Radha Iyengar Giovanni Mastrobuoni Princeton University. May 2006

Transcription

1 The Political Economy of the Disability Insurance. Theory and Evidence of Gubernatorial Learning from Social Security Administration Monitoring Preliminary version, please do not circulate Radha Iyengar Giovanni Mastrobuoni Princeton University May 2006 Abstract The dramatic rise in the disability insurance roles in the last 20 years has been the subject of much controversy in both popular and academic circles. While, the relationship between DI and labor force participation has been the subject of a growing literature, the mechanism by which this transition from employment to DI remains unclear. We hypothesize that one mechanism is the state-level administration of the program which creates a classic principal-agent problem. This paper analyzes the impact of continuing conflict of interests for DDS agencies between SSA standards and state gubernatorial political interests interacted with the increased demand for disability insurance as an alternative for low-skilled works during the period of 1982 to We find evidence that multi-term governors allow a greater fraction of applicants than do first term governors. We then develop a model that illustrates how these differences can be due to they type of monitoring conducted by the Social Security Administration. We provide additional evidence supporting this hypothesis in the form of sub-group analysis by economic and political constraints. Overall, we find evidence that the monitoring system is counter-productive and encourages over-use of the disability insurance program to serve political ends. R.Iyengar@lse.ac.uk, gmastrob@princeton.edu

2 1 Introduction The dramatic rise in disability insurance roles in the last 20 years has been the subject of much controversy in both popular and academic circles. The Social Security Administration s (SSA) Disability Insurance (DI) and Supplemental Security Income (SSI) are the primary means by which the federal government provides income protection for individuals who are unable to work for an extended period of time due to some form of disability. Interest in this program is heightened by the fact that the federal Disability Insurance (DI) and Supplemental Security Income (SSI) programs are the largest income replacement program to non-elderly adults in the United States, distributing nearly $78.2 billion in benefits to about 8 million individuals with disabilities in While, the relationship between DI and labor force participation has been the subject of a growing literature, the mechanism of the transition from employment to DI remains unclear. The answer, at least in part, lies with the state level administration. By law, disability determinations are made by state agencies under contract with the Social Security Administration. The director of Disability Determination Services (DDS) is appointed by the state government. This naturally generates a conflict of interest for these agencies which depend wholly on the federal SSA for funding but remain under the administrative and political direction of state governors. Although the Congress attempted to address this problem through a set of administrative reforms in 1980, there remains a great deal of unexplained variations in the determination process among states. 2 This is related both to the underenforcement and inherent unenforceable nature of the reforms. The reforms authorized the SSA to set standards for performance of the DDS, in theory constructing an objective outcome measure with which to measure the effectiveness of the DDS agency. The reforms also required individuals whose disability is not permanent to undergo a disability review every three years to ensure continued 1 From the Annual Statistical Supplement, Social Security Administration Advisory Board (1998) How SSA s Disability Program Can be Improved 2

3 eligibility. In order to monitor agencies, the reforms included a requirement that SSA conduct regular reviews of a percentage of DDS decisions and gave the SSA the option of taking over the DDS if they failed to follow the Commissioner s rules. While these rules changed the formal review process, the SSA does not penalize deviations from acceptable outcomes in various state DDS agencies. Thus, as the rules for DI applicants relaxed, the failure of monitoring has generated a great deal of room for marginally disabled individuals to successfully access the DI system. In addition, federal budget restrictions prevent credible exercise of penalties by the SSA, making even threats of punishment largely ineffective. This has left room for political interests to affect the determination process, abetting the steep increase in acceptances of DI applications. 3 The politicizing of this process is of heightened importance because of the increased demand for disability insurance as an alternative for low-skilled works. This paper analyzes the impact of continuing conflict of interests for DDS agencies between SSA standards and state gubernatorial political interests. Although the DI program is administered relatively uniformly, the political pressures on gubernatorial appointees vary with respect to political institution and economic factors. Moreover, while our analysis focuses on how the supply of disability benefits in the form of DDS s allowance rates are affected by institutional changes; it is useful to note that throughout this period there was also an increase in demand for these benefits. The increased desire for these benefits will thus shift the political value of varying allowance rates. In order to link DI acceptance rates with political factors, we first consider differences based on gubernatorial characteristics. We demonstrate that acceptance rates are significantly higher for first term governors relative to second and third term governors. This suggests that acceptance rates may be related to political outcomes. We next develop a model of delegation where governors have a preference for higher allowance rates than the Social Security Administration and can learn about how much more they can safely allow 3 Even popular guides such as Nolo s Guide (2004) discuss the possibility that DDS directors may be influenced by political concerns and thus amenable to more lenient allowance policies. In addition, several reports by the Social Security Advisory Boards express concern over this conflict of interest. 3

