulligan looks at the 2009 expansion of means-tested welfare in at least the following areas:

  • unemployment benefits
  • food stamps
  • mortgage forgiveness
  • non-mortgage debt forgiveness
  • health insurance subsidies (Obamacare; not yet implemented during the period of Mulligan’s analysis)

Underlying Mulligan’s work is an assumption that policymakers (and family court judges) reject:

A basic economic principle in this chapter, and much economic analysis of the labor market, is that the pecuniary reward to working is an important determinant of how much people work. When social programs increase what they pay to someone who does not work, they diminish this difference, and the result is that some people work less.

Nobody who believed in this principle would offer to pay people to sit home and play Xbox for 99 weeks (January 2011 posting and January 2013 follow-up citing economic analysis). Yet that is apparently what the American people wanted their elected government to do. Thus it may be the case that Mulligan’s book will have limited impact because more than half of Americans disagree with the assumption that payments to non-workers encourage non-working.

Mulligan makes some effort to justify this assumption:

Before the recession began, well over one hundred million Americans were not working. To be sure, some of them could find no reward in the labor market and would be stuck without gainful employment no matter how lean the safety net got. But many others were not working by choice. We all know skilled stay-at-home mothers or fathers who could readily find a job but believe that the pay from that job would not justify the personal sacrifices required. They are examples of people who deliberately do not maximize their income. Others are people who turn down an out-of-town promotion in order to avoid relocating their family, and workers who eschew higher-paying but less safe occupations. Earning income requires sacrifices, and people evaluate whether the net income earned is enough to justify the sacrifices. When the food stamp or unemployment programs pay more, the sacrifices that jobs require do not disappear. The commuting hassle is still there, the possibility for injury on the job is still there, and jobs still take time away from family, hobbies, sleep, etc. But the reward to working declines, because some of the money earned on the job is now available even when not working.

And he cites research that tries to put numbers on the correlation between increased welfare and reduced working hours:

Decades of empirical economic research show that the reward to working, as determined by the safety net and other factors, affects how many people work and how many hours they work. To name a small fraction of the many studies: Hoynes and Schanzenbach (2012) show how potential participants stopped working or reduced their work hours when the food stamp program was introduced. Studies of unemployment insurance (see Appendix 4.2) find that program rules have a statistically significant effect on how many people are employed, and how long unemployment lasts. Yelowitz’s research (2000) shows how a number of single mothers found employment exactly when, and where, state-level Medicaid reforms increased their reward from working. Gruber and Wise (1999) and collaborators show how the safety net for the elderly results in less employment among elderly people. Autor and Duggan (2006) and the Congressional Budget Office (2010) explain how the number of disabled people who switch from work to employment-tested disability subsidies depends on the amount of the subsidy relative to the earnings from work. Murphy and Topel (1997) show how poor wage growth among less-skilled men helps explain their declining employment rates during the 1970s and 1980s. Jacob and Ludwig (2012) show that means-tested housing assistance reduces labor force participation and earnings among able-bodied working-age adults.

But most of the book assumes that readers are convinced by Econ 101 that economic incentives will change peoples’ behavior and proceeds with analysis based on that assumption.

If you’re wondering why you can’t get anyone to come over and fix your roof when supposedly millions of Americans are unemployed, Mulligan explains:

Traditional labor and macroeconomic theory predicts that marginal labor income tax rates and binding minimum wages distort the labor market and thereby reduce aggregate labor usage, reduce aggregate consumer spending and investment, and, in the short term, increase wages, labor productivity, and the usage of factors that can take the place of labor hours. As a result of greater labor productivity, part of the population—those (if any) not subject to the marginal tax rates or minimum wages—actually works more, even while aggregate work hours are less.

In other words we’re trending toward a society where about half of the working-age adults will kill themselves with 60-80-hour weeks while the other half will relax on the sofa.

Just how much has the welfare state expanded?

With the exception of Medicaid, subsidies flowing to the unemployed and to financially distressed households in the forms of consumer loan forgiveness and government transfers almost tripled after 2007. A minority of that increase is due to an increase in the number of people who would have been eligible for subsidies under prerecession rules, and a majority is the result of more than a dozen changes in benefit rules made possible by several new federal and state government statutes.

