During World War II, a British clergyman gave a speech in which he contrasted the “warfare state” of Nazi Germany, dedicated to conquest, with Britain’s “welfare state,” dedicated to serving the welfare of its people. Since then, the term welfare state has come to refer to the collection of government programs that are designed to alleviate economic hardship. A large share of the government spending of all wealthy countries consists of government transfers—payments by the government to individuals and families—that provide financial aid to the poor, assistance to unemployed workers, guaranteed income for the elderly, and assistance in paying medical bills for those with large health care expenses.

There are three major economic rationales for the creation of the welfare state. We’ll turn now to a discussion of each.

1. Alleviating Income Inequality Suppose that the Taylor family, which has an income of only $15 000 a year, were to receive a government cheque for $1500. This cheque might allow the Taylors to afford a better place to live, eat a more nutritious diet, or in other ways significantly improve their quality of life. Also suppose that the Fisher family, which has an income of $300 000 a year, were to face an extra tax of $1500. This probably wouldn’t make much difference to their quality of life: at worst, they might have to give up a few minor luxuries.

This hypothetical exchange illustrates the first major rationale for the welfare state: alleviating income inequality. Because a marginal (or additional) dollar is worth more to a poor person than a rich one, modest transfers from the rich to the poor will do the rich little harm but benefit the poor a lot. So, according to this argument, a government that plays Robin Hood, taking from the rich to give to those in need, does more good than harm. Programs that are designed to provide payments based on need are known as social welfare programs.

2. Alleviating Economic Insecurity The second major rationale for the welfare state is alleviating economic insecurity. Imagine ten families, each of which can expect an income next year of $50 000 if nothing goes wrong. But suppose the odds are that something will go wrong for one of the families, although nobody knows which one. For example, suppose each of the families has a one in ten chance of experiencing a sharp drop in income because one family member is laid off or incurs large medical bills. And assume that this event will produce severe hardship for the family—a family member will have to drop out of school or the family will lose its home. Now suppose there’s a government program that provides aid to families in distress, paying for that aid by taxing families that are having a good year. Arguably, this program will make all the families better off, because even families that don’t currently receive aid from the program might need it at some point in the future. Each family will therefore feel safer knowing that the government stands ready to help when disaster strikes. Programs designed to provide protection against unpredictable financial distress are known as social insurance programs.

These two rationales for the welfare state, alleviating income inequality and alleviating economic insecurity, are closely related to the ability-to-pay principle we learned about in Chapter 7. Recall how the ability-to-pay principle is used to justify progressive taxation: it says that people with low incomes, for whom an additional dollar makes a big difference to economic well-being, should pay a smaller fraction of their income in taxes than people with higher incomes, for whom an additional dollar makes much less difference. The same principle suggests that those with very low incomes should actually get money back from the tax system.

3. Reducing Poverty and Providing Access to Health Care The third and final major rationale for the welfare state involves the social benefits of poverty reduction and access to health care, especially when applied to children of poor households. Researchers have documented that such children, on average, suffer lifelong disadvantages. As we saw in the Economics in Action in Chapter 16, The Impeccable Economic Logic of Early-Childhood Intervention Programs, children from economically disadvantaged backgrounds, even after adjusting for ability, are more likely to be underemployed or unemployed, engage in crime, and suffer chronic health problems—all of which impose significant social costs. So, according to the evidence, programs that help to alleviate poverty and provide access to health care generate external benefits to society.

More broadly, as the following For Inquiring Minds explains, some political philosophers argue that principles of social justice demand that society take care of the poor and unlucky. Others disagree, arguing that welfare state programs go beyond the proper role of government. To an important extent, the difference between those two philosophical positions defines what we mean in politics by “liberalism” and “conservatism.”

But before we get carried away, it’s important to realize that things aren’t quite that cut and dried. Even conservatives who believe in limited government typically support some welfare state programs. And even economists who support the goals of the welfare state are concerned about the effects of large-scale aid to the poor and unlucky on their incentives to work and save. Like taxes, welfare state programs can create substantial deadweight losses, so their true economic costs can be considerably larger than the direct monetary cost. We’ll turn to the costs and benefits of the welfare state later in this chapter. First, however, let’s examine the problems the welfare state is supposed to address.

Poverty is a social problem that governments around the world try to fight, by assisting the poor and those at risk of becoming poor. Governments in Canada attempt to reduce poverty through the provision of various social welfare and insurance programs such as employment insurance, affordable housing programs, income support, and other programs to alleviate the problems associated with poverty. Together these programs are collectively referred to as social programs.

