Incentives and the Work Decisions of Welfare Recipients

American Journal of Economics and Sociology, The, July, 2000 by Kevin Duncan

The remainder of the paper is organized along the following lines. The data used in the empirical analysis is discussed in section II. As mentioned above, The Omnibus Budget Reconciliation Act of 1981 included significant welfare policy changes that, in particular, affected work incentives and the income strategies of welfare recipients. The implications of this policy are discussed in section III. Harrison's analysis implies that the work and welfare decisions are affected by wage and AFDC benefit levels. In sections IV and V these implied hypotheses are tested by examining the effect of wage and AFDC levels on the probabilities that a welfare participant will work without AFDC, receive only AFDC or combine the two. Finally, the paper concludes with a discussion of policy recommendations and implications for future research.

II

Data

AS IS THE CASE WITH THE STUDIES BY BANE AND EllWOOD AND HARRISON, the data for this study are derived from the Panel Survey of Income Dynamics (PSID). The PSID contains human capital, income and demographic information on over 7000 families. Over sampling of low income families has made this longitudinal sample well suited for tracking the experiences of welfare recipients. This Study uses a subsample of female headed households who received one dollar or more of AFDC income between 1980 and 1987 (corresponding to PSID survey years 1981-1988) and who participated in the PSID every year over the period. [3]

III

Policy Changes, 1980-1987

SINCE THE PERIOD OF THE STUDY OVERLAPS the enforcement of the Omnibus Budget Reconciliation Act of 1981 (OBRA), the effect of this policy on the work behavior of welfare recipients can be examined. OBRA reduced the cost of AFDC by reducing the number of individuals who could qualify for the program. This was achieved, in part, by increasing the benefit-loss rate which indicates the reduction in the basic welfare benefit for those recipients who also receive income from work. [4] In addition to affecting program costs, changes in this rate have a profound effect on the work incentives of welfare recipients. The example presented in Table 1 illustrates how AFDC subsidies were determined before and after OBRA and how changes in benefit-loss rate affected work incentives and the income strategies of working welfare recipients. Assume that the state in question offers a basic AFDC benefit (for nonworking recipients before OBRA) of $300 per month. If a recipient works, the basic benefit is reduced or "taxed" based on a percentage (the benefit-loss rate) of the earned income. The first "$30 and one third" of earned income was exempt from the "tax." So, with an earned income of $200 per month, "taxable" income was $103 (or $200 - $30 - $67 = $103). With this "taxable" income and a benefit loss rate of .67 the "tax" or reduction in the basic benefit is $69 (or $103 x .67 = $69). So, the actual AFDC subsidy for this working recipient is $231 (or $300 - $69 = $231). This is added to the wage income of $200 for a total income from work and welfare of $431. This example demonstrates the logic and incentive behind mixing welfare and work before OBRA. Those working at a low paying job could increase their family income by also receiving welfare. Or, from the other point of view, those on welfare could increase total income by working.