Earned Income Tax Credit (EITC)

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Presentation transcript:

Earned Income Tax Credit (EITC) Effects of Personal Income Taxes on Labor Supply

Tax Policy to Promote Labor Supply: The Earned Income Tax Credit Earned Income Tax Credit (EITC): A federal income tax policy that subsidizes the wages of low income earners. The EITC has two goals: Redistribution of resources to lower-income groups. Increases in the amount of labor supplied by these groups. EITC spending totaled nearly $60 billion in 2011 and has increased dramatically over the last two decades.

Background on the EITC

Background on the EITC The EITC is a refundable tax credit; the exact amount depends on earnings. Eligibility depends on the number of children: For families with more than two children, maximum earnings are $50,270. With two children, the maximum is $47,162. With one child, the maximum is $42,130. With no children, the maximum is $19,190.

The EITC Benefit Structure

Impact of EITC on Labor Supply: Theory

Impact of EITC on Labor Supply: Theory This figure illustrates the impact of the EITC on four distinct groups: People not in the labor force at all. People already in the labor force who earn less than $11,340. People already in the labor force and earning between $11,340 and $14,810. People already in the labor force earning between $14,810 and $36,348.

Impact of EITC on Labor Supply: Evidence Effects on Labor Force Participation: The EITC has increased the LFP of single mothers. Effects on Hours of Work: No effect, conditional on working. Impact on Married Couples: Married men’s labor supply appears not to respond to the EITC. Summary: EITC supports redistribution without reducing labor supply, accomplishing its goals.

EVIDENCE: The Effect of the EITC on Single Mother Labor Supply Eissa and Leibman (1996) studied the impact of the 1986 EITC expansion. Comparing single women with children (the treatment group) to single women without children (controls). The EITC expansion increased labor supply by 1.4 to 3.7 percentage points. 9

EVIDENCE: Changes in the EITC Structure

APPLICATION: EITC Reform The EITC, though successful, has some flaws: Very small benefit for childless workers. No credit increase for children beyond the second. Marriage penalty, as it is based on family income. The EITC is very complex; about 1/7 of eligible people do not participate, and the majority of EITC recipients hire professionals to help prepare their taxes.