Taxes, Transfers, and the Labor Supply of Single Mothers

The wage elasticities of labor supply at the participation and hours worked margins are focal parameters of interest for understanding the work disincentive effects of taxes and transfers and the attendant design of optimal tax and transfer schemes. In this paper I use sweeping changes in U.S. tax policy, welfare policy, and the demand for skill over the 1980s and 1990s to identify the wage elasticity of labor supply of single mothers at the extensive and intensive margins. Using data from the Current Population Survey from 1979-2001 along with a conditional-on-transfer-program participation model of labor supply, I estimate uncompensated, compensated, and participation wage elasticities of labor supply using a grouping dummyendogenous variables instrumental variables estimator. The results strongly reject the separability of labor supply and transfer-program participation. Failure to control for the fixed costs of transfer program participation overstates the uncompensated and compensated wage elasticities of hours worked by a factor of three, and overstates the participation elasticity by two-thirds. I estimate an average wage elasticity of employment of about 2.0 and a compensated wage elasticity of hours worked of about 0.15, though the labor-supply response to wage changes of women on welfare and food assistance programs is considerably higher. Because the elasticity at the extensive margin is larger than that found at the intensive margin, the optimal transfer policy based on the Saez (2002) model suggests an EITC-type program with a small guarantee and negative tax rates at low incomes.