A New Idea for Welfare Reform

This article analyzes several proposals to build work incentives into the U.S. welfare system. It concludes that the most cost effective way to do that is to offer a work subsidy to all low-income single parents—in other words, to simply pay them for working in the labor market. This conclusion is based on a model of the labor force participation behavior of low-income single mothers that the author developed with Robert Moffitt. Among the proposals evaluated in the article, besides the work subsidy, are proposals to reduce the rate that welfare benefits are reduced when welfare recipients work, to provide wage subsidies to low-wage workers, to expand the earned income tax credit, and to subsidize the fixed costs of working. The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. Welfare reform is now a top priority on the U.S. agenda.1 A broad consensus has emerged that the current welfare system discourages the very type of behavior it should encourage: the system discourages people who participate in welfare programs from making efforts to find jobs that will also provide income for themselves and their families. The U.S. public wants the system modified in order to get large numbers of welfare recipients completely off the welfare rolls and into the labor market. But what is the most cost effective way to do that? To be able to build effective work incentives into the current welfare system, we must understand how that system discourages work. Consider Aid to Families with Dependent Children (AFDC), the program that provides income support for single parents—primarily mothers—and their children. If a single mother does not work outside the home, then the AFDC program provides a basic level of income support, one well below the poverty line. But if a single mother receiving AFDC benefits gets a job, then everything she earns (beyond her child care and other work-related expenses) is deducted from those benefits, dollar-for-dollar. Given this, we should not be surprised that only 6 percent of AFDC mothers work. In this article, I examine several proposals for building work incentives into the AFDC system. I conclude that the most cost effective way to achieve this objective is a new proposal: a work subsidy targeted at all low-income single mothers. The results presented here come from a model of the labor force participation behavior of low-income single mothers that I developed with Robert Moffitt (Keane and Moffitt 1995). Using this model, I show here that a work subsidy can substantially increase the number of single mothers who work, reduce their reliance on welfare, and save the government money while at the same time actually making single mothers better off. The idea of the work subsidy is, simply, to pay single parents for working outside the home. The plan would provide a weekly earnings subsidy to any single mother who works at least 20 hours per week, regardless of whether or not she is on welfare. The subsidy would save the government money when it induced single mothers to work and get off welfare, provided the size of the subsidy was less than the benefits paid to nonworking mothers. The subsidy would cost the government money when it was paid to mothers who would have worked anyway. My results indicate that the subsidy can be designed so that it is revenue neutral—that is, so that the savings roughly offset the costs. My results also indicate that, in terms of cost effectiveness, the work subsidy idea dominates other ways proposed to build work incentives into the AFDC system. These include reducing the rate at which welfare benefits are taken away when a recipient chooses to work, providing wage subsidies for low-wage workers, and expanding the earned income tax credit. That last suggestion is of particular interest. The Clinton administration’s welfare reform proposal—the Work and Responsibility Act of 1994—adopts an expanded earned income tax credit as the main method to build work incentives into the welfare system, and such an expansion is already being implemented over the 1994–96 period, as laid out in the Omnibus Budget Reconciliation Act of 1993. My model predicts that expansion of the earned income tax credit along the lines planned in that act will increase labor force participation of single mothers, but that it will also dramatically increase government costs. A work subsidy can achieve the same increase in participation at a small fraction of the cost. The work subsidy idea I propose here is similar in spirit to some recent proposals to subsidize the fixed costs of working (costs like child care expenses and the loss of Medicaid coverage). That sort of subsidy may also be a cost effective way to increase market work effort. But a work subsidy has significant advantages over a fixed costs subsidy. Most important, a work subsidy is much more flexible, so it can be designed to lead to much larger increases in market work effort than would result from a subsidy tied to the fixed costs of working. The Current Debate In order to