4 from information gleamed through the monitoring process. We demonstrate that such a model can generate the observed differences in acceptance rates by term length. This model has predictions for the usage of DI allowance rates given their relative importance because of restrictions on governors and state fiscal and economic conditions. Using these facts, we provide some supporting evidence for this model. In particular, we show that in circumstances where governors face unfavorable economic or fiscal conditions and in state where governors are restricted in their ability to enhance state social welfare programs, the acceptance rates among multiple term governors is even higher. Finally, we provide some evidence that these differences are due to a governor s learning that the SSA does not effectively monitor them rather than a simple selection mechanism by which governors with low allowance rates do not survive to later terms. This paper contribute to the ongoing discussion about the growth of disability insurance by providing a mechanism by individuals who might otherwise choose to work or search for employment are provided disability insurance. In particular, we combine two distinct strands of research one on political institutions and one on labor supply and disability insurance in an effort to better understand the mechanism by which the DI program has grown so rapidly. There is a growing body of literature that highlights the importance of political institutions on the public expenditure decisions and the use of spending to buy off voters. 4 In short, there appears to be some evidence that political pressure and institutional design can combine to impact the administration of government programs. There is also a growing and influential body of literature on the impact of disability benefits on labor force participation in the United States and internationally. 5 This paper links these political institutions to economic events which can then combine to result in increased use of social welfare programs. In this case, the steep rise in the num- 4 In particular, there is evidence that political institutions matter for policy outcomes. In addition, whether an official is appointed or elected does impact the performance of these officials. See Besley and Case (2003) for an overview on political institutions and expenditures and see for example Petzman (1992) on vote buying behavior. 5 For example, Bound, 1989 finds only small disincentive effects from DI. In contrast, Gruber and Kubik, 1997 and Autor and Duggan, 2003, find a significant effect on labor force participation which appears concentrated among the low-skilled. 4

5 ber of individuals on disability insurance is clearly linked to the rising acceptance rates for this program. While in part the acceptance rates increased due to the liberalization of standards, we show that in part the acceptance rates increased due to political concerns in the face of fiscal and economic crises. In the eighties and nineties, disability insurance acceptance rates rose nearly 15 percent. Our results suggest one-tenth of that increase is due to political issues. Moreover, our framework illustrates the negative impact generated by the false sense of security a underenforced monitoring system can provide. Seen in this light, the use of the disability program as a political tool to allow politicians to diffuse the potential fallouts from what appears to have been adverse demand shocks was quite predictable. By establishing the underlying incentive structure that mediates the administration of DI with both a more structural model and more reduced form estimation, we enable the consideration of more effective reforms to deal with the innate principal-agent problem inherent in a federalist administration system. 2 Background on the federal disability insurance program The Social Security Administration (SSA) provides income and medical benefits to individuals eligible for disability insurance under the Social Securities Act (1935). 6 The provision of these benefits occurs through two programs: Social Security Disability Insurance (DI): Established under Title II of the Social Security Act, DI is a social insurance program. It is intended to protect workers who become disabled and therefore cannot (or at least cannot be expected to) work. Thus, DI eligibility requires workers be previously employed. 7 After age 65, 6 For many people, the true value of disability insurance is the entitlement to Medicare (for DI recipients after a 2 year waiting period) and Medicaid (for SSI recipients). 7 In fact, the program functions on a credit system which takes account of both how long an individual worked and the time period an individual worked. The number of work credits needed for disability benefits depend on the age of disability. 5

6 DI benefits are converted to Old Age and Survivors Insurance (OASI). Supplementary Security Insurance (SSI): Established under Title XVI of the Social Security Act, SSI is means-tested, intended to protect individuals with limited income and assets. SSI beneficiaries can continue to receive benefits past age 65. Both programs use the same health criteria to determine eligibility. The Social Security definition requires that an inability to engage in any substantial gainful activity by reason of any medically determined physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. 8 Substantial gainful activity is defined as working on a regular and continuing basis and earning over $830 a month (in 2005). 9 The disability must be demonstrable by medically acceptable clinical and laboratory diagnostic techniques. This restriction is not overly strict in part due to the liberalization of the DI program that occurred in Among other issues, this liberalization relaxed many of the requirements that governed the determination process. 10 Thus the criteria for disability while welldefined are not objective and leave room for discretion in the determination process. 2.1 The Claimant s Process After an individual files a Social Security disability claim with his or her treating physician, the case is sent to a disability examiner at the Disability Determination agency in your state. This individual, working with a doctor, makes the initial decision on the claim. Treating doctors typically fill out an SSA form as well as providing documentation of the medical condition. The treating physician s report typically 8 Social Security Administration Disability Insurance Red Book, emphasis added 9 It bears mentioning that the substantial gainful activity earnings restrictions only refer to money obtained from working and does not restrict income from investments. Thus a disabled individual may have income independent of his or her DI benefits. 10 This liberalization resulted in greater consideration of mental illness, increased weight placed on symptoms such as pain, and acceptance of diagnoses and evidence from personal physicians of applicants, among other changes. For greater discussion on the effects of liberalization, see Autor and Duggan (2003) 6