Mulligan says that “businesses perceive labor to be more expensive than it was before the recession began” and that’s why they aren’t hiring a lot of workers. Shouldn’t we then see a huge spike in capital spending as companies buy robots to replace the former human employees? Mulligan gives us the academic version of “no”:

Assuming, as economists usually do in aggregate analysis, that capital enhances the productivity of labor, and labor enhances the productivity of capital, then the efficient reaction to less labor is to have less capital. Investment is the rate of change of the capital stock, so even small reductions in the capital stock may be achieved by large investment reductions for a short period of time. For this reason, investment is expected to decline by a much greater percentage than consumption in the short term, and by the same percentage in the long term. In this view, the investment decline is entirely a reaction to the labor market, and not a cause of the low rates of labor usage.

Welfare is not equally available to everyone, however, and Mulligan digs into the demographics. Single mothers are in the best position to get cash without working. Custody of their child can yield payments from the father (over $100,000 per year tax-free if they use the information in Real World Divorce thoughtfully). If they didn’t choose a high-income father for their child(ren) then “Single mothers are much more likely than [married women without children] to be eligible for SNAP, Medicaid, and other means-tested government programs when not working because (1) they do not have a spouse present whose income by itself would likely put household income above FPG and (2) the latter group has no children (children are the target of a number of means-tested programs).” Mulligan finds that American women behaved in accordance with Econ 101. The married women who could not get welfare worked similar hours to their 2005-2007 hours. Single mothers, however, even those with at least some college education, dramatically reduced their working hours as welfare became more lucrative.

What about old people? Mulligan notes that they actually increased their working hours in response to the recession due to a lack of new welfare programs available to the elderly: “marginal tax rates [including the tax-like effect of reduced welfare eligibility] for the nonelderly increased sharply, while marginal tax rates for the elderly hardly changed.”

What about the minimum wage discouraging employment from the employer side? Mulligan looks at this carefully: “My 2011 paper (Mulligan 2011c) estimated a monthly time series model of national part-time and full-time employment per capita for each of twelve demographic groups distinguished according to race, gender, and age, relative to prime-aged white males, whose employment rates were assumed to be unaffected by the July 2009 minimum wage hike. I used the model to estimate the amount and composition of employment losses due to the hike for the average month between August 2009 and December 2010, and found that lower-skill groups had the greater employment losses. The net nationwide employment loss estimate was 829,000, which includes employment gains among more skilled people. … Thus, the minimum wage hikes since July 2007 might explain about roughly one-third to one-half of the employment decline among persons aged sixteen and over who were neither elderly nor household head or spouse.” [Personal experience: I have taken on a recent high school grad (friend’s son) as an intern in my web development business. He was an above-average student in a Harvard University intro CS class and also completed AP Computer Science in high school plus an additional programming class. His current productivity is about 1/100th of a $25/hour Ukrainian or Filipino contract programmer so any wage+benefit package above 25 cents per hour would be above the market-clearing price. Yet he can never reach the productivity of the foreign contractors unless he can get substantial work experience.]

Mulligan tells us that employers don’t want to pay more for workers with the same skill level: “To the extent that wages and other employment costs increased since 2007 without a commensurate increase in total factor productivity, it is no puzzle that employers do not want to return to the number of employees they had before the recession began. Wages and employment costs have been greater since 2007 in part because of the federal minimum wage hikes, but more significantly because the safety net expansions have given employees, and prospective employees, less reason to accept reductions in their compensation.”

One of the biggest surprises in the book is the importance of federal mortgage loan forgiveness: “This chapter shows how all of these outcomes, and more, may be a direct result of stark incentives created by the FDIC and HAMP programs (hereafter jointly referenced as FH) and their practice of targeting the ratio of housing expenses to borrower income. The FH programs offer modifications on the basis of borrower income reported to the United States Internal Revenue Service. The first section of the chapter shows how the programs resemble government safety net programs, except that the marginal income tax rates from mortgage modification far exceed 100 percent in some instances.” It turned out that a person’s mortgage payments would be reduced by $1.31 for every $1 fall in income. In other words a lower-income American with a mortgage would have more spending power by working fewer hours and/or quitting altogether. Mulligan also notes that as the program was unfavorable to lenders they had a huge incentive to “promote borrower confusion and uncertainty about the disposition of their modification application.” (i.e., the bureaucratic run-around might not have been accidental!)

