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FRBSF Economic Letter

1997-24 | August 29, 1997

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Labor Market Effects of Welfare Reform

Mary Daly

On August 22, 1996, President Clinton signed the Personal Responsibility and Work Opportunity Reconciliation Act into law and ended the sixty-two year old federal entitlement system for the needy commonly referred to as welfare. Since then, welfare caseloads in the U.S. have fallen by 12 percent (see Figure 1). Over the same period, approximately 2.3 million individuals have joined the labor force, boosting the labor force participation rate (the percentage of working age men and women employed or seeking work) by 0.4 percentage point to 67.1 percent in July 1997. The coincidence of these two events with the passage of welfare reform naturally raises the question: “Are they related?”

The relationship between welfare reform and labor market entry is important for two reasons. First, one of the primary goals of welfare reform is to induce those in need to replace welfare with work. Measurements of the extent to which the passage of welfare reform has influenced the labor market behavior of targeted populations are critical to assessing the effectiveness of this policy. Second, this late into the recovery, it is unclear who is entering the labor force so rapidly. Near the beginning of an expansion increases in labor force participation tend to be broad-based across types of workers, reflecting the response of a diverse pool of individuals to improving employment opportunities. If, in contrast, most of the recent increase in labor force participation is due to proactive current and potential welfare recipients, many of whom are low-skilled, then the pool of new labor entrants may be less able to meet a diverse set of employer demands.

This Economic Letterexamines these topics. The analysis assesses the extent to which welfare reform has induced targeted populations to enter the labor force and whether or not reform-related labor market entry has affected the U.S. aggregate labor force participation rate. The results suggest that welfare reform appears to have induced a portion of the targeted population to enter the labor market rather than move onto the welfare rolls, but that relative to the number of individuals entering the U.S. labor market during the past year, potential welfare recipients make up only a small fraction.

The Personal Responsibility and Work Opportunity Act of 1996

The act replaced the federally managed Aid to Families with Dependent Children (AFDC), JOBS, and Emergency Assistance to Needy Families programs with Temporary Assistance to Needy Families (TANF) block grants awarded to states. Under the new law, states that comply with federal restrictions on fund disbursement gain control over a predetermined share of federal funds earmarked for needy families. Three of the federal restrictions are relevant to labor market behavior: (1) the elimination of welfare benefits as entitlements; (2) the imposition of work participation requirements; and (3) the introduction of individual lifetime limits on the use of programs funded by TANF. The goal of these restrictions is to make work both mandatory for current recipients and a desirable alternative for current non-recipients.

Effects of welfare reform on labor force entry of targeted populations

The simultaneous occurrence of declining welfare caseloads and accelerating labor force growth suggests that welfare reform may have induced individuals to enter the labor market. However, a convincing connection between welfare reform and labor market behavior requires a more detailed picture of the populations entering the labor market. Data to fill in this picture can be obtained from the Bureau of Labor Statistics (BLS) which produces a monthly release on the employment situation in the U.S. These data provide current estimates of the number of individuals in the labor force by a variety of demographic characteristics.

The BLS subgroup most likely to be affected by welfare reform is single women maintaining families. Figure 2 shows changes in the labor force levels of women maintaining families and the total U.S. population from July 1995 through July 1997. For ease of comparison each series is indexed by its July 1995 level. As Figure 2 illustrates, the number of women maintaining families entering the labor force increased dramatically following welfare reform. During the year before the reform, July 1995 to July 1996, the number of women maintaining families who were in the labor market increased by 2.4%. In contrast, between August 1996 to July 1997 labor force growth among these women surged to 7.4% at an annual rate.

While the large pickup in labor force growth for women maintaining families appears correlated with the passage of welfare reform, part of the observed acceleration may be attributable to broader economic factors rather than to changes in welfare regulations. One proxy for the non-welfare related component of the recent labor force growth among these women is labor force growth for the total U.S. population, also shown in Figure 2. Labor force growth among the entire population also picked up slightly after August 1996, accelerating from 1.4% over the year ending in July 1996 to 2.0% at an annual rate between August 1996 and July 1997. However, this 0.6 percentage point acceleration for the total population was far smaller than the 5 percentage point acceleration observed for women maintaining families.

