The Welfare Implications of Increasing DI Benefit Generosity

Abstract

The empirical literature on DI has primarily focused on the impact of program parameters on caseload growth or reduced labor force attachment. The focus on the efficiency costs of DI provides a misleading view of the social desirability of the program itself and of the adequacy of benefit levels. In order to provide a more comprehensive view, we develop a framework that allows us to simulate the benefits as well as the costs associated with a marginal increase in benefit generosity using a representative crosssectional sample of the population. Using the 1991 March CPS, we estimate the total cost of providing an additional $1 of income to current DI recipients to be $1.42. While the load factor due to moral hazard is fairly high, we demonstrate that it is moderate enough that representative workers should be willing to "buy" additional insurance through reduced take-home pay at this price. The reform looks less attractive, however, once the financial benefits and costs are distributed across individuals in the sample. Fist, the average implicit price of an additional dollar of insurance is actually much higher than $1.42 for all but the least educated category of workers due to the redistribute nature of the program. We predict that the reform leads to a net welfare loss for these more highly educated groups, regardless of the level of risk aversion. Second, despite an average implicit price of less than $1, the expected utility gain also turns negative for high school dropouts under high levels of risk aversion. Second, despite an average implicit price of less than $1, the expected utility gain also turns negative for high school dropouts under high levels of risk aversion. This counterintuitive finding arises since the utility calculation weighs low income individuals more heavily as risk aversion increases and individuals with income below the floor provided to current DI recipients help to finance the benefit increase.