At the heart of the current welfare reform debate is the future
of Aid to Families with Dependent Children (AFDC), the program
that provides income support for single mothers and their children.
AFDC is widely unpopular because AFDC recipients rarely work.
This makes AFDC an attractive political target - and the consensus
in both parties is that the system should be changed so that recipients
are encouraged or required to work. It is clear that AFDC will
be changed. The question is, how?
The problem with AFDC is that it 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. Thus, under the current
system, there is little to no incentive for a low-wage single
mother to work.
One of the most basic economic principles 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. Recently I completed a study with Robert Moffitt of Brown
University 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.
Consider the following analysis that is representative of our
results. We examine the effect of creating a modest work subsidy
of at most $32 per week ($1,660 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. We find that this modest work
subsidy would reduce the AFDC caseload by 17 percent and reduce
by 20 percent (or approximately 850,000 people) the number of
non-working 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 non-working 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 work subsidy is cost neutral.
The subsidy saves the government money when it induces single
mothers to work and get off welfare, for the cost of the subsidy
is less than the benefits paid to non-working mothers. The subsidy
costs money when it is paid to mothers who would have worked regardless.
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 modest overall increases in
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. The welfare benefits of a typical
single mother are reduced by approximately 70 percent if she shifts
from non-work to part-time work. Correspondingly, the most substantial
reductions in government welfare costs come from encouraging single
mothers to work part time (rather than full time). Hence, targeting
the work subsidy to encourage part-time work leads to the greatest
possible AFDC cost reduction for each work subsidy dollar spent.
Another key aspect of the work subsidy is that it 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--thus increasing
the AFDC caseload.
In summary, our results indicate that a work subsidy program
for single mothers would encourage work and reduce welfare caseloads
without increasing total welfare costs. Furthermore, the provision
of 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.
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 9.5 million children of the 4.5 million single mothers
currently on AFDC if their mothers fail to find good jobs in two
Despite its problems, the current 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. If society refuses to tolerate such a situation,
then alternative means to support these children, such as publicly
provided foster care, would be vastly more expensive than AFDC.
Consider next the Clinton administration plan. It also calls
for a two-year limit on AFDC receipt, but with guaranteed public
works jobs for women who cannot find work after two years. 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). The EITC is a type of
work subsidy, but 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 increase in the
EITC proposed by the administration would substantially increase
government welfare costs.
In conclusion, our research indicates that a universal work
subsidy is the most promising strategy for welfare reform. Among
the proposals currently being debated, only a universal work subsidy
can encourage work and reduce welfare caseloads, without simultaneously
increasing program costs or hurting single mothers and their children.
Michael Keane is an associate professor at the University
of Minnesota, in the Department of Economics and the Department of Industrial
Relations, Carlson School of Management. He is also a consultant to
the Federal Reserve Bank of Minneapolis. The study described here was
commissioned by the Food and Nutrition Service of the U.S. Department
of Agriculture, and the research was supported by the Federal Reserve
Bank of Minneapolis. It will be published in the bank's Quarterly
Review (Spring 1995).