The Marginal Labor Supply Disincentives of Welfare Reforms

Existing research on the static effects of the manipulation of welfare program benefit parameters on labor supply has allowed only restrictive forms of heterogeneity in preferences. Yet preference heterogeneity implies that the marginal effects of welfare reforms on labor supply may differ in different time periods with different populations and which sweep out different portions of the marginal distribution of preferences. A new examination of the heavily studied AFDC program examines changes in its tax rates in 1967, 1981, and 1996 and estimates the marginal effects on labor supply of a change in participation in each of those reform years. The estimates are based on a theory-consistent reduced form model which allows for a nonparametric specification of how changes in welfare program participation affect labor supply on the margin. Estimates of the model using a form of local instrumental variables show that the marginal treatment effects are quadratic, rising and then falling as participation rates rise. Applying the estimates to the three historical reform periods shows that marginal responses differed in each period because of differences in the composition of who was on the program and who was not