Welfare Dependence and Self-Control: An Empirical Analysis

This paper investigates the behavioral and policy mechanisms that generate dependence on welfare programs. A dynamic model with labor supply disincentives and state dependence in preferences is expanded to incorporate time-inconsistency, which induces addictive behavior due to problems of self-commitment. Estimation is based on data from a welfare reform experiment, which contains a unique policy feature that helps identify the time preference parameters. Various results indicate that the commitment problem is an important consideration in the design of policy. Around one-fourth of the individuals are time-inconsistent, and neglecting time-inconsistency will cause state dependence in preferences to be overestimated. These individuals are more responsive to policy changes due to the presence of commitment-related incentives. Time-inconsistency reduces income and net tax contribution by at least 15 and 50 percent, respectively. An increase in welfare benefits aggravates the commitment problem, and reduces utility from a time-consistent perspective. Certain dynamic policy interventions are more effective than static interventions in alleviating the commitment problem. For instance, a dynamic nonwork tax generates strong commitmentrelated work incentives, and over half of time-inconsistent individuals will voluntarily adopt it as a commitment device. The implications of time-inconsistency for other policy interventions, such as Earned Income Tax Credit (EITC) and a prowork time limit, are examined. JEL CLASSIFICATION: I3, C3, J2