The Economics of Vouchers

The Economics of Vouchers

Description

This chapter provides a swift tour of the economic issues presented by vouchers, which have been defined as “grants earmarked for particular commodities, such as medical care or education, given to individuals.” Among its main conclusions are the following: A voucher is cash equivalent if the allocation between commodities that the recipient chooses at her budget line is identical to that which she would have chosen if she instead had been given cash in the amount of the voucher. In practice, vouchers may be cash equivalent more often than is commonly believed. The greater the recipient’s preference for the commodities the voucher can be used to purchase, and the smaller the amount of the voucher relative to her other resources, the greater likelihood of cash equivalence. Since non-cash-equivalent vouchers are inferior to cash from the standpoint of a recipient with stable and well-defined preferences, replacing them with cash would be a Pareto improvement in the absence of other considerations. That is, it would leave recipients better off and no one else worse off. Among the other considerations that may support using vouchers are paternalism, externalities (including preferences by those who pay for the vouchers to induce a particular commodity choice), and the distributional aim of measuring need when it cannot be observed directly. An example related to the latter is a wage tax—in some respects a negative voucher program that conditions negative grants on the commodity choice of market goods rather than leisure. Any voucher program can be said to have a marginal reimbursement rate (MRR) structure, describing the size of the grant per dollar of ear-marked expenditure as the amount of such expenditure by the consumer increases. The programs most likely to be characterized as involving “vouchers” are those that have an MRR structure of 100 percent-0 percent. For example, someone who has $10 worth of food stamps can use them to pay 100 percent of qualifying food purchases up to $10, and 0 percent thereafter. By contrast, a food subsidy program with a flat MRR structure would pay a fixed percentage of the cost of all the consumer’s qualifying food expenditures. Determining appropriate MRRs presents an optimal tax problem that can be compared to that of setting marginal tax rates, or MTRs. Where a voucher responds to paternalism or externalities, Pigovian taxes (such as a pollution tax that requires polluters to bear the costs they impose on others) provide a useful analytical tool for solving this optimal tax problem, since they similarly attempt to alter marginal incentives. Where a voucher program serves the distributional aim of measuring need that cannot be observed directly, the optimal income tax perspective with respect to wage taxes may provide a better analogy. 2 In some circumstances, either of these perspectives can suggest that the classic 100 percent-0 percent MRR structure of vouchers is inappropriate. That structure is perhaps most likely to be optimal in the Pigovian setting if at some point the extra utility from increasing recipients’ choice of earmarked commodities steeply declines. One rationale for vouchers’ typical MRR structure of 100 percent-0 percent that is not generally persuasive, however, is that of using the top rate of zero as a cap for “budget control” purposes. This rationale ignores the likely option of holding expenditure constant by increasing the top MRR while reducing lower-tier MRRs, and it treats a nominal accounting measure of dollars spent in a given program as normatively significant. If a terminal MRR of zero is desirable, this presumably is because an underlying rationale based on paternalism or externalities has ceased to apply. The incentive effects of voucher eligibility criteria, such as income or asset tests, can be important. Poor households often face effective MTRs on their earning or saving that approach or even exceed 100 percent, because of the combination of explicit income and other tax liability with multiple phaseouts of transfers under both voucher and nonvoucher programs. Such MTRs, which can produce “poverty traps,” may become likely (even if they look unappealing when considered directly) if policymakers fail to integrate their consideration of “poverty” with that of distribution generally or of specific income-conditioned transfer programs with the overall tax-transfer system. Vouchers do not have uniform allocation and price effects, given variations in how they affect demand and supply. To the extent that particular vouchers are cash equivalent, only income effects could lead them to increase demand for earmarked commodities. The direction and magnitude of the income effects of vouchers on demand are a function of the relative income and price elasticities of beneficiaries and others. In cases where a voucher increases demand, its price effects depend on supply elasticity, which tends to be greater in the long run than the short run. In markets such as housing that are thought to have fixed short-term supply, concern about a price increase if direct grants to consumers (such as vouchers) increase demand, resulting in transition gain to suppliers if demand is not fully anticipated, may motivate the use of public supply instead of direct grants. Yet any such transition gain can be reduced without regard to the choice between public and private supply. Moreover, short-term supply may be less fixed than is commonly thought (for example, because housing is a multidimensioned commodity), and the prospect of transition gain may have desirable incentive effects, inducing short-term supply to increase in anticipation of the adoption of direct grants. Thus the choice between public and private supply should depend in large part on how well each responds in a given setting to the underlying incentive and information problems posed by supply of the particular commodities at issue. Both the transitional and the long-term effects of increasing demand for a commodity are easier to analyze where the suppliers are for-profit firms than otherwise. Thus in primary education, where nonprofit firms dominate private supply, transition gain from an underanticipated demand increase (such as from newly provided school vouchers) would be locked into the industry by the lack of owners with a claim on residual profits. The use of the transition gain in the industry would likely depend on the consumption preferences of the managers or of those with whom they had dealings, with the prestige effects of alternative uses possibly playing an important role. In choosing a supply mode for a given commodity, the level of supplier competition can be important and is distinguishable from, although potentially affected by, the choice between public and private supply. Government supply through vouchers or other mechanisms is most likely to be successful (whether or not preferable on balance to private supply) in industries where nonprofit firms have proven to be competitive among private suppliers.

Source Publication

Vouchers and the Provision of Public Services

Source Editors/Authors

C. Eugene Steuerle, Van Doorn Ooms, George E. Peterson, Robert D. Reischauer

Publication Date

2000

The Economics of Vouchers

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