An Agency Model of Welfare and Disability Assistance

Abstract

Welfare programs including disability benefits have been considered as an efficient way of delivering transfers to the needy. This paper addresses the importance of administrative cost of welfare systems by focusing on an agency problem arising between the government and social workers, whose job is to use tagging to determine eligibility for welfare benefits. Tagging is imperfect in that it involves type I and II errors, and its accuracy depends on the effort of the social workers, which is private information. To induce positive effort, the government needs to monitor the social workers using a costly auditing procedure. Using the framework of optimal non-linear income taxation, we characterize second-best redistribution policies when the government can operate a welfare program alongside a negative income tax. The welfare program contains a disability benefit and a general welfare component. Welfare applicants that are tagged receive the disability benefit, while those who are untagged are accepted for general welfare benefits. It is emphasized that whether or not general welfare recipients, who may be the abled or disabled, should be allowed to work is substantially affected by the nature of the administration cost of welfare programs and by indivisibilities that may exist in labor supply. Our ultimate objective is to contribute to the debate concerning transferring income to the poor using welfare programs versus negative income tax systems. This involves trading off the costs of administering welfare relative to the benefits of tagging.

JEL Classification: H53, H31, D82, I12, I18, H2, I3