The Region

America's Second Currency

A Staple for 1 in 10 Americans, Food Stamp Program May Face Reforms

Ben Senauer | Professor of Economics and Director, Center for International Food and Agricultural Policy, University of Minnesota

Published March 1, 1993  | March 1993 issue

Delaine Lee, an unemployed single mother living in rural Minnesota, speaks bluntly about the importance of food stamps in her life: "I wouldn't make it without the food stamps. That's plain and simple," she told the Minneapolis Star Tribune.

She's not alone. The Food Stamp Program is a crucial part of the social safety net for the poor, with over 26 million people receiving food stamps in September 1992, a record number of recipients. Program benefits of $20.9 billion were paid in fiscal year 1992 by the federal government, with an additional $1.53 billion spent on administration.

However, while food stamps are generally regarded as an effective means to aid the poor, the program remains controversial. Concerns have been heightened by recent major cases of fraud. In September 1992 three New York City businessmen who operated a wholesale meat company pled guilty to laundering $82 million worth of food stamps, which had illegally been redeemed for cash. Also in September, police raided 10 convenience stores in Minneapolis that were suspected of illegally exchanging food stamps for cash.

With one in 10 Americans receiving them, food stamps have become a large part of the economy; as such, they not only impact retail food sales, but they also allow recipients to use their regular currency for other purposes (non-food spending). The prevalence of food stamps—and the politics associated with them—also means that the program will not easily be affected by current calls for changes in the nation's welfare system.

But change is afoot for the program. The first food stamps were issued about 60 years ago to disperse agricultural surpluses, while the current program became a national aid program in the early 1970s. Current change involves the method of disbursement, from paper coupons to plastic cards and electronic transfers, a move that is meant to streamline the program and to address the problems of errors and fraud.

Assessing the Impact of Food Stamps

Although the Food Stamp Program is very large, its relative impact on food and agricultural sales is quite limited. Studies have found that households increase their food purchases by 20 cents to 35 cents for each dollar's worth of food stamps. This means that the $20.9 billion worth of food coupons issued in fiscal year 1992 increased retail food sales by an estimated $4.2 billion to $7.3 billion, an increase of only 1.5 percent to 2.6 percent. For farmers, food stamps increased farm sales by about $1.1 billion to $2 billion, or only about 1.1 percent to 2 percent, given the $101 billion worth of commodities that farmers sold in 1991.

Since food stamps must, by law, be spent for food, why is the increase in food purchases not dollar for dollar, but only 20 cents to 35 cents per dollar? The reason is that participating households can substitute stamps for some of the cash which they spent on food before joining the program. As an example, a household that spent $500 per month for food before and receives $300 in coupons after joining the program, may increase its food purchases to $600 per month. They use all $300 of stamps for food but now need to spend only $300 of their own money. The effect is that they have saved $200 to spend for other things, which is perfectly legal. Since food purchases have only risen by $100, the increase in food expenditures is 33 cents per dollar of food stamps in this case.

More generally, the Food Stamp Program acts as another automatic counter-cyclical stabilizer in the economy, like unemployment insurance and other programs. Program participation rises when the unemployment rate increases and the number of people living below the poverty level goes up. For example, in June 1974, with an unemployment rate of 5.1 percent, 13.5 million people received food stamps. By May 1975, when unemployment was 8.9 percent, food stamp participation had risen to 19.3 million—an increase of over one million people for each 1 percent rise in the unemployment rate.

More recently, participation climbed from an average of 18.8 million in fiscal year 1989 to over 26 million, largely in response to the weak economy. The unemployment rate, which was only 5 percent in March 1989, reached 7.8 percent in June 1992. During this time, the number of Americans below the official poverty level also rose, from 31.5 million people, or 12.8 percent of the population in 1989, to 35.7 million, or 14.2 percent in 1991, the latest year for which figures are available. As in the past though, as the economy starts to improve and unemployment and poverty rates fall, the number of food stamp participants can be expected to decline substantially.

The Food Stamp Program embodies many of the principles that welfare experts advocate. The program has uniform national standards for eligibility and benefits. Under a program such as Aid to Families with Dependent Children (AFDC), benefit levels vary enormously from state to state. With food stamps, coverage is universal. They are available to all who meet the eligibility requirements and not just certain categories. Food stamps can be received by intact households in which the husband is present. The benefits are automatically adjusted for inflation, so that the real value of the allotment is not eroded.