7 establishes the diagnoses of injuries or illnesses that are causing severe impairment of work capacity explains the restrictions on work capacity resulting from the diagnosed medical conditions gives examples from real life of what the patient can and cannot do explains whether severe impairment is expected to last at least 12 months or result in death. At each DDS, a team consisting of a disability evaluation specialist and a physician or psychologist evaluated the evidence provided and determines whether the claimant is disabled under the Social Security law. If the claim is denied and the individual requests reconsideration, the case is then sent to another disability examiner at the Disability Determination agency, where it goes through much the same process. 11 If a claim is denied at reconsideration, the claimant may then request a hearing with an Administrative Law Judge who works for Social Security. The Administrative Law Judge makes an independent decision upon the claim. Further appeals are handled in federal court. 2.2 The Federal-State Administration System A crucial aspect of the Federal DI/SSI system is that it is federally funded but administered by the states. This administration occurs through the Disability Determination Services (DDS) offices in each state. These offices are part of state governments and are typically headed by an individual appointed by the governor. This agency manages the disability insurance claims sent by the SSA field office. The SSA conducts regular reviews of the allowance rates and decisions made by these agencies. State DDS offices that are 11 Ten states do not offer a reconsideration appeal stage. As part of a test, SSA has eliminated the reconsideration appeal stage in: Alabama, Alaska, California (Los Angeles North and West areas), Colorado, Louisiana, Michigan, Missouri, New Hampshire, New York (Brooklyn and Albany areas), and Pennsylvania. In these states and locales, applicants whose claims are denied in the initial SSA decision can appeal directly for a hearing before an administrative law judge ( ALJ ). This appeal must be made within 60 days of the SSA notice of decision. 7

8 determined to have unacceptable performance level receive technical and management assistance (TMA) from the SSA. After 1-2 years, if performance is still unacceptable, the SSA can take over the administration of DI determinations in that state. 12 This State-based administrative mechanism was originally established to facilitate coordination with existing State vocational rehabilitation agencies and to encourage physician acceptance and participation in the disability insurance program. 13 However, state management, subjective decisionmaking standards, and lack federal oversight is believed to be responsible for the great deal of variation in the disability allowance rates. State agencies are required to follow the regulations set for by the SSA, but there are relatively few Federal requirements relating to their administrative practices. The agencies follow State established personnel policies with respect to such matters as salaries, benefits, and educational requirements; do their own hiring; provide most of the training for adjudicators; follow their own quality assurance procedures; and pay State-established reimbursement rates for purchase of medical evidence. This results in different training and administrative practices that affect the determination process. Variation in training and practices is exacerbated by the increased subjectivity of the determination process. Court decisions as well as changing perceptions what constitutes disability has resulted in a number of new policies that require individual judgment by the those adjudicating disability applications. For example, all adjudicators are required to assess such subjective factors such as the weight that should be given to the opinion of a treating source and credibility with respect to allegations of pain and other symptoms. 14 Finally, the independence and subjectivity are compounded by the relatively lax oversight and monitoring provided by the SSA. The SSA conducts regular audits and reserves the right to abolish the state DDS and take control of DI admittance in any state. However, while these audits occur, there appears to be no penalty for mismanagement and 12 GAO Report, (1985) 13 A detailed discussion of the original and current structure of the DI program is available in Social Security Advisory Board (2001) 14 Court cases include Schisler v. Bowen, 787 F. Supp. 76 (2 Cir.1986), which dealt with treating source opinion, and Hyatt v. Heckler, 579 F. Supp. 985 (4 Cir. 1986), which dealt with assessment of pain. 8

9 thus far, the SSA has never exercised its right to directly manage DI admittance. In fact, in 1981 when SSA wished to assume responsibility for the DDS agency in Wisconsin, the Office of Management and Budget refused to fund the requisite amount of personnel to staff a DDS. The SSA was thus unable to impose its threat of takeover making future threats less credible. These factors have thus resulted in a disability determination process that appears far from uniform across states. This lack of uniformity is not surprising in many respect, even given the administrative failures. Differences in the health status, occupational composition, and demographics of different states would naturally give rise to differences in allowance rates. The concern about lack of uniformity arises because of the administrative environment leaves DDS agencies vulnerable to the influence of state-level political considerations. Indeed a General Accounting Office (GAO) report worried explicitly about the impact of politics on disability determinations given that all DDS employees were state employees working for an executive agency. 15 In recent years the SSA has sought to establish more effective monitoring processes but there remain broad inconsistencies in the allowance rates across states. One attempt made to disperse the political pressure on the determination process was to decentralize the DDS offices. 16 Moving DDS offices outside of the gubernatorial office buildings to neutral or even SSA buildings may help reduce the pressure on employees to make allowance decisions based on political considerations. Moreover, having localized DDS offices, rather than a central state DDS may further reduce political pressures while enhancing applicant access to local decision-makers. Unfortunately, only a handful of states have adopted such changes and differences appear to remain linked to political considerations. 15 GAO Report to Senator Jim Sasser (September 1985) 16 GAO Report to the Chairman, Subcommittee on Social Security, Committee on Ways and Means, House of Representatives (July 2004) 9

