Determinants of AFDC Caseload Growth. 2. The Budget Constraint for an AFDC Family

07/01/1997

In order to understand how the structure, as well as the benefit value, of AFDC and other programs potentially affect AFDC participation, it is helpful to consider a stylized budget constraint--the trade-off between disposable income and "non-market time" (time spent in activities other than paid employment) -- for the current month that is faced by a single mother who is making the choice between participation and non-participation in that month (Exhibit 1.2).

We treat the value of the combined AFDC and Food Stamp benefit as a single benefit because, from the woman's perspective, a dollar's worth of food purchased with Food Stamps frees up a dollar of cash benefits or other income for spending on other goods and services. Point C represents the value of her combined AFDC and Food Stamp benefits if she does no market work--her maximum monthly benefit (MMB) from the combined programs, sometimes called her "guarantee." If she has earnings, the first dollars earned do not reduce her benefits, and her income increases by one dollar for every dollar earned--along the line segment CI. This ignores payroll taxes (FICA) and the earned income tax credit (EITC), which we will consider later, as well as in-kind benefits such as Medicaid and housing subsidies. At I, a share of each additional dollar she earns is lost through a reduction in AFDC benefits--the marginal benefit reduction rate (MBRR). The MBRR is currently very high--essentially 100% -- in most states. The slope of the line from point I to point D is her wage rate times one minus the MBRR. Point D is the point at which her combined benefits are entirely "taxed" away, and her income at that point is usually called her "break-even income" or "cut off earnings." The slope of dashed line CD is her wage rate times one minus the average benefit reduction rate (ABRR).

Exhibit 1.2

Stylized Budget Constraint for a (Potential) AFDC Family

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The earnings of some AFDC mothers may reach the "gross income limit" (GIL) before they reach the break-even level. OBRA81 mandated a GIL of 150 percent of the state's need standard; households with pre-benefit income above this amount were declared ineligible for AFDC benefits even if the state's formula otherwise resulted in some benefit; DEFRA84 increased the GIL to 185 percent of the need standard. The GIL only affects the budget constraints of mothers with substantial disregards for work expenses or child care; the GIL has always been above the break-even income level in all states for families with minimum disregards. The effect of the GIL on a budget constraint with high disregards is illustrated by line KL in the exhibit. The level of the GIL is depicted by L. When L is less than the break-even income (the height of D in the diagram), as depicted, the GIL creates a "notch" in this household's budget constraint, depicted by MKD. If the GIL is sufficiently high relative to the cut off earnings of most households, it is irrelevant to the budget constraint.

The stylized budget constraint can be fully described with the wage rate and four "program parameters:" the MMB, the ABRR, the MBRR, and the GIL. That is, the full budget constraint is completely determined by these parameters and the wage rate. We use these parameters, slightly modified, to characterize the budget constraints of an AFDC family with one adult and two children in each state and each quarter of our sample, assuming minimum disregards. Modifications are made for the effects of the EITC and payroll taxes on net income for mothers with earnings, and to capture the fact that the GIL is only relevant to the budget constraint if it is sufficiently low relative to the earnings cut-off of a family with minimum disregards. The EITC and payroll taxes change the rate at which earnings are reduced at the margin, and on average. We take these into account and replace the MBRR and ABRR with the marginal and average tax and benefit reduction rates (ATBRR and MTBRR), respectively. Our measure for the restrictiveness of the GIL is AFDC cut off earnings for our hypothetical household divided by the GIL.

We also attempt to estimate the effects of Medicaid on participation. If the mother receives AFDC payments, she and her children will automatically qualify for Medicaid benefits. In the exhibit, the value of her Medicaid benefit is the distance from point C to point E; point E represents the combined value of her AFDC, Food Stamp, and Medicaid benefits if she performs no market work. Medicaid benefits are not implicitly taxed until her income reaches the "Medicaid need standard" (income at point H); if her income passes that level, she loses all of her benefits. Before OBRA89 the Medicaid need standard was the same as AFDC break-even income in most states. Changes mandated by OBRA89 and OBRA90 expanded Medicaid coverage to individuals with incomes above the AFDC break-even level including pregnant women and children under age six with family incomes below 133 percent of the federal poverty level and children under age 19 with family incomes below 100 percent of the federal poverty level.(4) Thus, given the stylized AFDC budget constraint, two critical parameters determine the Medicaid "add-on" to the budget constraint: the value of Medicaid benefits and the Medicaid need standard. We attempt to capture both of these features in the model, through the use of an estimate of the value of Medicaid benefits to our hypothetical three-person family and a variable intended to capture the effects of the OBRA89 and OBRA90 Medicaid expansions.(5)

All of the following hypotheses are related to the budget constraint and are testable under the methodology:

  • Increases in the mother's wage rate (or, more generally, job opportunities) reduce participation, other things constant;
  • Increases in the MMB increase participation, other things constant;
  • Increases in the ATBRR reduce participation, other things constant;
  • Increases in the MTBRR reduce participation, other things constant:
  • Increases in the GIL increases participation, other things constant:(6)
  • Increases in the value of Medicaid benefits increase participation, other things constant; and
  • The Medicaid expansions of OBRA89 and OBRA90 reduced participation.(7)

Changes in these factors have parallel effects on aggregate expenditures. The direction of effects of changes in the parameters on average benefits per person are less clear, however. Even though a change in a parameter that increases the incentive to participate will generally increase the value of benefits received by families that would be participating anyway, it also draws in families that are likely to receive benefits that are below average in value.