How about the theory that spreading cash around to low-income Americans will grow the economy because low-income people spend all of their cash instead of saving any? Mulligan points out that this may not be true in practice: “… some of the most labor-intensive industries are hotels, coal mining, and restaurants, whereas farm commodities and cell phone services are some of the least labor-intensive. If the safety net redistributes resources from people who spend a relatively large fraction of their resources on restaurants and hotels toward people who spend a large fraction on groceries and cell phone services, the redistribution may well reduce national labor demand rather than increase it. … The fact that unemployed people tend to consume their benefits when they receive them is an important indicator of the insurance benefits of the UI program, because it tells us that the benefits are especially important for maintaining their living standards (Gruber 1997). But this fact is irrelevant for understanding aggregate labor demand, unless it happens to be that the consumption items purchased by the unemployed are more labor-intensive in their production than are other goods and services in the economy. … it is possible that the poor use their safety net benefits to purchase consumer items that are of less-than-average labor intensity, and the rest of the country reduces spending on labor-intensive items, so that the net result of redistribution is to reduce aggregate labor demand.”

Mulligan considers a theory popular among pro-handout politicians and their non-economist supporters: “safety net expansions do not prevent people from finding jobs during a recession because there are no jobs to be found.” He points out that “This exposition is literally untrue because millions of jobs were found every month during the recession (de Wolf and Klemmer 2010), but I take it to mean that good jobs are difficult to find during recessions. But a lack of good jobs might mean that the safety net is even more potent at keeping people from working during recessions because safety net benefits look more generous when compared to the pay from a bad job than when compared to the pay from a good job.” He then tests the theory carefully by looking at the seasonal teen labor market. These young workers become available during Christmas and summers both in recessions and expansions. Mulligan looked at thirteen summers and fourteen Christmases during recessions since 1948 and found that teens were able to get jobs at roughly the same rates in both recessions and expansions. As childless teens are ineligible for welfare this tends to confirm Mulligan’s theory that people who don’t have an alternative way to get cash will resort to finding a job.

With 363 pages of analysis and mathematical models, Mulligan shows that essentially all of what we have observed since 2009 can be explained by the following:

  • many able-bodied Americans will not work if they have a reasonably attractive alternative
  • the federal government, starting in 2009, made not working much more financially rewarding for tens of millions of working-age adults

I have a feeling that the high switching costs and long switching delays to getting back onto welfare are not completely accounted for in Mulligan’s models. Housing, health care, food stamps, and cash don’t automatically start flowing as soon as a job is lost and people hate uncertainty about where their housing, health care, food, and cash are coming from (look how many people are willing to take boring jobs with mediocre pay if they believe that there is very high job security). If the cost and delay of getting back onto welfare were weighted more heavily, Mulligan’s models might show an even larger drop in employment with increased welfare benefits. As it is, however, his model matches pretty closely what happened in terms of employment and capital spending.

This is an important book and deserves to be read by anyone interested in the U.S. economy. There is a lot of interesting information still accessible even to those whose econ/math background isn’t adequate for fully appreciating Mulligan’s mathematical model. And given the political debate around raising the minimum wage to $15 per hour (uncharted territory for the U.S. economy where the historic minimum wage peak was $8.54 in 2014 dollars, reached in 1968 (Pew Research)), the book is highly relevant for policymakers going forward.

More: Read the book.

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9 Comments

  1. RobF

    June 1, 2015 @ 2:14 pm

    1

    Here in Cambridge, Massachusetts, for example, the welfare families that I have spent the most time with occupy apartments with a market rent of about $4,500 per month ($54,000 per year in post-tax income) in a building with a swimming pool, two gyms, and a variety of other luxurious facilities. … They would need to earn at least $160,000 per year pre-tax to obtain the same standard of living at market prices.

    If I’m reading you correctly, you are asserting that aggregate government assistance in Boston is so lucrative that families on the dole live in luxury on handouts that put their effective annual income at 2.5x the Boston median family income (i.e. in the top 15% of Boston households)

    http://www.clrsearch.com/Boston-Demographics/MA/Household-Income

    That doesn’t strike me as remotely plausible, but maybe I’m just naive. Other than the book you are reviewing, can you point me toward some online source that ads detail to the story of upper-class luxury that awaits the bulk of Boston’s unemployed?