Also, the program is largely federally financed, with the federal government covering the total cost of the food stamp benefits and 50 percent of the states' administrative costs. In addition, uniformity of administration is maintained at the state level through federal supervision and regulation.

Moreover, the program has tried to embody increasingly strong work incentives. The rate of benefit reduction per dollar of earned income is only 30 cents, meaning there is an incentive to increase earned income through employment. Under some welfare programs the reduction in benefits may actually exceed what can be earned at a job.

Why Stamps and not Cash

To many people, and particularly to many economists, it would seem much more efficient to simply give low-income families cash rather than food stamps, or other in-kind benefits such as rent subsidies. Part of the explanation for why we have a Food Stamp Program is historical and political. The history is that food stamps originated with a major objective of reducing agricultural surpluses. That food stamps and the other food programs have remained in the Department of Agriculture and under the agricultural committees in Congress has been very important politically. Support for food stamps among rural legislators with agricultural constituents has been traded for support for farm programs among urban representatives and those with particular concerns about poverty and hunger.

There may be more fundamental reasons for in-kind social welfare programs though. Clearly, many recipients would rather receive cash than stamps; they could spend the money in line with their own preferences. However, particularly since the purchase requirement was eliminated, the food stamp allotment is less than most recipients spend for food, so recipients are not actually being restrained. Many program participants indicate they actually prefer receiving stamps rather than cash, because stamps ensure that benefits are spent for food and they make it easier to budget for food expenses. On the other hand, cash would eliminate the stigma and embarrassment that comes from paying with food stamps in the grocery store.

The preference of the donors, in this case the American taxpayers, must also be taken into account. Donors may consider certain types of consumption as more important and worthy than others. Our current social welfare programs reflect this perspective and are targeted at the consumption of food, housing, education and medical care. Public concern is greater over minimum consumption standards for such merit goods than for other goods and services.

The evidence from many studies is that food stamps do increase food expenditures more than an equal amount of cash. As mentioned earlier, food stamps are estimated to increase food spending by 20 cents to 35 cents per dollar of coupons. The food purchases of low-income households typically only increase by 5 cents to 10 cents for each additional dollar of cash income. The results from switching the citizens of Puerto Rico and certain elderly on Supplemental Security Income (SSI) to cash grants rather than food stamps suggest the difference in the impact on food spending may not be so great under some circumstances.

Recently, experimental cash-out demonstrations have been run in Alabama, Washington state and San Diego. For example, in Washington, food stamp benefits were incorporated into the public assistance checks received by a sample of participants. The evaluations of these cash-outs on food spending and other responses have not yet been released.

Errors and Fraud

Given the size and complexity of the Food Stamp Program, it should perhaps not be surprising that errors and fraud pose serious problems. Errors and fraud in food stamp issuance result in the payment of about $1 billion in unwarranted food stamp benefits annually, according to estimates. Even though this represents a large amount of money, it amounts to only 5 percent of the total food stamp benefits paid in 1992. Caseworkers make about half the mistakes in determining applicants' eligibility and benefit levels. Recipients account for the rest by lying or making errors on their applications.

The Food and Nutrition Service works with states to ensure the accurate issuance of benefits and has a quality control system to monitor the accuracy of eligibility certification and benefit determination. States receive increased federal administrative funding for low error rates. However, states are liable for errors above a certain standard of accuracy. The Department of Agriculture is currently seeking millions of dollars from states for unwarranted benefit payments. Errors can also lead to underpayment, as well as overpayment of benefits.

There are three types of food stamp fraud and abuse: falsifying applications, misuse and trafficking. As previously mentioned, the first type occurs when applicants knowingly falsify information when applying for food stamps. Retailers may also provide false information when they apply for authorization to accept food stamps. In the second type, recipients and retailers misuse the program when food stamps are exchanged for ineligible items or are used to make small purchases to accumulate the change that is given in cash.

The most serious violation, trafficking, involves the sale, purchase or barter of food stamps for cash or nonfood items. In addition to recipients and retailers, trafficking can involve intermediaries such as drug dealers, fencing operations and street traffickers. Concern about trafficking has increased, especially with the attention given to certain cases, such as those mentioned in the introduction. The actual number of allegations of trafficking remains small relative to the total number of recipients and retailers. However, since it is nearly impossible to conduct a reliable survey, the government does not have a good estimate of the magnitude of trafficking in food stamps.

But there are good reasons to believe the problem is limited. A trafficker may only receive, for example, 50 cents per dollar of food stamps. As discussed earlier, the food stamp allotment is less for most participating households than their total food purchases for the month. Therefore, there is no incentive to cash food stamps at a 50 cent discount, unless the cash is desperately needed.

