Designing Cash Transfers in the Presence of Children’s Human Capital Formation

This paper finds that accounting for the human capital development of children has a quantitatively large effect on the true costs and benefits of providing cash assistance to single mothers in the United States. A dynamic model of work, welfare participation, and parental investment in children introduces a framework for calculating costs and benefits when individuals respond to incentives. The model provides a tractable outcome equation in which a policy’s effect on child skills can be understood through its impact on two economic resources in the household – time and money – and the share of each resource, in combination with childcare quality, as factors in the production of skills. These key causal parameters are cleanly identified by policy variation through the 1990s. The model also admits simple and interpretable formulae for optimal nonlinear transfers, with novel features arising from the child skill formation channel. Using a broadly conservative empirical strategy, estimates imply that optimal transfers are up to 50% more generous than the US benchmark, with quite different labor supply incentives.