understand the issues involved in welfare reform, we will find it useful to understand something about the history of welfare and welfare reform in America. Historically, welfare reform has usually meant changing the AFDC program, because that program is what most people have in mind when they say welfare. The AFDC program was created in 1935 as part of the Social Security Act. At that time, single mothers were usually widows, and the common view was that widows should be able to stay home and take care of their children rather than being forced to leave the home and enter the labor market. Since 1935, some fundamental changes in American society have changed the nature of the AFDC caseload. Divorce, separation, and births to unmarried women have become more common, so the majority of AFDC recipients no longer are widows. Rather, the majority of these recipients today are women who are divorced or separated or who were never married. Since 1935, mothers working outside the home has also become much more common and acceptable. The change in the composition of the AFDC caseload, combined with the changed attitude toward mothers working, has changed the public perception of the AFDC program. Today, many people see this program as allowing unwed mothers to avoid work in a world where women are expected to work. Furthermore, many even believe that young unwed women living in ghetto areas have babies so that they can become eligible for AFDC benefits and avoid entering the labor force. Some people go so far as to blame the AFDC program itself for the changes in American society since 1935 that they see as a disintegration of the family. As a result of these perceptions, recent polls of the U.S. public indicate that the AFDC program is one of the most unpopular of the federal government programs.2 Because social conservatives have adopted the view that the AFDC program causes family disintegration, the current welfare reform debate has focused primarily on changing this program in order to end its presumed role in encouraging divorce, separation, and out-of-wedlock births. The problem of the work disincentive effects of the program has assumed a secondary role. This emphasis is misguided. The dramatic claims that the AFDC program is causing family disintegration are rather simple to discount. Contrary to widespread public perceptions, there is no empirical evidence that this program causes any of the social changes attributed to it. (See Ellwood and Bane 1985, Jencks 1992, Moffitt 1992.) AFDC benefits vary dramatically both across states and over time. If high benefits caused family disintegration, we would expect to see higher levels of divorce, separation, and out-of-wedlock births in states and time periods when benefits were higher. But instead we see essentially no correlation, either across states or over time, between the levels of benefits and the levels of divorce, separation, and out-of-wedlock births.3 The criticism of the AFDC program that cannot be discounted is that it discourages work in the labor market. Surveys by Danziger, Haveman, and Plotnick (1981) and Moffitt (1992) suggest that the reduction in work hours by single mothers induced by the welfare system is around 30 percent. Therefore, I argue that welfare reform should concentrate on the work incentive effects of welfare programs, rather than being distracted by discussions of any role of welfare in generating divorce, separation, and outof-wedlock births. Historically, even when the work disincentive effects of the welfare system were the focus of attention, welfare reform proposals have not focused exclusively, or even primarily, on incentives as a means of inducing welfare recipients to increase their efforts to work in the market. For example, the centerpiece of the last major welfare reform measure, the Family Support Act of 1988, was the Job Opportunities and Basic Skills Training Program, a job training program. Also, although the current Clinton administration proposal calls for expansion of the earned income tax credit, it does not rely solely on tax incentives to induce welfare recipients to work. It also includes a component of job training and job search assistance. Further, it includes a form of negative incentive, or penalty, that would encourage work: a two-year time limit on collecting welfare benefits; after that point, a welfare recipient must start to work. But for those who cannot find work, the Clinton plan calls for guaranteed public jobs. The training and time limit components of the Clinton plan are likely to be expensive. The notion that a few months of inexpensive job training or job search assistance could get sizable numbers of people off welfare is illusory. Existing studies of the effects of training and job search assistance indicate that inexpensive programs lead to small gains in earnings and employment (Burtless 1989). Studies estimate that a full year of college raises a person’s annual earnings only about 7 or 8 percent (Weiss 1986, Willis 1986); thus it would be surprising if an