Transfers to families with children as a principal-agent problem

The relationship between government and parents is modelled as a principal-agent problem, with the former in the role of principal and the latter in that of agents. We make four major points. The first is that, if the well-being of the child depends not only on luck, but also on parental actions that the government cannot readily observe, the latter can influence parental behaviour by conditioning income transfers to families on child performance. The second point is that, if there are market inputs into the making of a happy or successful child, which the government can observe, but not ascribe to any particular parent or child because they are bought anonymously, an income transfer policy can be usefully complemented by an indirect subsidy on the price of these inputs. The third is that, if parents care about their children, incentive considerations may have to be tempered by the need to compensate those who have the misfortune of getting a child with low ability. The fourth is that parents can be induced to have the socially desirable number of children by making the transfer conditional, not only on child performance, but also on number of children. Ways of making these findings operational, and the effects of administrative costs, are discussed in some detail.