AT the heart of the welfare-reform debate is the future of Aid to Families with Dependent Children (AFDC), the federal program that provides income support mainly for single mothers and their children. Because many AFDC recipients do not hold jobs, the program is widely unpopular and an attractive political target. The consensus in both parties is that the system should be changed to encourage or require recipients to work. The question is, how?
AFDC creates a framework in which work is not a rational economic choice for most single mothers. The ''typical'' single mother is a poorly educated white woman with two children who has experienced a divorce or separation, and who can only get low-wage jobs. If she does not work, then AFDC provides a basic level of income support, albeit well below the poverty line. But, if she gets a job, everything she earns (beyond her child-care and other work-related expenses) is subtracted from her AFDC benefits, dollar for dollar.
A basic economic principle states: If you want less of something, tax it; if you want more of something, subsidize it. The AFDC system heavily taxes work. The obvious way to get AFDC recipients into the labor market is to start subsidizing work.
Benefits of a work subsidy
Recently I completed a study with Robert Moffitt of Brown University in Providence, R.I., in which we assess the impact of providing a work subsidy to single mothers. According to our analysis, provision of a modest work subsidy would lead to a substantial reduction in the AFDC caseload and a substantial increase in the number of single mothers who work. Strikingly, we also find that a modest subsidy would be roughly cost-neutral.
We examine the effect of creating a modest work subsidy of at most $32 per week ($1,664 per year), paid to any single mother who works at least 20 hours per week. To limit the subsidy to low-income women, we reduce the basic $32 per week subsidy by 7 cents for each dollar earned.
This modest work subsidy would reduce the AFDC caseload by 17 percent and reduce by 20 percent (approximately 850,000 people) the number of nonworking single mothers. It would also reduce total government welfare costs by 3 percent, while increasing the net after-tax earnings of the typical low-income single mother by 2 percent.
It may be surprising that a modest work subsidy of less than $32 per week would induce 850,000 nonworking single mothers to enter the labor market. But consider a woman with an opportunity to work 20 hours per week at $5 per hour. For her, the subsidy would come to $25 per week. This would raise her effective wage rate to $6.25 per hour -- a substantial increase.
It may also be surprising that the subsidy saves the government money when it induces single mothers who were receiving welfare to work instead, for the cost of the subsidy is lower than AFDC benefits. The subsidy costs money when it is paid to mothers who would have worked without it. For the specific subsidy formula used in the above example, the costs of the subsidy are roughly offset by the savings. More-generous work subsidies would cause greater numbers of AFDC recipients to start working, while leading to a modest overall increase in welfare costs.
A key aspect of the subsidy proposal is that it targets part-time work. There are two reasons for this. First, from a social perspective, it may be undesirable to have single mothers spend 40 hours per week away from their children. From an economic perspective, it is also not cost efficient. Welfare benefits are reduced by approximately 70 percent if a recipient shifts from nonwork to part-time work. Targeting the work subsidy to encourage part-time work leads to the greatest possible AFDC cost reduction for each work-subsidy dollar spent.
The work subsidy is provided to any single mother who works at least part-time, regardless of whether or not she is on AFDC. This differentiates it from many other welfare-reform proposals, which involve building work incentives into the AFDC program itself. For example, one idea is to provide free day care to AFDC recipients who work and to allow them to keep a fraction of any income they earn in excess of work expenses. But providing work incentives to AFDC recipients alone (rather than to all single mothers) would have the perverse effect of making AFDC participation more attractive.
In summary, our results indicate that a work subsidy for single mothers would encourage work and reduce welfare caseloads without increasing total welfare costs. Furthermore, a work subsidy would actually make single mothers and their children better off. Alternative proposals to get AFDC recipients into the labor market should be judged by whether they can achieve these same objectives.
Flawed Washington proposals
Unfortunately, the welfare-reform proposals of both the House Republicans and the Clinton administration fail to meet this standard. In particular, both proposals would be extremely expensive. Consider the welfare-reform legislation recently passed by the House. Its centerpiece is a two-year time limit on collecting AFDC benefits. This would certainly force single mothers off AFDC. But many single mothers on AFDC have wages too low to support a family by work alone. The House legislation begs the question: ''What will happen to the children if their mothers fail to find good jobs in two years?''
Despite its problems, the AFDC program provides support for these children in a remarkably cost-efficient way. In 1990 it cost only $20.4 billion, or 0.33 percent of gross domestic product, and it provided support for 9.5 million children at a cost of only $2,250 per child annually. If AFDC were simply cut off after two years, many of these children would be left without adequate support. Alternative means to support these children, such as publicly provided foster care, would be vastly more expensive than AFDC.
The Clinton administration plan also calls for a two-year limit on AFDC receipt, but with guaranteed public-works jobs if none other are found. The creation of such jobs is notoriously expensive (about $15,000 per job per year).
In addition, the administration plan includes an incentive for low-income people to work through expansion of the Earned Income Tax Credit (EITC). Our results indicate that most EITC dollars go to full-time workers who would have worked full-time regardless. Thus, the EITC is an extremely cost-inefficient way to encourage work. In fact, our research indicates that the proposed increase in the EITC would substantially increase government welfare costs.
A universal work subsidy is the most promising strategy for welfare reform. Among the proposals being debated, only a universal subsidy can encourage work and reduce welfare caseloads without simultaneously increasing costs or hurting single mothers and their children.