The welfare impact of targeted transfers to poor households

Despite widespread poverty there is general consensus among policymakers about the preference of targeted welfare transfers over non-targeted grants due to the budgetary implications of the latter. Targeting, however, adds to the administrative complexities of disbursing welfare grants, thus introducing a cost dimension that is as yet largely unexplored. In this paper a series of targeted transfer simulations are run in a general equilibrium model calibrated with a Social Accounting Matrix for South Africa. Deficit financing and tax replacement policies are considered as financing options, assuming a hypothetical budget constraint of R15 billion. The effectiveness of broad targeting and a low per capita transfer value versus narrow targeting and high transfer value in terms of reducing poverty and inequality is explored. Results on per capita expenditure changes (disposable income) from the general equilibrium model are extracted and fed into a micro-level survey-based module that calculates poverty and inequality at the individual level. Preliminary results suggest that the poverty impact is small: the poverty headcount falls from about 49% in the base to approximately 46% in the simulations. However, for some household groups poverty may actually increase due to the increases tax burden, also on households that are close to the poverty line. This highlights the importance of ensuring an equitable distribution of the increased tax burden. Inequality also declines marginally in all the simulations considered, mainly because poor households are targeted while non-poor households typically carry a larger share of the increased tax burden. In as far as the effectiveness of broad versus narrow targeting is concerned the results suggest that narrower targeting generally implies greater reductions in poverty and inequality, although it depends crucially on how far the transfer recipients are located from the poverty line.