inexpensive job training program could raise the earning capacity of welfare recipients sufficiently to eliminate their dependence on welfare. Turning to the time limit proposal, note that public works jobs are very expensive to create. Haveman (1980) estimates that creation of each such jobs would cost $15,000 per year (in 1994 dollars). A key difference between the Clinton proposal and the welfare legislation recently passed by the House Republicans—the Personal Responsibility Act of 1995—is that the Republican plan relies on penalties for failure to find market work, as opposed to positive work incentives, as the main way to encourage work. In particular, while both the Clinton proposal and the House bill include two-year time limits on receipt of AFDC benefits, the House bill does not include guaranteed public jobs for single mothers who fail to find work in two years.4 The time limit component of the House legislation would certainly force single mothers off the AFDC rolls, and the threat of lost benefits after two years might well induce them to search harder for jobs. But many single mothers receiving AFDC benefits are poorly educated and have access only to low-wage jobs. Hence, many cannot support a family by market work alone. Also, the House legislation begs the question of who will care for the 9.5 million children of the 4.5 million single mothers who currently receive AFDC benefits if these mothers fail to find adequate jobs in two years. Society is unlikely to tolerate a situation in which such children are not supported. In this context, we should remember that the most cost effective way for society to guarantee support for the children of single mothers is to simply transfer income to the mothers. Contrary to a popular myth, the AFDC program represents a rather small share of the federal budget. In 1992 it cost only $20.4 billion, which was 0.33 percent of the gross domestic product that year, yet the program provided support for roughly 9.5 million children of single mothers—a cost of only about $2,250 per year per child supported. Alternative means of support, like orphanages or publicly run foster care, would be vastly more expensive. The U.S. Department of Health and Human Services estimates that supporting children in orphanages would cost $36,500 per child annually, while providing foster care would cost $4,800 annually (Sample 1994). Another idea for welfare reform included in the Clinton plan is to place more of the burden of child support on absent fathers and less on the government. This could be done by setting national standards for child support awards and providing better enforcement of awards. [A strong advocate of this idea is Ellwood (1988, p. 163).] Unfortunately, most absent fathers of children in households headed by poor single mothers are themselves poor. Thus improved child support may only put a small dent in the problem of providing support for children in femaleheaded households (Meyer 1993). The real challenge of welfare reform is to increase work effort by welfare recipients and reduce welfare caseloads without simultaneously increasing program costs or hurting single mothers and their children. In light of the above discussion, I argue that the best way to achieve the goals of welfare reform is through positive work incentives, rather than through other options like time limits, job training, work requirements, publicly created jobs, or child support assurance. Within the realm of work incentives, I will attempt to show that the key proposals that are currently either being considered or being implemented, such as benefit tax rate reductions, wage subsidies, or earned income tax credit expansions, do not accomplish these goals. But according to my analysis, a work subsidy can substantially increase work effort by welfare recipients and reduce welfare caseloads without simultaneously increasing program costs or hurting single mothers and their children. Some Survey Data In order to examine the market work and welfare program participation behavior of low-income single mothers, I will examine data from the Survey of Income and Program Participation (the fourth wave of the first panel), which was administered by the U.S. Department of Commerce in the fall of 1984. These are the same data Moffitt and I (1995) used in our study of the behavior of single mothers. This survey covers a nationally representative sample of the U.S. population, approximately 20,000 households, and is especially designed to elicit information on income and participation in various transfer programs, including the four I am most interested in here: the AFDC, food stamp, public housing, and Medicaid programs. From the survey results, I select data for all female heads of household aged 18–64 with children under the age of 18. The survey data include 1,148 such women. In order to look specifically at the behavior of low-income single mothers, I invoke four screens on this sample. First, I exclude families with asset levels over $4,500. Such families are far above the AFDC and