10 2.3 Existing Literature on Disability Insurance and Political Considerations The astonishing rise in disability recipients has been intensely scrutinized by a growing body of literature. Much of this research has focused on the labor supply implication of disability allowances. There is a great deal of variation in the estimated disincentive effects of DI. 17 A separate strand of literature focuses on classification errors in the DI determination process. There appears to be significant Type I errors (rejection of truly disabled individuals) and Type II errors (acceptance of not disabled individuals). 18 There has also been some exploration into how the structure of the DI program played a role in generating these errors. These two sets of research intersect to imply that misclassification of non-disabled individuals as disabled has resulted in the rise in the disability roles. In particular, Autor and Duggan (2003) find that the reduced screening stringency, declining demand for less skilled workers, and an unforeseen increase in the earnings replacement rate as the main factors for the rise in the DI beneficiaries. 19 Underlying these sets of research is the assumption that the mechanism by which disability is determined is sufficiently flexible to allow classification errors. There has been little exploration as how the DI determination process can be manipulated to increase allowance rates. However, there is a large literature on political institutions and policy choices. 20 There is evidence that state-level politics and election consideration affect important policy decisions. For example, Kubik and Moran (2003) find that election-year political considerations play a role in determining the timing of executions. Moreover 17 Bound (1989) concludes that the disincentive effects of SSDI are small. On the other hand, Gruber and Kubik 1997) find that every 10 percent increase in denial rates leads to a nearly 3 percent fall in labor force non-participation among year old males. 18 In two studies reviewed by Parsons (1991), reconsideration of initial determinations by either the same review panel one year later or a separate team of medical experts revealed substantial errors. There appears to bee supporting evidence from Benitez-Silva, Buchinsky and Rust (2004). 19 Autor and Duggan also find that the DI program encouraged exit from the labor force. In particular they measure the unemployment rate among adults aged would have been about half a percentage pint (or about 13 percent) higher had it not been for the liberalized changes they identify. 20 Persson and Tabellini (2000) are a good survey for the theory. Besley and Case (2003) review most of the theoretical and empirical literature. 10

11 political power appears to matter. Poterba (1994) finds that when a single party controls the state house and the governorship, governors are much better able to adjust fiscal policy in response to economic downturns. This paper connects the observed linkage between unemployment rates and disability insurance and the observed linage between unemployment rates and gubernatorial popularity. Cohen and King (2004) find that when the state unemployment is lower than the national average, governors lose political capital and face worse approval ratings. Approval ratings are important not only because they are a key indication of re-election prospects (King 2001) but also because they expand the executive s ability to set their own policy agenda (Canes-Wrone and de Marchi, 2002). Moreover recent work by Wolfers (2005) has found that voters systematically make attribution errors regarding economic conditions. In such a world, governors have strong incentives to adjust perceptions of the state economic conditions relative to national conditions. Moreover, the large increases in DI allowance rates appears to be contemporaneous with some of the more stringent welfare reforms and restrictions on social welfare programs. If disability insurance serves the role of a long-run unemployment insurance or welfare for those with poor re-employment prospects, then governors may DI as a costless way to reduce unemployment, thus improve their own political outlook. 3 Data and Trends in Disability Insurance Acceptance Rates In order to explore the relationship between political considerations and DDS s DI allowance rates, we use Social Security Administration data from 1982 through We link this statistical supplement to data on political variables collected by Besley and Case (1995). This political data has information about electoral rules, decision-making rules, legislative outcomes, and gubernatorial outcomes. 11

12 3.1 Data on Disability allowances and Economic Factors The disability application variables, reported in Panel A of Table 1, include applications and allowance rates for individuals who apply for DI or SSI separately as well as individuals who apply for DI and SSI combined. The allowance rate is defined as the number of approved applications at the DDS level divided by the total number of applications. The denominator of this outcome is reported as the number of applications for DI and SSI separately as well as combined DI/SSI applications. Table 1 shows that about 43 percent of DI claims and 40 percent of SSI claims are accepted. Moreover, this number has been increasing over time. In 1982 only about 35 percent of DI applications and 33 percent of SSI applications were accepted. This rose to a peak of 49 percent of DI applicants and 47 percent of SSI applicants in State demographic and economic variables, which are used to control for expected variation in DI allowance rates, are reported in Panel B of Table 1. The unemployment rate averaged about 6 percent during this period though in the post-liberalization period (after 1984) it was on average only about 5.5 percent. States vary a great deal in their unemployment rate, however. For example, during that time period both West Virginia (in 1985) and Louisiana (1986) had unemployment rates well over 10 percent. In contrast, in those years New Hampshire and Massachusetts had unemployment rates of well below 5 percent. Similarly, 25 percent of the population lives below 150 percent of poverty. However, this varies widely as some states less than 10 percent of the population lives below 150 percent of poverty (Connecticut) and in some states over 40 percent of the population lives below poverty (Mississippi). These factors are useful in illustrating the reason why due to various economic factors, states are likely to differ widely in their allowance rates and the political value of a higher allowance rate. Another source of variation in the demand for disability insurance is the relative value of DI payments. There is considerable variation in the DI replacement rate (i.e. the average DI payment/ the average wage) as well as the unemployment insurance (UI) 12