But what, exactly, do we mean by poverty? Any definition is somewhat arbitrary. In Canada the poverty line (or poverty threshold) is the minimum level of income considered adequate to purchase the necessities of life. Anyone who falls below the poverty line is considered to be in a state of poverty. Although there is no official definition of the poverty line, Statistics Canada constructs the low income cut-offs (LICOs) to study poverty. The LICOs are income thresholds below which a family will likely devote too large a share of its income to the necessities as compared to the average family. According to the LICOs measures, if a family is expected to spend 20 percentage points more than an average family on necessities (for example, 63% of their income instead of 43%), then that family is considered to be living below the poverty line. Since the LICOs compare individual or family spending to that of the average person or family, they are a relative measure. To address issues related to differences in family sizes and the types of communities they live in, Statistics Canada calculates 35 LICOs for 7 different family sizes and 5 different community sizes, using before-tax and after-tax income.

Although the LICOs are the most commonly used criterion to measure poverty in Canada, other measures such as the low-income measure (LIM) are also used, especially for international comparisons. The LIM is defined as 50% of median adjusted household income in which household size is taken into account—a larger household needs more income to meet its needs. The LIM is another relative measure of poverty: households with income below a certain percentage of the median, usually 50%, are deemed poor. If median income declines, then the LIM threshold declines, too.

An absolute measure, which defines an amount of money a family or individual needs, is the alternative to a relative measure. The market basket measure (MBM), developed by Human Resources and Skills Development Canada, is an absolute measure of poverty. The MBM is a measure of low income based on the cost of a specific basket of goods and services for a family with two adults aged between 25 and 49 and two children aged between 9 and 13.

The poverty line depends on the size of a family and the size of the community. Using the after-tax LICOs measure, in 2012 the poverty line for a family of four living in a community of at least 500 000 residents was $37 052; if the same family lived in a community of 100 000 to 499 999 people, it was $31 335.

Trends in Poverty Based on conventional wisdom, you might expect that as the economy grows and becomes more prosperous, and as average income rises, the percentage of the population living below the poverty line would decline steadily. Is that the case in Canada? Let’s see. Panel (a) of Figure 18-1 shows the poverty rate—the percentage of the population below the poverty line—from 1976 to 2011, using the different measures mentioned above. As you can see, the poverty rate fluctuated during that period, and it began to show a declining trend starting in 1996.

Panel (b) shows the poverty rate by age group using the after-tax LICOs. The poverty rate for seniors shows a clear declining trend, dropping from 30% to 5% in recent years. The poverty rate for those who are under 18 was above the overall poverty rate for most of the years during the period and has only dropped slightly below the overall rate in recent years. Unfortunately, the picture for those between 18 and 64 was a bit gloomier; their poverty rate moved from below the overall poverty rate in earlier years to just above the overall rate in recent years.

Who Are the Poor? Who are the poor in Canada? Obvious answers are likely to be the single-parent families, families with a female as the primary breadwinner, Aboriginals, and visible minorities. Is this true? Let’s take a look of how these groups fare.

In 2011, according to the after-tax LICOs as a measure of poverty, nearly 3 million Canadians were in poverty—about 8.8% of the population, or about one in eleven Canadians. The incidence of poverty was equally split between females (1.5 million) and males (1.46 million). About 1.394 million unattached individuals were considered to be poor in 2011, and 85% of those individuals (about 1.2 million) were under 65.

There is a correlation between family makeup and poverty: families with a woman as the major income earner had a higher chance of living in poverty—about 56% of the poor were families with female breadwinners. Single-parent families had a poverty rate of 19.7%, and almost 90% of these families had single mothers. Although married couples with children were much less likely to be poor, with a poverty rate of 5.1%, about 21% of the poor were in families with children and both parents present.

Based on the 2006 census data and using the LIM to measure poverty, a 2013 report by the Canadian Centre for Policy Alternatives (CCPA) showed that poverty rates among the First Nations were significantly higher than among other ethnic groups in Canada. Even worse, half of the status First Nations children in Canada lived in poverty, compared to a 15% poverty rate for all other children in the country (the average poverty rate for all children in Canada was 17%).

Another study by the CCPA showed that race played a role in determining the likelihood of an individual living in poverty.¹ Once again, using the 2006 census data for Ontario, the report found that visible minority families were three times as likely to live under the poverty line as families who did not consider themselves as visible minority (for visible minority families the poverty rate was 18.7%, compared to 6% for non-visible minority families); the findings were similar for individuals.

