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Irp Discussion Papers Assessing the Effects of the 1981 Federal Afdc Legislation on the Work Effort of Welfare Recipients: a Framework for Analysis and the Evidence to Date

The 1981 federal Omnibus Budget Reconciliation Act (OBRA) increased the benefit-reduction rate in the AFDC program, thereby generating possible work disincentives for welfare recipients. This paper reviews the theoretical basis for the existence of such disincentives, provides a statistical framework for their empirical measurement, and reviews critically the studies that have been completed to date. It is found that (1) standard economic theory implies that the effect of OBRA on labor supply is ambiguous, not unequivocally negative; (2) statistically measuring the ( effects of OBRA requires careful allowance for macroeconomic effects within a correctly designed study using either cross-sectional or panel data; and (3) the studies that have been completed to date, although indieating little effect of OBRA on labor supply, are incomplete and therefore unable to provide any definitive answer as yet on the labor supply effects of OBRA. Assessing the Effects of the 1981 Federal AFDC Legislation on the Work Effort of Welfare Recipients: A Framework for Analysis and the Evidence to Date In the summer of 1981 Congress passed and the President signed the Omnibus Budget Reconciliation Act (OBRA), a piece of legislation that significantly altered many transfer programs. Major changes were made in the Aid to Families with Dependent Children (AFDC) program, one of the better-known welfare programs in the United States. Among its many changes, perhaps the most important are those that eliminated or reduced the benefits of working AFDC recipients through the institution of a gross income eligibility limit, restricted the amount of available earnings deductions, and put a cap on permitted work-related deductions. Although the intent of these provisions was to direct a greater proportion of federal AFDC expenditures toward those in greatest need (i.e., those with no earned income), a possible by-product of the provisions may be a reduced incentive to work. This paper analyzes the effects on work incentives of the 1981 Act and reports the evidence gathered to date on measuring those effects. First, the standard economic theory of work effort is used to show the expected effects of the OBRA changes in AFDC. Perhaps surprisingly, the analysis shows that the elimination or reduction of benefits for workers does not necessarily discourage work effort as a whole. Although some working recipients will presumably reduce their work effort in order to stay on the rolls or to increase their benefits, others will choose not to stay on the rolls but instead to work additional hours to obtain more earnings to make up for the loss in welfare income. The net effect of these two responses is ambiguous and cannot be predicted a priori.