13 replacement rate (i.e. the average UI payment/ the average wage). There is also variation in the number of people without health insurance (on average 75 percent but as low as 55 percent. This is particularly relevant because individuals are eligible for Medicare 24 months after an individual is deemed disabled. These factors regarding access to public welfare may also influence demand and thus the political value of disability insurance. 3.2 Data on Political and Electoral Institutions The political variables are reported in Tables 2. Panel A of Table 2 reports descriptive variables about the governors. About 60 percent of the state-years have governors serving their first term in office. About 30 percent of the state-years have governors serving their second term in office. About 49 percent of the state-years have democratic governors. The average governor is about 54 years old. In addition to the descriptive variables in Panel A, we also report some outcome variables in Panel B. Only about 13 percent of incumbents lose re-election (either in a primary or a general election). About one-quarter of the sample are ineligible for another term. Another 17 percent were eligible to run but did not do so. Thus about 30 percent of the sample as governors who did not get re-elected even though they were eligible for re-election. On average, winning governors won about 57 percent of the votes, but some won with as little as 35 percent of the vote. Only about 6 percent of the sample won by a margin of greater than 10 percentage points. Panel C of Table 2 reports rules which may limit gubernatorial power. Over 80 percent of the sample has gubernatorial line-item veto, where the governor can eliminate individual items in omnibus legislation. Only 20 percent of the sample has supermajority requirements to approve tax increases. 45 percent of the sample has indexed limits on tax and expenditure changes but only 25 percent of the sample has limits that are restrictive. Panel D of Table 2 reports other political variables relevant for gubernatorial political power. In 16 percent of the sample, one party received more than 60 percent of the vote indicating strong party ties. On average, 57 percent of state senate members and 56 13

14 percent of state house members are democrats and indeed about 56 percent of the sample has a democratic legislature. In general, democrats are believed to be associated with higher government spending and in general fiscal laxness. However, we find evidence of a significantly negative relationship between having a democratic legislature and the fraction of expenditures that are deficit funded. About 20 percent of the state senate members and 14 percent of state assembly members are women and again, there appears to be little correlation with government expenditures. Higher fractions of women in political office are sometimes thought to indicate the political liberalness of an area and would be associated with higher spending levels. We find evidence that a higher fraction of women is associated (in a marginally significant sense) to higher rates of deficit spending. Finally, about 48 percent of the sample has a split government, where the governor and the majority of the legislature are of opposite parties. It is typically thought that split governments are more fiscally conservative. We find no evidence of a significant relationship between split government and deficit spending. Panel D also reports the relationship between the governor s party and the current president s party. The relationship between the governor and president s party may relate to career concerns of governors. For example, if a governor is too extravagant in allowances for his or her state, then while there is little consequence for within state politics, there may be reputation consequences in national politics. Nearly 40 percent of the sample has governors who are of the same party as the president. Of the 60 percent of the sample in which the governors and presidents are of opposite parties, about 23 percent have republican governors and democratic presidents. The political party may be important if there are different reputational and electoral consequences for higher welfare spending by political party. 14

15 3.3 Allowance Rate Trend Analysis In order to explore the relationship between disability insurance allowance rates and gubernatorial politics, we first want to establish the importance of acceptance rates relative to application rates in the expansion of the disability program. Figures 1 and 2 illustrate the DI application rates (per 100,000) and allowance rates (respectively) from 1982 until Similarly, figures 3 and 4 show SSI application rates (per 100,000) and allowance rates. First consider figures 1 and 2. It appears that there as a steady rise in the allowance rate in the early to mid-eighties despite relatively stagnant application rates. This may be due to the liberalization that occurred in It is also likely related to the 1980 Amendments, in which Congress, through Federal regulations, explicitly described the nature of the DDS role the disability decision making process. Until the 1980 Amendments, SSA had agreements with individual states regarding the nature and scope of the DDS role. Because of inconsistencies in administration and the difficulty different agreements posed for enforcement, the Congress attempted to strengthen the Federal role in the Federal-State system. The 1980 law required the Secretary to issue performance standards as well as administrative requirements and procedures to be followed in order to assure effective and uniform administration of the disability insurance program throughout the United States. However, recent reports by the GAO and Social Security Advisory Board suggest that these regulations, as they were issued, may have reduced the Federal management role This description of events borrows heavily from the information collected by Fred Arner in a comment on Federal Disability Regulations posted on the Social Security Administrations Comment site. Fred Arner has spent nearly 50 years working on the Social Security disability programs. His positions include Chief of Education and Public Welfare Division, Congressional Research Service, consultant to the Ways and Means and Finance Committees on legislation, Committee Counsel on Ways and Means Subcommittee on oversight of the disability program(1959), Staff member Ways and Means Social Subcommittee( ), consultant to Office of Disabilty and OHA( ), and intermittent consultant on disability, including SSA Advisory Board (to date). He also received an Alfred P. Sloan Foundation grant and study A Model Disability Structure for the SSA ( ) 15