What really stands out in the data is the number of Canadians moving above or below the poverty line. From 2009 to 2010, the number of individuals remaining below the poverty line was 1.52 million. At the same time, 0.889 million individuals moved out from under the poverty line and 0.78 million individuals fell below it. Individuals without a university degree were more likely to remain poor and to become the poor. Among those who remained poor, about 70% didn’t have a post-secondary degree or diploma. For those who moved below the low income line, about two-thirds didn’t have a post-secondary degree or diploma. These observations are consistent with the conventional wisdom that the level of education plays an important role in the financial well-being of an individual.

What Causes Poverty? Poverty is often blamed on lack of education, and educational attainment clearly has a strong positive effect on income level—those with more education earn, on average, higher incomes than those with less education. For example, in 1980 male workers with a bachelor’s degree earned 32% more than those who had only graduated from high school. Female workers with a bachelor’s degree earned 49% more than those who graduated from high school. By 2005, the premium enjoyed by workers with a bachelor’s degree had risen to over 45% for males and over 60% for females.

Lack of proficiency in English or French is also a barrier to higher income. For example, immigrants to Alberta with poor English skills are more likely to work for minimum wage in industries like retail and manufacturing, which offer temporary jobs and are more susceptible to economic fluctuations. Even for immigrants who are proficient in English, finding a decent job may not be easy if they lack connections and Canadian experience.

And it’s important not to overlook the role of racial and gender discrimination; although less pervasive today than 50 years ago, discrimination still erects formidable barriers to advancement for many Canadians. Visible minorities earn less and are less likely to be employed than whites with comparable levels of education. Studies find that visible minorities and Aboriginals suffer persistent discrimination by employers. Women earn lower incomes than men with similar qualifications.

In addition, one important source of poverty that should not be overlooked is bad luck. Many families find themselves impoverished when a wage-earner loses a job or a family member falls seriously ill.

Consequences of Poverty The consequences of poverty are often severe, particularly for children. In 2011, 8.5% of children in Canada lived in poverty; this is using the after-tax LICOs measure (using the after-tax LIM, the child poverty rate was 14.3%).² Poverty is often associated with lack of access to a nutritious diet, which can lead to higher risk of suffering health problems, developmental delays, and behavioural problems. Child poverty can also result in lower attainment in education and is more likely to lead to adult poverty when the children grow up. Recent medical studies have shown that children raised in severe poverty tend to suffer from lifelong learning disabilities. As a result, Canadian children growing up in or near poverty don’t have an equal chance at the starting line: they tend to be at a disadvantage throughout their lives. Even talented children who come from poor families are unlikely to finish college or university.

To make things worse, the problems of child poverty do not hit the country evenly. Some provinces have higher child poverty rates than others. Table 18-1 shows the provincial child poverty rates in 2011 using the after-tax LICOs. British Columbia and Manitoba had the highest child poverty rates, sitting at 11.3%. The high rate in British Columbia caused lots of concern among advocacy groups who urged the provincial government to take immediate actions to reduce child poverty, with policy recommendations including raising the minimum wage, providing low-cost day care, increasing income assistance payments, and imposing a fairer tax system.

Similarly, some ethnic groups are more likely to live in poverty than others. As mentioned earlier, a report by the Canadian Centre for Policy Alternatives showed that half of First Nations children were living in poverty in 2013. This disturbingly high child poverty rate explains, to some extent, why Aboriginal children were behind non-Aboriginal children in other measures of well-being such as educational attainment and overall health, while dealing with higher rates of substance abuse, suicides, and homelessness. Unfortunately, disadvantages from childhood can carry forward to adulthood, making it more likely that a First Nations person will suffer lifelong poverty.

Canada is a rich country. In 2007, the year prior to the recent recession, the average income for a Canadian household with at least two people was $93 100 (measured in 2011 dollars), far exceeding the poverty line.³ Even after the 2008–2009 recession, average income rose to $95 000 in 2011. How is it possible, then, that so many Canadians still live in poverty? The answer is that income is unequally distributed, with many households earning much less than the average and others earning much more.

Table 18-2 shows the distribution of pre-tax income in 2011 among Canadian families, as estimated by Statistics Canada. Households are grouped into quintiles, each containing 20%, or one-fifth, of the population. The first, or lowest, quintile contains households whose income put them below the 20th percentile in income, the second quintile contains households whose income put them between the 20th and 40th percentiles, and so on.

For each group, Table 18-2 shows three numbers. The second column shows the income ranges that define the group. For example, in 2011, the lowest quintile consisted of households with annual incomes of less than $42 800, the next quintile of households had incomes between $42 800 and $65 300, and so on. The third column shows the average level of family income in each group, families in the highest quintiles had an average income of $202 800, almost seven times the average level of income of families in the lowest quintile. The fourth column shows the percentage of total Canadian income received by each group.