food stamp program asset limits. Second, I exclude women with hourly wage rates over $15. Third, I exclude women with nonlabor income more than double the food stamp program’s nonlabor income screen ($728 per month for a family of two, with an extra $189 for each additional family member). Fourth, I exclude self-employed women and those for whom data are missing for key variables used in the analysis. The remaining sample consists of 968 women. The variables used in the analysis are defined as of the month before the individuals were interviewed for the survey. Participation in the AFDC, food stamp, and public housing programs is defined with regard to whether any participation took place in the month. Work status is defined as the average weekly hours of market work in the month, with 1–35 hours defined as part-time and more than that defined as full-time. Hourly wage rates for those who work are computed from earnings and hours of work in the month before the survey and are used to compute weekly earnings from part-time and full-time work. Nontransfer nonlabor income is computed as the sum of asset income and the income of others in the family. Variables are also constructed for a set of socioeconomic characteristics, including education, age, number of children, regional location, race, residence in a standard metropolitan statistical area, and various state characteristics. The sample means of the variables are shown in Table 1. Some of the statistics in Table 1 contradict popular notions about low-income single mothers. For example, the typical low-income single mother is thought to be black and very young and to live in a big northern city. In the sample, however, 61 percent of the women are white, the average age is 34 years, 41 percent do not live in a large metropolitan area, and 35 percent live in a southern state. The typical low-income single mother is also thought to be an unwed mother. In the sample, however, the large majority of women were once married and have become single, primarily through divorce (43.4 percent) or separation (22.3 percent). Only about a quarter of the sample were never married. More accurate is the popular notion that the typical low-income single mother is poorly educated. In the sample, the average number of years of education is 11.48, not quite a high school degree. However, for the average to be this high, many women in the sample must have a high school degree. Contrary to popular notions, therefore, a more accurate description of a typical low-income single mother would seem to be a white woman in her thirties without a college degree who is divorced or separated. Table 1 also shows that the average number of children under 18 among women in the sample is 2.06, and the average nonlabor income is only $4.36 per week. Since 65.7 percent of the sample are divorced or separated, this indicates that alimony and child support payments are typically small. A striking feature of the data is that the mean hourly wage rate in this population is only $5.20 in 1984 dollars.5 In 1993 dollars, this translates into $7.23 per hour.6 For someone working 2,000 hours per year, this would translate into an annual income of $14,460 in 1993 dollars. Given that the 1993 after-tax poverty lines for families of three and four are $11,513 and $14,757, respectively, many of the women in the sample would obviously have trouble supporting families by market work alone (U.S. Bureau of the Census 1994). Table 2 shows the distribution of the sample across the work and welfare program participation categories. The first row of the table indicates that 516 single mothers (53 percent) participate in no transfer programs. Of these, 440 (85 percent) work in the market at least part-time.7 The pattern is very different for welfare program participants. Note, for example, that 175 single mothers (18 percent) participate in both the AFDC and food stamp programs, but not in public housing. Among these women, only 7 percent work at least part-time. The pattern is even more striking for those who participate in all three programs. Of these 80 single mothers (8 percent of the sample), only 4 percent work. Thus we see a striking fact about the population of low-income single mothers: at a point in time (the month for which the survey was taken), of those who are on welfare, few work; and of those who are not on welfare, almost all work. As we will see in the next section, this is exactly the pattern we would expect the current welfare system to generate, given rational economic decision making by single mothers. The Welfare Benefit Rules To understand why working and participating in the current welfare programs at the same time is almost never optimal, we will find it useful to look at the type of budget constraints that these welfare programs create. I will describe those constraints under the 1984 welfare benefit rules, the rules in effect when the transfer program survey was taken. The current welfare rules are similar in structure to those in effect in 1984. The only major difference