The differential acceleration in labor force growth highlighted in Figure 2 supports the claim that welfare reform influenced the labor market behavior of women maintaining families. However, other factors also may have played a role. To account for some of these factors Figure 3 compares women maintaining families with three groups: married women, adult black men and teenagers. These comparisons are meant to control for continuing secular growth in female labor force participation, recent and delayed reaction to economic growth among workers with weaker labor force attachment, and the effects of raising the minimum wage, respectively. While none of these comparisons is perfect, each one helps separate the effects of welfare reform from other factors. Again, for convenience, each series is indexed to its July 1995 value.

As was the case for the total U.S. population, Figure 3 shows a general upward trend in labor force growth among adult black men and teenagers beginning in the latter half of 1996. However, neither group posted labor force growth close to 7.4%. As for the number of married women in the labor force, that growth rate has been relatively unchanged over the past two years. Thus, to the extent that these groups represent reasonable comparisons, Figure 3 suggests that women maintaining families behaved differently from other groups and that this change in behavior occurred following the signing of welfare reform.

Welfare reform and the U.S. labor force participation rate

While these patterns suggest that welfare reform influenced the labor force participation decisions of one targeted population, they do not reveal the extent to which these changes have altered the national labor force participation rate. As mentioned above, measuring this effect is important for gauging the ability of new labor force entrants to meet employer demands and modify wage pressures typically associated with tightening labor markets.

To quantify the effect of welfare reform on the national workforce, the analysis moves to calculations of the labor force participation rate, or the percentage of the civilian non-institutionalized population either employed or looking for work. Over the past 11 months the U.S. labor force participation rate has increased by four-tenths of a percentage point, from 66.7% in August 1996 to 67.1% in July 1997. The following calculations attempt to parcel out the proportion of this increase associated with the passage of welfare reform.

If one assumes, naively, that the entire increase in labor force entry among women maintaining families was associated with welfare reform and subtracts all new entrants in this category from labor force growth since August 1996, then the participation rate over the last 11 months would have risen to 66.8% rather than 67.1%. Under this assumption welfare reform would be credited with three-tenths of the total four-tenths increase in labor force participation since August.

However, a number of factors make such an assumption suspect. First, not all women included in the BLS population of women maintaining families were equally affected by changes in welfare regulations. Approximately 30% of women in this group care for families without children and are less likely to be eligible for welfare benefits. If these women are removed from the analysis category, the effect on labor force participation of the remaining women is reduced to two-tenths of a percentage point. Moreover, as the earlier analysis indicated, some fraction of the labor force growth among these women should be attributed to broader economic factors and other policy changes rather than to welfare reform. Assuming that these other factors are captured by the average labor force growth among the total U.S. population, (i.e., assuming that the welfare reform effect was 5.4 percentage points of the total 7.4% increase) the total effect on labor force participation is estimated to be about 0.1 percentage point. Thus, taking all of these factors into account suggests that, in the absence of welfare reform, approximately 296,000 women maintaining families would not have entered the labor market, and the current labor force participation rate would be 67.0 rather than 67.1%.

Conclusion

On the heels of welfare reform welfare caseloads declined precipitously and labor force participation rose, suggesting that welfare reform induced individuals to replace welfare with work and that their entry may be behind the rather unexpected surge in labor force participation that began late in 1996. Comparisons of the post welfare reform labor force growth between women maintaining families and other groups in the population suggest that welfare reform has had an effect on labor market behavior. However, because the size of the population potentially affected by reforms is relatively small, the effect on the aggregate U.S. labor force has been minimal.

Mary Daly
Economist

Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Sam Zuckerman and Anita Todd. Permission to reprint must be obtained in writing.

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