Author(s):
Marc K Chan, Economics Discipline Group, UTS Business School, University of Technology, Sydney
Date of publication: March 2014
Abstract:
We use data from Florida Transition Program, a welfare reform experiment in the 1990s, to estimate a discrete choice dynamic programming model of labor supply and welfare participation with potentially time-inconsistent individuals. The time preference parameters are identified through exclusion restrictions generated by welfare time limits. Around one-fourth of the individuals can be regarded as present-biased, and they exhibit a low degree of naivety. Time-inconsistency reduces income by 15 percent and the net tax contribution by almost half. Present-biased individuals are generally more responsive to policy changes than time-consistent individuals. By aggravating the commitment problem, an increase in welfare benefits reduces utility from a time-consistent perspective. An expansion of Earned Income Tax Credit (EITC) can be revenue-neutral due to cross-subsidization between present-biased and time-consistent individuals. A “prowork time limit” is proposed as a more incentivizing policy than standard time limits. A dynamic nonwork tax that is triggered by past employment can generate strong commitment-related incentives and increase utility from a time-consistent perspective. The nonwork tax can be implemented as a targeting intervention, as an estimated 70 percent of present-biased individuals will adopt the policy as a commitment device.
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