An Agency Model of Welfare and Disability Assistance

Welfare programs including disability benets have been considered as an ecient 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 benets Tagging is imperfect in that it involves type I and II errors and its accuracy depends on the eort of the social workerswhich is private information To induce positive eort the government needs to monitor the social workers using a costly auditing procedure Using the framework of optimal nonlinear income taxation we characterize secondbest redistribution policies when the government can operate a welfare program alongside a negative income tax The welfare program contains a disability benet and a general welfare component Welfare applicants that are tagged receive the disability benet while those who are untagged are accepted for general welfare benets It is emphasized that whether or not general welfare recipients who may be the able or disabled should be allowed to work is substantially aected 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 o the costs of administering welfare relative to the benets of tagging