Trafficking problems are most likely to occur among participants without children, those living on the street and recipients with substance abuse problems. The most frequent locations for trafficking are near liquor stores, in areas where illegal drugs are sold and outside welfare offices where food stamps are issued.

In some cases of trafficking, food retailers have been involved. Food stamps can circulate as a "secondary currency" (in this case, a currency that is circulated more than once, beyond its intended purpose), when trafficking involves multiple transactions at progressively smaller discounts. Authorized food retailers can also engage in "laundering" large quantities of stamps by buying them for cash and then redeeming them in the normal fashion.

The state agencies involved with the program are responsible for investigating and prosecuting fraud and misuse by recipients. In 1991, they conducted over 420,000 individual investigations and more than 80,000 recipients were disqualified as a result. In addition to disqualification from the program, cases can be referred for criminal prosecution.

The Food and Nutrition Service is responsible for identifying food retailers that abuse the program. In 1992, investigators examined 4,800 cases of suspected abuse, of which over 1,400 led to retailer disqualification from the program and 750 involved trafficking. The penalties for fraud and abuse were tightened under the part of the 1990 Farm Bill dealing with food stamps. The illegal use of coupons or authorization cards involving more than $5,000 was made a felony with a maximum fine of $250,000 and/or 20 years in prison.

Alternative Delivery Methods

Food stamps are issued to recipients in person, by mail or through an electronic "debit card" arrangement, depending on the locale. The latter is an electronic benefits transfer (EBT) system in which the food stamp participant uses a plastic "debit card" at store computer terminals to access their available benefits.

EBT is a special type of electronic funds transfer, such as many people use with automated teller machines. Under the EBT system, the amount of the purchase is automatically subtracted from the food stamp account and a receipt is presented that includes the amount remaining in the account. No money or stamps are exchanged, and all accounting is handled by computer, including crediting the food retailer's bank account.

There are some clear advantages to the EBT system. Currently there is an enormous flow of paper coupons; the accounting task is complex as the stamps move through the system from printing, to issuance, to the program recipient, the retailer, the bank and finally to the Federal Reserve bank or branch that processes the stamps. The coupons must be counted and safeguarded at each step. EBT eliminates the need to physically move and account for paper coupons and automates much of the accounting.

In particular, program recipients find EBT more convenient and secure. If a debit card is lost or stolen, unlike paper stamps, it cannot be used without the code number and can be easily canceled and replaced. The stigma of using food stamps is also removed. Costs for retailers are 25 percent lower with EBT than with paper coupons because of less handling by employees and automatic accounting, although special equipment must be installed.

The banks like EBT for the same reasons. For the federal government, the costs involved in printing, transporting, distributing and, in the end, destroying the used stamps are eliminated. Furthermore, the possibilities for abuse and fraud are greatly reduced. Program participants receive no stamps that they can sell at a discount for cash, but can only receive their benefits at a grocery for food purchases. No change is given in cash. EBT also generates a "paper trail" documenting each food stamp transaction, which makes it easier to catch abuses by retailers or recipients.

The first EBT demonstration project for food stamps was initiated in Reading, Penn., in 1984. The first system to draw benefits from multiple welfare programs, including food stamps and AFDC, was started in Baltimore in 1989. Additional EBT pilot programs, which emphasized reducing costs and improving operations, were begun in Ramsey County (St. Paul), Minn., and Bernalillo County (Albuquerque), N.M., in 1991.

A project using a "smart card" technology began in Dayton, Ohio, in 1992. A microprocessor is embedded in the card and contains the information necessary to authorize food stamp purchases. It can record food purchases and subtract them from the allotment. Recently, South Carolina announced it will become the first state to institute an EBT system as an operational alternative for issuing food stamps.

The shift to EBT has not been more rapid because it costs more than the conventional issuance system. Administrative costs per participation household with paper coupons are about $3 per month. In the first EBT demonstration project in Reading, monthly costs were about $9 per household. However, it is expected that costs will drop as EBT is implemented on a larger scale and when other welfare programs such as AFDC are also paid by EBT and share the cost. The EBT system will also become more efficient with experience. Assuming a combination of favorable—but still realistic—assumptions, EBT costs per household are estimated to fall to current paper levels.

An important issue is whether EBT accounts are individual bank accounts and consumer protection regulations should be applied. EBT accounts had been operating under a waiver from these regulations because the benefits are disbursed from an account of the county administering the program, and not a bank account established or controlled by the individual consumer or program recipient.