Mean versus Median Household Income At the bottom of Table 18-2 are two useful numbers for thinking about the incomes of Canadian households. Mean household income, also called average household income, is the total income of all Canadian households divided by the number of households. Median household income is the income of a household in the exact middle of the income distribution—the level of income at which half of all households have lower income and half have higher income. It’s very important to realize that these two numbers do not measure exactly the same thing.

Economists often illustrate the difference by asking people first to imagine a room containing several dozen more or less ordinary wage-earners, and then to think about what happens to the mean and median incomes of the people in the room if a Bay Street CEO, some of whom earn millions of dollars a year, walks in. The mean income soars, because the CEO’s income pulls up the average, but median income hardly rises at all. This example helps explain why economists generally regard median income as a better guide to the economic status of typical families than mean income: mean income is strongly affected by the incomes of a relatively small number of very-high-income Canadian, who are not representative of the population as a whole; median income is not.

What we learn from Table 18-2 is that income in Canada is quite unequally distributed. The average income earned by the poorest fifth of families is less than 40% of the average income earned by families in the middle, and the average income of the richest fifth is 2.6 times the average income earned by those in the middle. The Economics in Action at the end of this section discusses long-term trends in Canada’s income inequality.

The Gini Coefficient It’s often convenient to have a single number that summarizes a country’s level of income inequality. The Gini coefficient, the most widely used measure of inequality, is based on how disparately income is distributed across the quintiles. A country with a perfectly equal distribution of income—that is, one in which the bottom 20% of the population received 20% of the income, the bottom 40% of the population received 40% of the income, and so on—would have a Gini coefficient of 0. At the other extreme, the highest possible value for the Gini coefficient is 1—the level it would attain if all a country’s income went to just one person.

One way to get a sense of what Gini coefficients mean in practice is to look at international comparisons. Figure 18-2 shows the most recent estimates of the Gini coefficient for many of the world’s countries. Aside from a few countries in Africa, the highest levels of income inequality are found in Latin America, especially Colombia; countries with a high degree of inequality have Gini coefficients close to 0.6. The most equal distributions of income are in Europe, especially in Scandinavia; countries with very equal income distributions, such as Sweden, have Gini coefficients around 0.25. Compared to other wealthy countries, Canada, with a Gini coefficient of 0.365 in 2011 (based on total income for economic families), has high inequality, though it does have the lowest Gini coefficient in all of North and South America.

How serious an issue is income inequality? In a direct sense, high income inequality means that some people don’t share in a nation’s overall prosperity. Although the poverty rate in Canada has declined somewhat in the past two decades, the Gini coefficient in the country is relatively stable, indicating that income inequality persists. Also, extreme inequality, as found in Latin America, is often associated with political instability because of tension between a wealthy minority and the rest of the population.

It’s important to realize, however, that the data shown in Table 18-2 overstate the true degree of inequality in Canada, for several reasons. One is that the data represent a snapshot for a single year, whereas the incomes of many individual families fluctuate over time. That is, many of those near the bottom in any given year are having an unusually bad year and many of those at the top are having an unusually good one. Over time, their incomes will revert to a more normal level. So a table showing average incomes within quintiles over a longer period, such as a decade, would not show as much inequality.

Furthermore, a family’s income tends to vary over its life cycle: most people earn considerably less in their early working years than they will later in life, then experience a considerable drop in income when they retire. Consequently, the numbers in Table 18-2, which combine young workers, mature workers, immigrants, and retirees, show more inequality than would a table that compares families of similar ages.

Despite these qualifications, there is a considerable amount of genuine inequality in Canada. In fact, inequality not only persists for long periods of time for individuals, it extends across generations. The children of poor parents are more likely to be poor than the children of affluent parents, and vice versa. Moreover, the fact that families’ incomes fluctuate from year to year isn’t entirely good news. Measures of inequality in a given year do overstate true inequality. But those year-to-year fluctuations are part of a problem that worries even affluent families— economic insecurity.

As we stated earlier, although the rationale for the welfare state rests partly on the social benefits of reducing poverty and inequality, it also rests in part on the benefits of reducing economic insecurity, which afflicts even relatively well-off families.

One form economic insecurity takes is the risk of a sudden loss of income, which usually happens when a family member loses a job and either spends an extended period without work or is forced to take a new job that pays considerably less.

Even if a family doesn’t face a loss in income, it can face a surge in expenses. The most common reason for such surges is a medical problem that requires expensive treatment, such as heart disease or cancer. Canadians receive basic health care coverage from the government, which handles a large share of medical expenses. However, some expensive medications and treatments are not covered and could impose a huge financial burden on a family.