Transfer Payment

What It Means

A transfer payment is money or other aid that is given by a government without any good or service in return. The government simply transfers money, for example, from its tax revenue to an individual or business. In the United States federal, state, and local governments all make transfer payments. The three major types of transfer payment at the federal level are social insurance programs, welfare, and business subsidies.

Social insurance programs provide benefits to people regardless of their income level. Examples include Social Security payments to retired workers, unemployment payments to workers who cannot find jobs, and Medicare, a form of free health insurance that benefits the elderly.

Welfare programs provide benefits to the poorest members of society. Examples include direct payments under the Temporary Assistance for Needy Families (TANF) program, credit that can be used to purchase food under the food stamps program, and Medicaid, a form of free health insurance.

Farms are an important target of business subsidies. There are two main types of farm subsidies. Export subsidies are payments to encourage farmers to sell their crops abroad. Domestic subsidies have a variety of purposes: to promote the cultivation of certain crops; to support farmers who are not able to make a profit because of declining prices or increasing costs; to reward farmers who use sustainable, or environmentally friendly, growing practices; or to offset the economic consequences of drought, sudden frost, or other weather-related problems that result in abnormally low crop yield.

Some transfer payments are made as direct cash payments, while others are “in-kind” payments, or payments made in the form of specific goods or services. In either case, transfer payments are a means of redistributing income. The government takes in money via taxes from those who have the capacity to earn it and transfers this money to those who do not. While a substantial amount of transfer payments benefit the poor, many beneficiaries of social insurance programs are middle-class Americans. Social Security and Medicare, for instance, account for far more government spending on transfer payments than any other program. Also, a significant portion of U.S. government farm subsidies are received by the owner-operators of large, successful commercial farms. At the end of the twentieth century transfer, payments represented 44 percent of spending at all levels of government in the United States.

When Did It Begin

Transfer payments in their various forms were not implemented in the United States until the 1930s, although their antecedents in Europe date back much further. In England at the outset of the seventeenth century, Queen Elizabeth I initiated Poor Laws, which used tax revenues to establish orphanages, hospitals, housing, and other forms of aid for those in need. These laws are considered as precursors to modern welfare systems. At the end of the seventeenth century, the English government also instituted a form of agricultural subsidy by offering so-called bounties to grain farmers as incentives to export their crops. Much like modern day export subsidies, these bounties enabled farmers to sell grain abroad at a lower price than they would otherwise need to command in order to cover their costs of production. At the same time, the bounties led to an increase in the domestic price of grain. As such, the English people not only shouldered not only the burden of funding the bounties through the taxes they paid but were also faced with paying higher prices for their own food.

Social insurance programs did not take root until the nineteenth century. At this time the Industrial Revolution (the change from a primarily agricultural economy to an industrial one, made possible by new technologies such as the steam engine) was changing the fabric of society in Europe and the United States; it greatly increased the number of people who worked for wages while diminishing the traditional interdependence between employers and workers. One result was an increased level of risk for the worker. Employers who had no personal responsibility toward their employees could, for example, adjust their workforce depending on economic conditions, cutting jobs in order to maintain profitability regardless of the impact that this would have on individuals or society. This instability led governments in Europe, beginning with Germany in the 1880s, to pass social insurance laws.

It was not until the Great Depression, the severe economic crisis of the 1930s during which roughly 25 percent of U.S. workers lost their jobs, that the federal government began providing transfer payments and other forms of financial aid to those who needed it. One of the centerpieces of President Franklin D. Roosevelt’s New Deal, the sweeping series of laws meant to spur recovery from the Depression, was the Social Security Act of 1935, which provided for payments to retired workers, as well as to those who were willing but unable to find work. The Social Security Act also introduced the transfer payments and other forms of aid that would become known as the welfare system. Another key piece of New Deal legislation was the Agricultural Adjustment Act (AAA) of 1933, which offered subsidies to farmers to decrease their crop production by leaving some fields unplanted—the idea being that a reduction of crop surplus would increase the value of the crops, which would restore farmers’ economic stability. In addition to aiding struggling farmers directly, the AAA was intended to ensure the viability of rural communities and protect the nation’s food supply.