16 Note also that both allowance and application rates rose dramatically in the late eighties (around ) until the mid-nineties (around ). They both drop off relatively around However, application rates especially for multi-term governors continued to decline steadily throughout the nineties. In contrast, after a sharp drop between 1992 and 1995, allowance rates rose quite steeply in the nineties, especially for multi-term governors. The decline from is likely due major judicial and legislative factors. In 1992, several states filed class action suits against State DDS s and/or the SSA. Much of this was settled by the Schisler v. Sullivan decision (which in 1993 upheld SSAs regulatory use of power in regulating the treatment of opinions of treating physicians) and the settled Hyatt class action suit (in which some 80,000 disability claims would be re-adjudicated using the pre-1991 standards). Finally, in 1994 Congress restricted and eliminated benefits for drug addicts and alcoholics. Figures 3 and 4 plot SSI rates from 1982 to Some of the trends are similar to DI but there are marked differences. The first clear difference is that SSI rates rose dramatically beginning in the late-eighties and more steeply in the early nineties. While the steepest portion of this rise overlapped with an increase in DI applications, it spans a much longer time period. The allowance rates, in contrast, move in an almost identical manner to DI rates. Moreover, there is a much larger difference between first term and multi-term governors in SSI application rates versus DI application rates. This may be related to the uses of SSI versus DI. Recall that SSI is means tested and provides differential health care treatments. Recent evidence suggests that SSI may be serving a form of welfare, especially for children. 22. While there appear to be some differences by term length, these differences are not significant once controls are included for state fixed effects and demographic/socio-economic trends. 23 Having established the relationship between application and allowance rates, we turn 22 This has been noted with respect to children by Kearny and Duggan (2005). In particular figures 3 and 4 confirm the results reported in Kearny and Duggan and suggest that there may be some political underpinnings to this usage of SSI as welfare. 23 Results relating application rates to term length are available upon request. 16

17 to differences between governors of different term lengths. From figure 1 is also clear that there are pronounced and consistent differences between first-term and multi-term governors. There is no ex-ante reason to believe that allowance rates should be in any way related to gubernatorial term length. Moreover, because states change governors every few years from 1980 to 2000, any relationship between governors term length and allowance rates is likely more than a simple state effect. The relationship between the ease of misclassification (by DDS agencies of applicants) is also apparent in the divergence of the allowance rates by gubernatorial term length. Notice that before the 1984 liberalization, term length appears to have little effect on the DI allowance rate. This may be because the liberalization reduced the monitoring of governors, allowing them more flexibility to deviate from the SSA s desired allowance rate. After the 1984 liberalization, multi-term governors maintain a much higher rate of disability allowances than do first term governors. Moreover, much has been made of the steep rise in the late-eighties, and from Figure 1 it appears that much of that was driven by multi-term governors. Note that the allowance rate for first term governors declined from and only rose again from By 1992, allowance rates in states with first-term governors were only 3 percentage points higher than they had been in 1984 and did not rise monotonically in the period. In contrast, allowance rates in states with multi term governors were about 10 percentage points higher and either remained insignificantly changed or rose during every year in the period. In short, Figures 1 and 2 reveal there are two factors that affect the adjustment of DI allowance rates by governors. The first is information about detection. First term governors may be wary of moving DI allowance rates in response to poor economic conditions because they do not have enough information about how the Social Security Administration will react. On the other hand, second term and later governors have much more information and therefore adjust DI rates much more as economic/political needs arise. The second issue is flexibility. Applying higher than expected allowance rates is risky because it risks detection and potential reputational consequences. Governors will often 17

18 prefer not to do this if it is difficult. Thus we see much more movement and larger differences by governor term length during periods of little scrutiny and reduced monitoring. 4 Explaining Term Differences: A Model of Gubernatorial Learning There appear to be fairly substantial differences by governor term length which is somewhat puzzling since one might expect governor term length to be uncorrelated with disability allowance rates. In order to better understand why multi-term governors might have higher allowance rates, we develop a model of strategic interaction between governors and the Social Security Administration (SSA). We show that gubernatorial learning in the face of SSA monitoring would produce the observed results. 4.1 Defining the Game To begin, suppose the governor has utility U (x), where x = a a ssa represents the difference between SSA s desired allowance rate (a ssa ) and the allowance rate set by the governor (a). SSA observes x. SSA can take one of three actions: do nothing, send a warning, or take over. To decide which action to take, SSA follows these rules: send a warning if x > c (i.e. define a variable such that s = 1 (x > c )) takes over if x > c (i.e. define a variable such that t = 1 (x > c)). In these rules c represents the cost to the SSA of taking over any DDS and is the amount by which SSA shades the true costs of takeover in order to ensure compliance. For illustrative purposes we will treat as exogenously given. 24 Assume that governors 24 An interesting extension to this model is one in which is also a choice parameter strategically set to induce maximal compliance. 18

