Tuesday, August 01, 2006

Eissa and Hoynes on the EITC

Over the past decade or so, the EITC has been the subject of a considerable amount of research. In a recent working paper (for the NBER's Tax Policy and the Economy volume), Nada Eissa and Hilary Hoynes conclude:
Perhaps the main lesson learned from the evidence is the confirmation that real responses to taxes are important; labor supply does respond to the EITC. The second major lesson is related to the nature of the labor supply response. A consistent finding is that labor supply responses are concentrated along the extensive (entry) margin, rather than the intensive (hours worked) margin.

There is also a short summary of the article in the NBER digest for this month. Here are two interesting excerpts:
The cost of the EITC is offset in part, they note, by a reduction in the number of single mothers receiving welfare. Moreover, the EITC now lifts more children out of poverty than any other government program. In 2002, it removed 4.9 million people, including 2.7 million children from poverty. Advocates see it as promoting the values of both family and work. Traditional welfare programs, according to their critics, do the opposite.


The largest group of EITC recipients is single mothers, typically in their early thirties with a high-school diploma, and with fewer than two children. Among this group, the EITC is expected to lead to higher rates of employment though fewer hours worked by those already working (through the cash transfer and the lower returns to work in the phase-out range). The expansions in the credit have led to dramatic declines in average tax rates, from 14.5 percent in 1985 to a negative 4.1 percent in 2000; that is, the IRS provided a subsidy equivalent to 4.1 percent of income. The evidence consistently suggests that such EITC expansions raise employment rates. One study finds that 60 percent of the 8.7 percentage point increase in annual employment of single mothers between 1984 and 1996 is attributable to the EITC with its expansion. There is no evidence, however, that the credit leads to reduced hours worked for those already in the labor market. Eissa and Hoynes survey the various explanations for the different responses on participation and hours, including measurement error, the inability of workers to choose continuous hours of work, and the lack of knowledge of the structure of the EITC schedule.

In the case of married mothers, the EITC has indeed led to a small reduction in labor market participation - about 1 percentage point, according to another study by Eissa and Hoynes. This occurs because the credit is based on family earnings and income. If, for example, the husband is the primary earner, and these earnings place the family in the phase-out range of the EITC, then the family gets the credit even if the wife remains out of the labor force. And, if she goes to work, her earnings will decrease the credit. The real boost in family income may be much smaller than the nominal extra earnings and therefore may provide an incentive for the second earner to move out of the labor force. At $10 an hour, for example, the tax rate for married women could be 41 percent of her earnings. These are extremely large marginal tax rates for low- to moderate-income families.

I think that the generally positive impact of the credit, and particularly its positive impact on the group most in need (single mothers), is what accounts for the popularity of the EITC with policy analysts across the political spectrum.

1 comment:

Ri. Davis said...

The EITC would be even better if H&R Block and Jackson Hewitt did not receive so much of it in fees for refund loans.