More Detailed Information

Transfer payments represent activity that goes against the grain of the capitalist system. Capitalism is characterized by the right of individuals to own property and pursue profits freely. The economy is controlled not by the government but by the independent actions of countless buyers and sellers acting in their own self-interest. The desires of buyers and sellers, as expressed in markets (the places and systems bringing buyers and sellers together), determine what will be produced and in what numbers, how it will be produced and distributed, and who will benefit from all economic activity.

While market-based capitalism is unsurpassed at matching buyers and sellers of products and at producing a wide variety of products in the most efficient ways possible, some economists and other social scientists argue that markets often fail to provide benefits that society would like them to provide. One of these benefits is a reduction of economic inequality. Markets reward those who have economic resources and have the ability to use them effectively, but they have no way of providing for those who are not capable of competing in the economy. Welfare programs are thus sometimes justified as a means of correcting this failure.

One prominent economic argument for social insurance programs also focuses on market failures. If, for example, workers were required to purchase insurance that would provide them with income in case they lost their jobs, companies selling such insurance might suspect that the people buying the insurance are those members of society most likely to lose their jobs. Thus, in order to remain profitable, such firms would have to charge unreasonably high rates or decline to offer coverage. Market forces acting alone fail, according to this view, to produce an outcome that society wants, so government must step in to offer unemployment insurance.

One common justification for Social Security benefits is that many individuals, caught up in the demands of everyday economic life, do not have an adequate awareness of the need to save for retirement. In the absence of government aid, society would have to be content with letting some of its elderly members suffer in extreme poverty after retirement. Most people in the United States find such a scenario unacceptable.

Farm subsidies, too, are expressly intended to insulate both producers and consumers from the vagaries of market forces: without this protection, it has long been argued, farmers would suffer from declining prices in years of production surplus, while consumers would suffer from price hikes in years of production shortage. With the benefit of subsidies, on the other hand, farmers can maintain robust production without the consequence of lower prices, while consumers are assured of having an abundant food supply at reasonable prices.

In spite of these justifications, transfer payments are subject to serious and sometimes passionate criticism. Much of the criticism stems from the fact that the money and in-kind benefits people get as a result of transfer payments are essentially gifts rather than payments made in exchange for labor or products. Because of this, some critics argue, transfer payments have adverse effects on individuals’ economic decision-making. For example, if a poor person is guaranteed of getting money and food regardless of whether he does any work, then he has no incentive to work. Similarly, some economists argue that Social Security payments create a disincentive to save for retirement. During the active years of a worker’s career, these economists argue, one would naturally be compelled to save for the future if there were no alternative sources of income in old age. Since people know they can count on Social Security to supply them with some income, they save less than they would naturally. The same argument is often raised against farm subsidies—that these transfer payments prop up inefficient producers, effectively removing any incentive for them to improve their production efficiency while fostering farmers—dependence on government handouts.

Recent Trends

The end of the twentieth century and the beginning of the twenty-first century saw major political debates about the future of transfer payments in the United States. After decades of criticism from political conservatives, the welfare system was overhauled by President Bill Clinton, a Democrat, in 1996. Seeking to address the disincentive to work that welfare benefits supposedly created, Clinton’s reforms restricted welfare recipients to a maximum lifetime limit of five years’ worth of aid and made the amount of benefits a family could receive contingent upon the parents’ active participation in the job market.

Meanwhile, many economists and government leaders voiced serious concerns about the future of Social Security and Medicare, the two largest transfer payment programs. The aging of the “baby boom” generation (those who were born in the two decades following the end of World War II in 1945) was expected to present enormous challenges to the programs. The members of the baby boomer generation were far more numerous than any previous generation, and they were expected to live much longer due to advances in health care and medical technology. Many experts worried that there would not be enough money in these programs’ coffers to make transfer payments in such quantities over so many years. Reform of Social Security and Medicare proved complicated, however, and the issues surrounding these programs were expected to remain a contentious political issue well into the twenty-first century.

Also during this period U.S. farm subsidies came under increased scrutiny, and many politicians, analysts, and members of the public called for their abolishment. Opposition to the subsidies centered on the idea that farm policy was outdated: the U.S. agricultural industry of the 21st century bore little resemblance to its predecessor of the 1930s, particularly since the small family farms that had originally been the focus of AAA protection had largely been swallowed up by commercial mega-farms. In 2005, when nearly half of the nation’s agricultural output was concentrated among the top 10 producers, transfer payments to such highly profitable businesses were widely derided as a form of corporate welfare.