19 know, but don t know c. 25 That is, we assume that governors know how much SSA will shade by but they do not know the true cost of takeover. Also, assume that if x > c governors utility is zero (i.e. U(x) = 0 for) the period and any period after. That is governors receive zero utility in this period and future periods if SSA takes over and as such governors will always avoid setting x > c. In a one period model the governor weights the utility gain from setting a higher acceptance rate with the increase in the probability of takeover. 26 In a two period model, however, information is transmitted based on the SSA s action in the previous period. The governors will therefore maximize their utility over both period, i.e. max U (x 0,x 10,x 11 ) = Pr (t 0 = 0)U (x 0 ) + Pr (t 0 = 0,t 1 = 0,s = 0)U (x 10 ) (1) x 0,x 10,x 11 + Pr (t 0 = 0,t 1 = 0,s = 1)U (x 11 ). where x 0 is the difference between SSA s desired allowance rate and the allowance rate set by the governor at time t = 0, x 10 is the difference between SSA s desired allowance rate and the allowance rate set by the governor at time t = 1 if the governor does not receive a warning, and x 11 difference between SSA s desired allowance rate and the allowance rate set by the governor at time t = 0 if the governor receives a warning. 4.2 Solving the Governor s Maximization Problem Suppose that c has a known distribution, F(c), which admits a density f(c). Substituting in the distribution function for the probabilities, the expected utility in 1 simplifies to: [1 F (x 0 )]U (x 0 ) + [1 F (x 10 )]U (x 10 ) + [F (x 0 + ) F (x 11 )] U (x 11 ) (2) To solve the model we work backwards. Suppose the governor maintains the admin- 25 Assuming that is also unknown does not alter the results, while if the governor knows c, x = c, an uninteresting case. 26 Note that to assure an interior solution in a one period model the main regularity condition is that the hazard rate f(x) 1 F(x) is monotonic. 19

20 istration of the disability program (i.e. t 0 = 0,t 1 = 0,s = 1) and he received a warning, then x 1 is implicitly defined by: arg max x 1 P (c > x 11 c > x 0,s)U (x) = (1 F (x 11 x 0 < c < x 0 + ))U (x 11 ) (3) The first order condition from equation 3 is: (1 F (x 11 x 0 < c < x 0 + ))U 1 (x 11,α) f (x 11 x 0 < c < x 0 + )U (x 11 ) = 0 or more simply: (F (x 0 + ) F (x 11 )) U 1 (x 11 ) f (x 11 )U (x 11 ) = 0 (4) In a parallel manner the governor s strategy in the state of the world where there is no warning at time (i.e. t 0 = 0,t 1 = 0,s = 0) is implicitly defined by the first order condition: (1 F (x 10 ))U 1 (x 10 ) f (x 10 )U (x 10 ) = 0 (5) Let x 10 and x 11 be the solutions to these two maximization problems. We can then rewrite equation 2 as: max x 0 U (x 0 ) = [1 F (x 0 )]U (x 0 ) + [1 F (x 10)] U (x 10) + [F (x 0 + ) F (x 11)] U (x 11) with corresponding first order condition: (6) 0 = [1 F (x 0 )] U 1 (x 0 ) f (x 0 ) U (x 0 ) (7) + {[1 F (x 10)]U 1 (x 10) f (x 10)U (x 10)}x 10 (x 0 ) 20

21 + {[F (x 0 + ) F (x 11)]U 1 (x 11 (x 0 )) f (x 11)U (x 11)}x 11 (x 0 ) +f (x 0 + )U (x 11) In equation 7, x 10 (x 0 ) is the change in the second period solution (without warning) with respect to x 0, and similarly x 11 (x 0 ) is the change in the second period solution (with a warning) with respect to x 0. We can show that the three first order conditions (equations 4, 5, and 7) cannot be simultaneously satisfied. If all there are satisfied that implies that 0 = [1 F (x 0 )] U 1 (x 0 ) f (x 0 )U (x 0 ) + f (x 0 + )U (x 11) (8) Define G (x 0 ) = [1 F (x 0 )] U 1 (x 0 ) f (x 0 )U (x 0 ). Equation 8 then implies that G(x 0 < 0). However, we have assumed G (x 10) = 0. Because of the regularity condition G (z) is decreasing, implying that x 10 < x 0, which cannot be optimal. Governors will never set x 1 < x 0 if there was no takeover in the initial period (i.e., governors should always set x 1 x 0 ). Let us now consider a case where governors choose the interior solution if they do not receive a warning, so that G (x 10) = 0. If there is a warning instead, governors pursue the safest strategy and maintain the same acceptance rate in the second period (i.e. if s = 1, then x 11 = x 0 ). In this situation, we can rewrite the first order condition: 0 = G (x 0 ) + [F (x 0 + ) F (x 0 )]U 1 (x 0 ) f (x 0 )U (x 0 ) + f (x 0 + )U (x 0 ) (9) In order for equation 9 to hold, G (x 0 )+[F (x 0 + ) F (x 0 )]U 1 (x 0 ) f (x 0 )U (x 0 ) < 0. Since x 10 > x 0 and G(z) is decreasing in z, we know that G (x 0 ) > 0. This implies that F (x 0 + ) F (x 0 )U 1 (x 0 ) f (x 0 )U (x 0 ) < 0. Note however that this implies that: G (x 0 ) [F (x 0 + ) F (x 0 )]U 1 (x 0 ) f (x 0 )U (x 0 ) > 0 21

