From Microeconomic Insights:
Did welfare reform lead some American families to work less?, by Patrick Kline (Berkeley), Melissa Tartari (Chicago): The landmark US welfare reform of 1996 provided strong incentives for poor women to work while receiving assistance – but it also provided incentives for some women to reduce their earnings to qualify for benefits. This research develops a new approach to detecting this ‘welfare opt-in’ effect and uses it to analyze data from a large randomized evaluation of welfare reform in Connecticut: the “Jobs First” program. The results reveal that the Jobs First program induced a substantial fraction of the women who were capable of lifting their families out of poverty without assistance to opt for welfare instead. ...
While our findings are specific to the sample of women in Connecticut’s Jobs First experiment, the welfare opt-in results indicate that sharp provisions for phasing out benefits can significantly depress the earnings of disadvantaged people even when the net effect of the program is to get more people working. These earnings reductions are inefficient insofar as they cost taxpayers money and trap low-skilled workers in jobs that they otherwise wouldn’t want.
An important question for policy-makers is whether these inefficiencies can be diminished by adopting smooth benefit phase in and phase out provisions such as those specified by the Earned Income Tax Credit (EITC). By phasing benefits out more gradually, such schemes replace a large distortion concentrated over a small number of relatively high earners with a small distortion spread over a larger number of people.
There are reasons to suspect that such a tradeoff could be worthwhile: economists often find disproportionately large behavioral responses to stronger incentives (Chetty, 2012). This could be because the program rules that generate strong incentives (for example, the Jobs First eligibility thresholds) are more salient or because households deem adjusting to weaker incentives to be ‘not worth the trouble’.
More research on these questions is necessary to inform the optimal design of welfare and other transfer programs.