How does the EITC affect labor supply?

The Earned Income Tax Credit (EITC) provides a tax credit for those who qualify with positive earnings, low income, and minimal capital gains. It is more so directed at working families, whether it is 2 parents or a single mother. It is intended to push more people into the work force, especially low-income women. In fiscal year 1998 the EITC is expected to cost the federal government $24.5 billion, $7 billion of which will result from expansions incorporated in the 1993 Omnibus Budget Reconciliation Act (OBRA93) (Houser & Scholz, 2). It pushes for a “make-work pay” strategy of welfare reform so people do not rely as heavily on welfare programs. There are many articles that discuss what effect the Earned Income Tax Credit has on labor supply in America and the way the policy has affected so many.

In “The Impact of the Earned Income Tax Credit and Social Policy Reforms on Work, Marriage, and Living Arrangements” by Ellwood, he examines how changes in social reforms, such as the EITC, have impacted labor supply, marriage, and cohabitation. Ellwood acquired and used the current population survey from March 1995 of women ages 18-44 who worked at least 26 weeks, also separating between married or single, with children. Then he used a wage equation to predict a potential 1998 wage for the women. Then the predicted wage was used to place the women into predicted wage/skill quartiles after accounting for education level. The incentives were much higher for low skill single mothers to work. Differentiating the women between skill and wage levels is critical in determining which group of people receives benefits and which don’t get affected at all. In 1986, she could hope to earn just $2,800 more and her effective tax rate being 76 percent; but by 1998, the number had jumped to $7,600 with her effective tax rate falling to 31 percent (Ellwood). The lowest quartile showed the greatest amount of change, and the following quartiles showed change, but nothing too drastic. Employment rates were rising for unmarried mothers. For married women, incentives to work were sharply reduced for low-income women, with effective tax rates falling slightly for women in other quartiles. A large change in work by the lowest quartile occurred with employment rates shooting up from 34 percent in 1992 to 55 percent in 1999. In regard to married women, some cases led to them being discouraged to work. Roughly 54 percent of married women in the bottom quartile would have faced penalties up to $1,288 (had they been earning $10,000) whose husbands likely were earning less than the EITC maximum. Another 28 percent would have had no incentive to work because their husband’s income surpassed the EITC maximum. The EITC encouraged more work force participation by single mothers, but hadn’t had such an effect on married mothers. Overall, based on the number of mothers in each group affected, this article concluded the EITC results in a net increase of working women.

In “The Earned Income Tax Credit and Transfer Programs: A study of Labor Market and Program Participation” by Dickert and Scholz, they focus on the degree to which welfare policies, like the EITC, that alter after-tax wages affect hours of work, labor market participation, and welfare program participation. They used the following empirical model to study the effect of wages, taxes, and program benefits on labor market and program participation; bivariate probit models of labor market and transfer program participation. They included variables for income, transfers, and demographic characteristics in both participation equations. Two models are estimated separately: one for one-parent families and the other for primary earners in two-parents families. Net wages are key in influencing participation when it comes to the EITC. The empirical results for the single parent model found that net wages positively affected labor market participation. A 10 perce