is that AFDC grant levels have not kept pace with inflation since 1984. The U.S. welfare benefit rules are quite complex, so I will only describe their overall structure here. Some details are provided in Appendix A. The Major Programs The AFDC rules specify a monthly grant amount for a woman with no income. That amount is state-specific and varies tremendously across states. If a woman works in the market, the AFDC grant is reduced essentially dollarfor-dollar for all income in excess of child care and other work-related expenses. Thus the AFDC program imposes a 100 percent tax rate on earnings. AFDC recipients also receive free medical insurance through the Medicaid program. The food stamp rules are similar in structure to those for the AFDC program. The major differences are that the food stamp grant amount is uniform nationally, its tax rate is only 30 percent rather than 100 percent, and the food stamp program treats AFDC benefits as taxable income. Public housing can take the form of a unit in a housing project built and owned by the government or a voucher for rent in a privately owned housing unit (as described in Section 8 of the U.S. Housing Act of 1937). Basically, the public housing rules specify that a single mother need spend on rent only 30 percent of her net income (including AFDC benefits but with deductions based on the number of children). Any cost beyond that is paid by the program. Unlike the AFDC and food stamp programs, public housing is not an entitlement for women who are eligible based on meeting the income screen. Not all eligible single mothers can get into public housing because space is rationed. Furthermore, as Jencks and Edin (1990) point out, many single mothers say that even if they could move into public housing, they would not, because of the danger involved. Urban public housing projects typically have high incidence of crime, while Section 8 housing tends to be located in high crime areas.8 Examples Table 3 provides some examples of how the welfare benefit rules work. Consider a woman with a wage rate of $5.20 per hour (the mean wage rate in the sample) who has two children under 18 years old. Suppose this woman is facing the choice of working 0, 20, or 40 hours in a week. Table 3 calculates what her net income would be at each hours level under two scenarios: when she participates in all three major welfare programs (when eligible) and when she participates in only the AFDC and food stamp programs, not public housing. These calculations include federal taxes, Social Security taxes, and work expenses, but ignore state taxes. (See Appendix A.) Child care expenses are also ignored. Calculations are reported for three representative states: Minnesota, which among all U.S. states has a relatively high level of benefits; Kansas, which has an average level of benefits; and Alabama, which has relatively low benefits. Minnesota Consider first Minnesota. If a single mother of two in Minnesota doesn’t work in the market, she can get $117 per week in AFDC benefits and $19 in food stamps. She also qualifies for a $97 rent subsidy if she can get into public housing.9 Then, since she has no taxes or work expenses, her net weekly income will be $233. That’s $12,116 per year, or $16,853 in 1993 dollars. Now consider what would happen if this woman in Minnesota decides to work in the market. If she works 20 hours per week, she earns $104, but her AFDC benefit is reduced by $92, her housing benefit is reduced by $6, and she faces $29 in taxes and work expenses (excluding child care). Thus working part-time will actually reduce her weekly net income from $233 to $210. Next suppose she works 40 hours per week. Now she earns $208, but her AFDC and food stamp benefits are eliminated, and her housing benefits fall $27. Furthermore, she has to face $47 in taxes and work expenses. This leaves her with $225 in net income, which is less than if she didn’t work at all. Thus the effective tax rate on labor income in moving from 0 to 40 hours exceeds 100 percent. Consider next the income of this same single mother living in Minnesota if she does not receive public housing benefits. If she doesn’t work in the market, her net weekly income from the AFDC and food stamp programs is $136. That’s $7,280 per year, or $10,126 in 1993 dollars. This compares to the poverty line for a family of three of $11,513. Obviously, if a single mother is rationed out of public housing or refuses to live in it, then welfare benefits alone will not bring her up to the poverty line, even in a high-benefit state like Minnesota. If this single mother works part-time in the market, her net weekly income falls from $136 to $119, while if she works full-time, her weekly income rises from $136 to $161. Thus, for a woman not receiving housing benefits, the effective tax rate on labor income in moving from 0 to 40 hours is 88 percent. Looked at another way, since working a 40-hour week raises the woman’s net earnings $25, her after-tax average wage rate is only 63 cents per hour. Furthermore, the figures understate