In early January, the Federal Reserve Board, which regulates consumer protection laws for banking, voted to extend the rules to cover EBT accounts. The program recipients' liability for losses would now be limited to $50 if they promptly report the loss or theft of their EBT card, and government agencies would be required to correct account errors within 10 days. Some welfare agency officials have argued that providing these protections would be too costly and EBT will not be economically feasible. The Federal Reserve Board decision is tentative until the end of a 90-day comment period.

The System Works Improve it, Don't Eliminate it

As attention is likely focused on welfare reform in the coming months, certain key points should be stressed about the Food Stamp Program. First, although there are problems, food stamps function remarkably well in fulfilling the major objective of assisting millions of needy families to meet their food needs. The program embodies many of the principles that are advocated by welfare experts.

Second, participation and program cost have grown dramatically since 1989. However, if the United States enters a period of robust economic recovery with substantial declines in unemployment, the number of food stamp participants and the cost of the program should fall significantly.

Third, fraud and abuse are serious problems for the program's integrity and could undermine public confidence and political support for food stamps. Consequently, combating fraud and misuse should be given a high priority.

Fourth, the rapid conversion to the delivery of food stamp benefits by electronic benefits transfer should be encouraged. The electronic system provides a way to reduce many of the abuses of food stamps. In particular, it could eliminate much of the trafficking in which food stamps are exchanged for cash at a discount.

Finally, if a major reform of welfare programs is proposed by the new administration, the Food Stamp Program would almost certainly be included in those changes and could even be targeted for elimination. This would be inadvisable. While it is large, the Food Stamp Program is dwarfed by some of the other government transfer programs: Medicaid, for example, will reach an estimated $120 billion in 1992, up from $54.3 billion in 1988. The new administration would be right to focus on health care and medical insurance reform ahead of radical welfare reform.

A Brief History of The Food Stamp Program

Federal food assistance programs originated as part of the farm support laws enacted in the Great Depression of the 1930s. They were primarily aimed at disposing of agricultural surpluses but also were intended to help needy people. In addition to direct commodity distribution, a food stamp program was initiated in 1939 during the Roosevelt administration. Four million people were participating by 1941, but after the start of World War II agricultural surpluses vanished and the program was discontinued.

When agricultural surpluses reappeared in the 1950s, legislation to reinstate a food stamp program was considered in Congress. A pilot food stamp program was started under President Kennedy in 1961 and made permanent with the passage of the Food Stamp Act of 1964 under President Johnson. The stated purpose was "to raise levels of nutrition among low- income households," and "to promote the distribution in a beneficial manner of our agricultural abundance." However, the program remained small and participation reached only 1.4 million by 1967, with expenditures of $115 million.

In the late 1960s, public concern about hunger in America was aroused by the television documentary, "Hunger USA," the 1969 book, Let Them Eat Promises: The Politics of Hunger in America, the Citizen's Board of Inquiry report on "Hunger, USA," Senate subcommittee hearings in Mississippi, and the Poor People's March in Washington, D.C. In response, under the Nixon administration, the food stamp legislation was amended in 1970 to mandate nationally uniform eligibility standards and allotment schedules. In addition, 1973 amendments required that every county in the United States begin operating a food stamp program by mid-1974.

The expanded and reformed Food Stamp Program grew rapidly in the 1970s, reaching 12.9 million persons by 1974 and over 20 million by 1980. The requirement that all but the poorest households purchase some of their stamps was eliminated in 1979. Now recipients are simply given their allotment of free stamps. This action was taken to increase participation among eligible households, which often had difficulty meeting their purchase requirement.

Budget reduction measures enacted in 1981 under the Reagan administration reduced expenditures on food stamps below levels they would have reached otherwise. During the economic expansion of the 1980s, food stamp participation fell. In Puerto Rico, food stamps were replaced with a nutrition assistance block grant in 1982. Nationally, with the onset of difficult economic times in 1989, participation climbed to an average of over 25 million per month by 1992.

How the Food Stamp Program Works

The Food Stamp Program operates through the public assistance agency in each state and the local county welfare offices, which certify the eligibility of applicants and issue stamps. The federal government sets the overall policies and procedures and, through the U.S. Department of Agriculture's Food and Nutrition Service (FNS), covers the cost of the coupons and at least half of the states' administrative expenses.

The stamps can be used to purchase food at over 200,000 authorized grocery stores. Retailers deposit the food stamps which they have received in a bank and receive credit for their face value. The stamps are then passed to the Federal Reserve system which charges their value to the FNS account.

