Does the Social Safety Net Improve Welfare? A Dynamic General Equilibrium Analysis

Does the social safety net improve welfare? Conventional wisdom says that means-tested social safety net programs improve welfare because they provide partial insurance against large negative shocks by guaranteeing a minimum consumption floor, but some economists have argued that they may also discourage labor supply and reduce capital accumulation. Furthermore, recent research suggests that the welfare gain from the insurance channel may be small since the social safety net significantly crowds out private insurance decisions. In this paper, I quantitatively assess the tradeoff between these channels in a dynamic general equilibrium model with incomplete markets and endogenous health insurance decision. I find that the social safety net generates a significant welfare loss. I then show that the social safety net has a large crowding out effect on private health insurance, and this crowding out is important for obtaining the welfare loss result. In a counterfactual economy with exogenous health insurance, the social safety net can generate a substantial welfare gain. I also find that the model can account for a puzzling fact about the US health insurance markets, that is, a large number of Americans do not have any health insurance. Since many Americans (who are currently not qualified for means-tested programs) would become qualified after being hit by large health expense shocks, they are better off not buying any health insurance. This finding challenges the popular view that policy makers should force the currently uninsured to buy private health insurance.