22 G (x 0 ) ( {[F (x 0 + ) F (x 0 )]U 1 (x 0 ) f (x 0 )U (x 0 )}) > 0 G (x 0 ) + [F (x 0 + ) F (x 0 )]U 1 (x 0 ) f (x 0 )U (x 0 ) > 0 Thus there does not exist an interior solution where after a warning the governor will set the acceptance rate at the same level. Intuitively this results indicates that because governors know they still have some room to increase their acceptance rates and the warning itself does not impose any costs (so getting another warning without a takeover is costless), it is not optimal for them to simply maintain the status quo when given a warning. Next, consider a case where governors choose the optimal x 1 if they receive a warning (i.e. the first order condition for x 11is satisfied). If there is no warning, governors simply increase by (i.e. x 10 = x 0 + ). Note that since is known, and the strategy of the SSA is known, is the minimal amount governors can safely increase by and still avoid takeover. Note that G (x 11) > 0. Since we know that x 11 > x 0, this implies that G (x 0 ) > 0. The first order conditions can then be written as: 0 = G (x 0 ) + G (x 0 + ) + f (x 0 + )U (x 11) (10) 0 = [F (x 0 + ) F (x 11)] U 1 (x 11) f (x 11)U (x 11) The first condition can be satisfied if G (x 0 + ) is sufficiently negative. In this case, governors will always choose x 11 > x 0 and the warning by the SSA simply dictates the magnitude of the increase. 27 Summing up, the main prediction of the model is that ceteris paribus acceptance rates in the second period are at least as large as in the first period, and are larger whenever governors receive a warning. 27 Whenever it is not satisfied, there are no interior solutions in the second period and the two boundary solutions are x 11 = x 0, x 10 = x

23 5 Evidence Linking Allowance Rates and Political Factors 5.1 Evidence of Learning as a Source of Term Differences A model of gubernatorial learning appears to explain the simple observations from Figure 1. In order to more broadly explore the relationship between term length and acceptance rates, we estimate a series of regressions reported in Table 3. All specification control for the unemployment rate, average state income, fraction of working age population, the fraction married, and the fraction white. Newey West standard errors are reported in parentheses. Columns (1) through (3) report the DI allowance rate, columns (4) through (6) the SSI allowance rate, and columns (7) through (9) the concurrent DI plus SSI allowance rate. The first set of regressions, reported in columns (1), (5) and (9), use a specification that controls for year fixed effects. It appears that first term governors systematically accept 1.2 percentage points fewer applicants to the DI program corresponding to about a 2.5 percent difference. The estimates for SSI are about the same and for concurrent rates are slightly higher. Note that although SSI is a means-tested program unlike DI, it appears to be following a similar pattern. This may be related to the use of SSI as a welfare substitute for particularly hard-hit families. The second specification, reported in columns (2), (6) and (10) includes state and year fixed effects. The third specification clusters standard errors. The estimates are quite similar and in fact the point estimate on first term governors is not significantly different between the specifications. Note that in all three specifications DI and concurrent applications are increasing in term length. The specifications in columns (4), (8) and (12) include GLS estimates to correct for serial correlation. The point estimate shrink by about 0.4 of a percentage point for all allowance rates. Despite changes in the magnitude of the point estimates, the overall findings appear 23

24 to be robust to specification. Governors appear to have lower acceptance rates for applicants of the disability insurance and supplemental security income programs. These term differences appear even when controlling for unemployment rates and other workforce and population demographics. This suggests that the results are not due simply to correlations between various economic or demographic trends. Another potential cause of these differences could be that there are high allowance states which are also incumbentfavorite states. That is, some states are both more likely to have multi-term governors and more likely to have higher allowance rates. This is unlikely first because governors do indeed appear to change on a regular basis. The probability of winning re-election is only about 48 percent, when considering the governors who cannot run, choose not to run, and lose. Moreover, our specifications controlling for state and year fixed effects should absorb any state effects such as predisposition towards incumbents. While the results from Table 3 are indeed consistent with our model, they are not conclusive as to the political nature of disability insurance rates. 5.2 Political Need, Gubernatorial Power, and Disability Insurance Allowance Rates The model of gubernatorial learning has implications for the usage of DI as a political tool. While there are gains from using DI, if it indeed serves as a vote-buying mechanism, it is also risky. Because c is unknown, governors who are not constrained from otherwise addressing economic conditions may prefer not to use expand DI maximally while governors who are constrained either through political institutions or economic factors may be forced to increase allowance rates more than they might otherwise. Indeed, Table 3 shows a relationship between unemployment rates and acceptance rates. For example, in the first specification, without state fixed-effect, there appears to be a sizable negative relationship between state unemployment levels and allowance rates. In some senses this is misleading because when the unemployment rate increases, the number of marginal 24