The coupons cannot be used to buy alcoholic beverages and tobacco, pet foods or any nonfood items, except seeds and plants that can be used in home gardens to produce food. Ready-to-eat hot foods cannot be purchased, with the exception that some restaurants and other hot meal providers have been authorized to accept food stamps from homeless, elderly or disabled people in exchange for low-cost meals. It is illegal to exchange food stamps for cash.

A household's gross monthly income cannot exceed 130 percent of the official poverty level for that household size to be eligible for food stamps. In addition, net monthly income after subtracting certain deductions cannot exceed 100 percent of the poverty levels, shown in Table 1 below. These poverty figures are for the 48 contiguous states; they are slightly higher for Alaska and Hawaii.

There is a standard deduction of $122 for most households, and another for excess shelter expenses. Households with an elderly or disabled member must only meet the net income standards. Limits also exist on the assets a household may hold. Recipients may not own a car worth more than $4,500, unless it is needed for employment, nor have over $2,000 in cash and liquid assets, unless they are elderly, in which case it is $3,000.

The poverty guidelines used to establish food stamp eligibility were first derived in 1964 and are based on household food needs. A household is defined as poor if it would have to spend more than one-third of its income to buy a minimum, nutritionally adequate diet. This means the poverty levels were set at three times the cost of such a diet. The poverty guidelines are updated annually based on changes in the Consumer Price Index.

The monthly food stamp allotment (see Table 2 below) increases with household size and decreases with household income; the allotment is reduced by 30 percent of the household's net income. This reflects the idea that a household should spend 30 percent of its own income on food. As household income approaches the eligibility cutoff level, the program benefits become very small.

The maximum allotments in Table 2 are based on the Thrifty Food Plan, which is the lowest cost of four US Department of Agriculture household food plans. It is based on the Recommended Dietary Allowances for the various nutrients and the food choices of low-income households. The Thrifty Food Plan is expected to fulfill nutritional needs. However, households that do not plan meals and shop carefully, or lack the necessary nutrition knowledge or cooking skills, would have difficulty achieving a nutritious diet.

Many households do not receive the full allotments shown in Table 2 because of their income levels. Food stamp benefits per person averaged $68.43 per month for fiscal year 1992 through July. This works out to only 76 cents per meal, assuming three meals per day for 30 days. Based on a 1989 survey, 49.2 percent of all program participants were children and 8.4 percent were elderly.

Average household size was 2.6 persons and average monthly income was $443, equivalent to $5,316 annually. Countable assets averaged $84 for non- elderly households and $184 for elderly ones. Some 10.8 percent of non- elderly adult food stamp recipients were employed full-time and 19.5 percent of the households had earned income. Almost 25 percent of the household heads were registered as seeking work. Most of the others were either disabled or responsible for the care of a child or incapacitated person.

Sixty percent of those households eligible over the period of a year participate in the program. In some cases the eligible non-participants are unaware of their eligibility. Some would receive only very limited benefits because of their income levels. Others want to avoid the hassle of applying for the food stamps or the stigma of using them. The latter is particularly a factor in rural areas and among the elderly.

Table 1
Net Monthly Income Eligibility Standards:
100% of Poverty Level for 48 States
(effective October 1992 - September 1993)
Household Size Poverty Level
Each additional person

Table 2
Maximum Monthly Food Stamp
Allotment Levels
(effective October 1992 - September 1993)
Household Size Allotment
Each additional person

Processing Food Stamps: Another Fed Role

In a role that is similar to its cash and check processing duties, the Federal Reserve System is responsible for processing and destroying used food stamps. In 1991, the last year for which statistics are available, about 3.4 billion individual food stamps were destroyed by the System.

For the Minneapolis Fed, that means about 55 million food stamps are received each year from financial institutions within the Ninth District, according to Bruce Cripe, operations manager for the Minneapolis Fed's Cash Services Department. The Minneapolis Fed's Helena branch processes food stamps from Montana, at a rate of about 9 million annually.

When financial institutions send their food stamps to a Federal Reserve bank or branch, a deposit document and numerous redemption certificates are included that list all the food stamps in that delivery. The Federal Reserve bank then verifies the amount of food stamps with the accompanying document, credits the accounts of the financial institutions, electronically transmits data on the document to the United States Department of Agriculture—which funds the Food Stamp Program—and finally shreds the used food stamps. The accompanying documents are also destroyed after an appropriate retention period.