the true costs of working. Since the single mother considered here loses all AFDC benefits when she works 40 hours per week, she loses Medicaid eligibility as well. Also ignored here are the child care costs that may arise if she works. These calculations clearly illustrate why market work is unlikely to be a preferred option for a single mother with two children and a wage rate near $5.20 in Minnesota. Her distaste for collecting welfare benefits would have to be great indeed to make her prefer working 40 hours per week to earn $161 when she could get $136 from the AFDC and food stamp programs if she doesn’t work— especially when working would cause her to lose the medical coverage for herself and her children provided by Medicaid and require her to purchase child care. In order to make market work a preferred option, a typical single mother with two children would need a wage rate well above $5.20 per hour. As the wage rate rises, the net income gains a woman can obtain by moving from 0 to 20 to 40 hours naturally rise, making work more attractive. The Typical Decision Problem Chart 1 illustrates the labor supply decision problem faced by a typical single mother. Income is plotted on the vertical axis, and hours of market work are plotted on the horizontal axis. Note that as one moves from right to left along the horizontal axis, hours of work increase.10 The budget constraint ABC is representative of the type of constraint faced by a single mother of two in Minnesota with a market wage rate of $5.20 who participates (when eligible) in the AFDC and food stamp programs. The segment AB (representing income for work between 0 and 20 hours) is flatter than the segment BC (for work between 20 and 40 hours) because the average tax rate on labor earnings is greater for part-time work than for fulltime work. In fact, segment AB is drawn so that it slopes down as it moves to the left, because for most single mothers, income will actually decline if they shift from nonwork to part-time work. The indifference curve in Chart 1 connects different combinations of income and hours that give the woman equal utility (or satisfaction). As I’ve drawn this curve, the point at which the woman’s satisfaction can be maximized, given her budget constraint ABC, is where these two curves meet—at the point A. In other words, the woman facing constraint ABC will maximize utility by choosing not to work. Now consider an increase in the woman’s wage rate. As the wage rate rises, the budget constraint shifts upward. At a sufficiently high wage rate, constraint AB′C′ is obtained. With this new constraint, the woman is indifferent between not working at all and working full-time; she will receive the same level of satisfaction from both. Call the wage rate that generates constraint AB′C′ the reservation wage wR. If the woman was originally in a situation in which she could only get $5.20 per hour jobs and was then offered a job with a wage rate above wR, she would suddenly shift from not working at all to working full-time. Also, since AFDC and food stamp benefits go to zero with full-time work (Table 3), she would cease participating in both welfare programs. We see that, given the type of constraints created by the welfare system, a woman would have a decision rule that says to work full-time in the market (driving welfare benefits to zero) if the wage is above some reservation level and to not work at all (and collect full welfare benefits) if the wage is below that level. This is exactly the type of behavior we have seen in Table 2: For the most part, women either work full-time and collect no benefits or do not work at all while collecting both AFDC and food stamp benefits (perhaps along with public housing). Working part-time is rare, and so is working while collecting benefits. Given the type of constraints the welfare system creates, it is rational economic behavior to not work if one is collecting AFDC benefits. Kansas Although AFDC grant levels are much higher in Minnesota than in most other states, the type of budget constraints created by the welfare system are nevertheless similar in other states. Consider the budget calculations for Kansas, a state that is average in terms of the AFDC grant level. If the single mother in the Minnesota example lived instead in Kansas and participated in the AFDC and food stamp programs when she was eligible, her net income levels at 0, 20, and 40 hours of market work would be $114, $106, and $161, respectively. Again, the effective tax rate on earnings is over 100 percent in moving from 0 to 20 hours and 77 percent in moving from 0 to 40 hours. Note also that the $114 weekly benefit level at zero hours of market work in Kansas translates into an annual income level of $5,928, which is $8,246 in 1993 dollars. Since the 1993 poverty line was $11,513, the combination of AFDC and food stamp benefits does not bring a single mother close to the poverty line in a typical state if she does not work. Alabama An example of a state at the low end of the AFDC benefit scale is