  2. philg

    June 1, 2015 @ 2:27 pm

    2

    Rob: You read stuff in the original posting that I didn’t write. I didn’t say that I was a researcher who visited a random cross-section of the Boston area’s welfare recipients. My sample is biased because the welfare families I spend the most time with are those who live in the same apartment buildings as friends of mine (software engineers, biotech executives, company founders, etc.). My friends, since they have reasonably well-paid jobs, are not eligible to live in city-owned public housing complexes.

    As you can see from http://www.cambridgema.gov/CDD/housing/forapplicants.aspx there is a range of options for those who would like to have a taxpayer-funded residence in Cambridge. “The Housing Division administers the Rental Applicant Pool. The pool selects tenants for rental units created through the City’s Inclusionary Zoning Ordinance. These units are located throughout the city in privately owned mixed-income developments.” describes the buildings in which my friends live (they are “mixed-income” because the city would not have approved their construction unless a percentage of the apartments were given to City of Cambridge employees to dispose of as they see fit).

    This is not inconsistent with the household income stats that you cite. For one thing, if you get a taxpayer-funded house, taxpayer-funded medical care, and taxpayer-funded food you are still considered to have “zero income”. Nor is it inconsistent with the Congressional Research Service finding that average welfare spending nationwide exceeds median household income (see http://www.budget.senate.gov/republican/public/index.cfm/2012/12/total-welfare-spending-equates-to-168-per-day-for-every-household-in-poverty ; note that this study tracks spending at the federal level so it might miss a lot of state stuff (is likely an underestimate of welfare spending, in other words) and also that this tracks the money spent not the value received so it overestimates the benefit of receiving welfare). Living in the middle of Cambridge is too expensive for most people in the Boston area (that’s why we have suburbs and exurbs). Therefore it makes sense that a household to whom a family-sized apartment in a prime area of Cambridge has been given would enjoy a higher-than-median lifestyle.

  3. Izzie L.

    June 1, 2015 @ 3:20 pm

    3

    And yet, as we have seen (both from falling birth rates, even among welfare mothers and also from the fact that many women fail to permit their one night stands to become lucrative child support annuities), even large sums of money are no longer sufficient to induce Western women to have more than 1 or 2 children in most cases. We have had to outsource childbearing to Third World countries like most other work in this country.

    The other questions is whether this model is at all sustainable – can fewer and fewer working people support an ever growing non-working population (plus a large army of non-productive bureaucrats and people employed in dealing with governmental compliance matters only)? Is there a breaking point and what is it?

  4. mark

    June 1, 2015 @ 6:56 pm

    4

    Living in a $5,400/month apartment and getting additional TANF money might add up to $160,000 in government spending, but it’s in no way comparable to someone with a $160,000 income.

    The person living in a $5,400 apartment still doesn’t have a job, and while they might have TNAF or SNAP money, it’s largely supplemental, which at best will barely cover living expenses.

    So, while the politician pats himself on the back for fostering diversity in an apartment building (and for spending a lot of taxpayer dollars), very little aid has been given.

    I guarantee you that those living in the $5,400/month apartments would much rather live in a cheaper apartment and have more cash to cover living expenses. They’d also appreciate living in a place where the software engineers, biotech executives, company founders, etc. don’t sneer at them. Their position is not at all enviable.

    (the exception, and it’s a big one, would be in instances where the welfare recipients want to be in a better school system, which the $5,400 apartment areas are likely to provide.)

    An exaggerated example would be if the government gave a welfare recipient a $100,000 painting every year, but forbade them from selling it. You wouldn’t say that person was in a position enviable to someone making $50,000.

  5. philg

    June 1, 2015 @ 8:01 pm

    5

    Mark: It turns out that a lot of welfare recipients do have jobs that provide cash income, in addition to whatever they receive from TANF. It is simply that these jobs typically do not come with a W2 at the end of the year. See http://www.cbsnews.com/news/octomom-nadya-suleman-charged-with-welfare-fraud/ for an example.

