Earned Income Tax Credit(EITC)EFFECTS OF PERSONAL INCOME TAXES ON LABOR SUPPLY

• Earned Income Tax Credit (EITC): A federal income tax policy that subsidizes the wages of low income earners.

• The EITC has two goals: o Redistribution of resources to lower-income groups. o 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.

Tax Policy to Promote Labor Supply: The Earned Income Tax Credit

Background on the EITC

• The EITC is a refundable tax credit; the exact amount depends on earnings.

• Eligibility depends on the number of children:

o For families with more than two children, maximum earnings are $50,270.

o With two children, the maximum is $47,162.

o With one child, the maximum is $42,130.

o With no children, the maximum is $19,190.

Background on the EITC

The EITC Benefit Structure

Impact of EITC on Labor Supply: Theory

This figure illustrates the impact of the EITC on four distinct groups:

1. People not in the labor force at all.

2. People already in the labor force who earn less than $11,340.

3. People already in the labor force and earning between $11,340 and $14,810.

4. People already in the labor force earning between $14,810 and $36,348.

Impact of EITC on Labor Supply: Theory

• 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.

Impact of EITC on Labor Supply: Evidence

• 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.

EVIDENCE: The Effect of the EITC on Single Mother Labor Supply

EVIDENCE: Changes in the EITC Structure

• The EITC, though successful, has some flaws:o Very small benefit for childless workers. o No credit increase for children beyond the second.o Marriage penalty, as it is based on family income.o 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.

APPLICATION: EITC Reform