Alabama. There the weekly AFDC benefit of a single mother of two who doesn’t work in the market is only $23, and together AFDC and food stamp benefits provide $71 in net weekly income. This translates into an annual income of $3,692, which is only $5,136 in 1993 dollars. If this woman works 20 or 40 hours per week, her net income increases to $106 or $161, respectively. The case of Alabama illustrates that with a sufficient cut in the AFDC grant level, the effective tax rate of earnings for part-time work falls below 100 percent. However, the average tax rate on earnings is still 66 percent in moving from 0 to 20 hours and 57 percent in moving from 0 to 40 hours. Since working 40 hours only increases net earnings from $71 to $161, the after-tax average wage rate is still only $2.25 per hour. The Sample Averages A final way to look at the welfare benefit rules is to return to the survey data and look at average earnings and benefits across all sample members in all states. This I do in Table 4. For example, the table indicates that the mean weekly AFDC benefit for a member of the sample drops from $63.53 at zero hours to $13.74 at 20 hours to $2.20 at 40 hours. For the average member of the sample, going from nonwork to working full-time in the market would generate $208 in labor income each week, while causing her to lose roughly $61 in AFDC benefits, $26 in food stamp benefits, and $38 in housing benefits. Furthermore, she would incur $24 in federal income and Social Security taxes and lose eligibility for Medicaid benefits that are valued at $28 per week. (For details on the income and Social Security taxes, see Appendix A.) I also estimate that the fixed costs of working (excluding child care costs) average $21 per week. Thus lost welfare benefits, increased taxes, lost Medicaid benefits, and fixed costs of working eat up $198 of the $208 in earnings. On top of this, the typical single mother may face child care costs that I have not included. All in all, it is easy to see that market work may not be an optimal decision given the constraints that the typical single mother faces. In fact, since at the mean wage in the data, working rather than collecting AFDC and food stamp benefits appears to be a money-losing proposition, the real mystery is, why do so many women in this sample work at all? A Labor Supply Model The area of labor economics that studies the effect of wages, nonlabor income, and other factors on individual decisions about how much to work in the market is called labor supply. To analyze the various welfare reform proposals, I will construct and use a labor supply model. Here I describe the components of the model. (In Appendix B I estimate the coefficients of the model’s equations that represent the relationships between its variables.) In standard labor supply models, utility is specified as a function of hours of market work (H) and income (Y ), giving a utility function of the form U(H,Y ). In these models, people are assumed to like income but to dislike working, so that U is increasing in Y and decreasing in H. In static labor supply models, people are assumed to maximize current period utility subject to a current period budget constraint of the form Y(H) = wH + N, where w is the hourly wage rate and N is nonlabor income. Given a parametric specification for U(H,Y ), one can derive a labor supply equation, and its coefficients can be estimated using data on hours of work, wages, and nonlabor income of individuals. Given these estimates, one can derive elasticities of labor supply with respect to wages and nonlabor income—that is, how much hours of work will change in response to changes in wages and nonlabor income. A large literature exists in labor economics that derives such elasticities for data on married women and single women without children (Killingsworth and Heckman 1986). For the labor supply of single mothers, the simple labor supply model must be elaborated. Most importantly, since such a large percentage of single mothers are poor, the model must include available welfare benefits in the mothers’ budget constraint. Also, the fixed costs of working in the market (such as child care expenses) are often substantial relative to potential wage earnings for this group, so these costs must also be part of the budget constraint. As we have seen, the major welfare programs relevant for single mothers are the AFDC, food stamp, public housing, and Medicaid programs. In a recent paper, Moffitt and I (1995) developed a model of the behavior of single mothers that incorporates all four of these programs, along with taxes and work expenses in the budget constraint. The model I will present here is identical to that one. Let PA be an indicator function equal to 1 if a person participates in the AFDC program and 0 otherwise. Let PF and PR be the corresponding indicators for food stamp and public housing participation, respectively. Then the budget constraint takes this form: (1) Y(H,PA,PF,PR) = wH + N + BA(H)PA + BF(H)PF + γRBR(H)PR + γMedBMedPA + γPriBPri(1–PA) – T(H)