    Are the folks in Cambridge who live in public housing unhappy, as you suggest, because they don’t have prestigious W2 jobs? Certainly none of the ones that I have known over a 30-year period have been unhappy enough to move elsewhere! And they seem to spend a lot more time socializing than the working slaves in Cambridge, a factor that happiness researcher has said is very positive.

  6. liberal

    June 1, 2015 @ 8:34 pm

    6

    “But most of the book assumes that readers are convinced by Econ 101 that economic incentives will change peoples’ behavior and proceeds with analysis based on that assumption.”

    The same principle leads us to conclude that most economists are shills for the rich and powerful, because it pays well.

  7. mark

    June 2, 2015 @ 9:41 am

    7

    That’s true about the jobs without W2s but I think think ‘octomom’ is an outlier by any definition.

    Of course they don’t move. Living in the nice apartment is preferable to a cheaper apartment when you’re not the one paying. My simple argument is that the benefits of living in a free (for the occupant) apartment isn’t the same as a guy with $5,400 in his pocket – or even less. The latter would be preferable by anyone.

    The welfare system is broken. It rewards the wrong things. I just can’t buy into this idea that the current structure has working people slaving away while the ‘moochers’ live leisurely lives. I just don’t see it.

    It might be a regional thing. I’m in Alabama where $5,400 a month gets you a mansion. Less than $2,000/month can still buy a really nice 2-story house. Welfare recipients here get nothing close to either.

  8. philg

    June 2, 2015 @ 10:00 am

    8

    Mark: I don’t think the original posting suggests that welfare is “broken”. Just as with child support, it isn’t “broken” from the perspective of someone who can get $100,000/year in tax-free cash without having to get up every day at 0700 and commute to work. If there are people who enjoy working and paying higher taxes so that fellow Americans can live comfortably without working that is a desired political outcome, not a “broken” system.

    I am confused by your note that people without jobs don’t “live leisurely lives”. What is the definition of “leisure” if not “opportunity afforded by free time to do something” (a quick Google definition)? If someone works only a day per week at an under-the-table job to get extra spending money, isn’t that four extra days of “leisure” compared to a person with a standard full-time job?

    [Separately, since Cambridge is not that big a town, we do sometimes have an opportunity to say hello to the families whom we’ve met in these apartment buildings. We’ll see the moms out with the kids in nice weather. We’ll see the dads in Central Square during the middle of the weekdays enjoying drinks with similarly-situated (male) friends. Isn’t it “leisure” to be able to spend the afternoon with your buddies in a bar or spend the afternoon with your school-age children while other parents are at work?]

    Is welfare in Alabama as generous as in Massachusetts? http://object.cato.org/sites/cato.org/files/pubs/pdf/the_work_versus_welfare_trade-off_2013_wp.pdf shows that the average 013 welfare package in Massachusetts was worth $42,515 per year compared to just $26,638 in Alabama ($50,540 pre-tax and $23,310 pre-tax (bizarrely lower, I think due to the EITC)). As you have noted the cost of living in Alabama for everyone is much lower. But this may not be enough to compensate for the difference in generosity. Welfare pays 118% of median salary in Massachusetts and 78% of median salary in Alabama. Note that these numbers are not inconsistent with http://www.budget.senate.gov/republican/public/index.cfm/2012/12/total-welfare-spending-equates-to-168-per-day-for-every-household-in-poverty where the Congressional Research Service found that spending on a welfare family is about $61,000 per year. Apparently about half of the money gets soaked up by the government workers and contractors administering the system.

  9. mark

    June 2, 2015 @ 11:36 am

    9

    Oh man.. I actually typed “live leisurely lifestyles.” I’m living up to the Alabama grammar stereotype.

    Anyways, from the original post;

    “They would need to earn at least $160,000 per year pre-tax to obtain the same standard of living at market prices.”

    The dollar figure on aid from the government isn’t indicative of the “standard of living” held by the recipient. Your comment about half the money getting soaked up by government workers and contractors speaks to that point.

    You might find these links interesting. It shows the state tax structure for each state. It does mention the EITC as reason for Massachusetts’ ‘progressive’ tax structure;

    Massachusetts
    http://www.itep.org/whopays/states/massachusetts.php

    Alabama
    http://www.itep.org/whopays/states/alabama.php

    In short, it seems like it’s better to be rich in Alabama and poor in Massachusetts. Tell your friends to retire down here!

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