On the optimal reform of income support for single parents

Abstract

We characterize the optimal reform of U.S. income support for low-income single parents using a life-cycle heterogeneous agent model with idiosyncratic risk and incomplete asset markets. We use the U.S. tax-transfer system as the benchmark policy and a sample of single mothers drawn from the CPS to assess reforms that maximize average expected utility among single mothers-to-be. When policy cannot be tagged by the age of the children, the optimal reform calls for an increase in out-of-work income support by about 15 percent, and a decrease in earnings subsidies to low-wage workers by roughly 50 percent. This reform delivers substantial welfare gains. Tagging policy by the age of the children makes the government's trade-off between providing insurance to single mothers with children of pre-school age, on the one hand, and providing work incentives to those with school-age children, on the other hand, more favorable, thus increasing their scope for smoothing marginal utility throughout the life cycle. With tagging, mothers of pre-school age children get a substantial increase in out-of-work income support and no earnings subsidies. Tagging brings additional welfare gains.