Research Paper on "Effect of the Earned Income Tax Credit EITC Program on Labor Supply"

Research Paper 8 pages (2403 words) Sources: 5

[EXCERPT] . . . .

Earned Income Tax Credit (EITC) Program on Labor Supply

Originally enacted in 1975 to offset the Social Security taxes of low-income workers with children and to provide those taxpayers with an increased incentive to work, and vastly expanded in 1990 and 1993 the Earned Income Tax Credit (EITC) has become one of the primary antipoverty programs in the United States Federal budget (Cordes, Ebel, & Gravelle, 2005). But the EITC was envisioned as more than simply an anti-poverty program. After all, Temporary Assistance to Needy Families (TANF), better known as welfare, also works to alleviate poverty through a direct transfer of funding from the government to the poor, and thus provides much of the same poverty relief function as the EITC.

What differentiates the EITC from TANF is that the Earned Income Tax Credit was conceived with the goal of helping to alleviate poverty while also encouraging active participation in the labor market; in other words it was seen both as a short-term poverty alleviation mechanism, and also as a long-term curative for poverty. Former President Ronald Reagan called EITC "the best antipoverty, the best pro-family, the best job creation measure to come out of Congress (University of Alabama News, 2009)." TANF, on the other hand, while alleviating poverty in the short-term, often acts as a disincentive to those receiving its benefits inhibiting them from entering the labor pool and consequently, some argue, actually entrenches poverty in the long-term.

TANF often acts as a disincentive to labor in two key ways. First it does so, by providing as much income, or sometimes slightly more income, than low wage jobs, such as those which pay the federally mandated minimum wage. Given a choice between working and not working and roughly receiving the same income the rational economic actor would choose not to work. In addition, if someone receiving TANF benefits becomes gainfully employed, particularly at the lower paying, low-skilled positions that most who are on TANF are qualified to hold, their TANF benefits are often reduced at a rate equal to or faster than the rate at which their income increases. In this situation, the recipient is once again confronted with choosing between working and receiving slightly less income when adjusted for work-associated costs, or not working and receiving the same or slightly higher income. Again, in this situation, the rational economic actor, acting in their own short-term economic interests would likely choose not to work. Yet by not working or engaging in work-related programs, they continue to only remain qualified for the same low-to moderate-income positions.

To put this into a concrete example, suppose a person who earns no income from employment received $10,000 in TANF benefits, while a person who earns $6,000 in income receives $5,000 in Temporary Assistance to Needy Families benefits. The employed person will have a total spendable income of $11,000 - a mere $1,000 more than if they didn't work (Sobel, 2007). When one considers the additional costs of working such as transportation, child care, and clothing, which in total are likely to exceed the extra $1,000 in income generate by working, the economical decision is actually for that person not to work (Sobel, 2007). This is likely (partially) why, as Figure 1 below illustrates, that poverty levels have actually increased in the highest public aid states, while in the lowest public aid states poverty levels are now relatively lower (with the exception of Colorado). TANF acts as a disincentive for individuals to take the lower paying positions which are often the stepping stones to higher paying positions, they find themselves continuing to be dependent on TANF and thus the benefit only serves to entrench poverty rather than to eliminate it.

Figure 1: Has Public Aid Reduced Poverty? (Sobel, 2007)

In addition, it also explains why the majority of individuals on TANF in the majority of states are not engaged in work related activities (either working or engaging in work training programs), as illustrated in Figure 2 below.

Figure 2-Percentage of Adults Receiving TANF and Not Participating in Work-Related Activities (Sobel, 2007)

The Earned Income Credit (EITC) seeks to circumvent the problems associated with TANF. It does so by connecting financial remuneration of the poor and moderate income individuals and families to work -- you have to work to receive the credit. It is essentially a refundable federal income tax credit for low- and moderate-income working people. The refundable portion means that if the EITC if it exceeds a low-wage worker's income tax liability the IRS will refund the balance, unlike the case of most other tax credits (Center on Budget and Policy Priorities, 2009). Figure three shows the Federal EITC tax credit schedule for 2009 based on household income. In addition to the Federal EITC, twenty-four states have established their own EITCs to supplement the federal credit (Center on Budget and Policy Priorities, 2009). The refundable nature of the tax credit, and that one has to work to receive it seems to suggest that the EITC incentivizes non-workers to enter the labor force, thereby having lasting positive effects such as limiting long-term unemployment and building human capital.

Figure 3 (Center on Budget and Policy Priorities, 2009)

The question that immediately springs to mind, and the focus of the remainder of this paper, is if the goal of the EITC is to reward work, how effective is it at increasing participation in the workforce? This is after all the primary mechanism by which the United States seeks to transfer wealth: Almost 21 million American families received more than $36 billion in refunds through the EITC in 2004 (ACORN Financial Justice Center, 2004). Does the EITC achieve its goal of alleviating poverty by encouraging work, or does it, as so many well-intentioned policies do, go awry?

Because the EITC has been used in the United States since the mid-seventies, in addition having variants of the program in use in several countries around the world including Canada, Ireland, New Zealand and Austria, its effectiveness has been exhaustively researched and debated. The general consensus by most economists seems to be that the EITC works in getting people engaged in labor.

For example, a seven-year analysis of the economic impacts of the EITC in Nashville found that the EITC not only supported the working poor population with tax assistance, but also worked redundantly to actually provide a small portion of the working poor population through the creation of jobs, generally in the low-to middle-income bracket (Haskell, 2006)

Figure 4 - Davidson County Local Jobs (FTE's) Sustained by the EITC (Haskell, 2006)

This make sense, as a number of economists suggest that every increased dollar received by low and moderate-income families has a money multiplier effect between 1.5 to 2 times the original amount in terms of its impact on the local economy and how much is spent in and around the communities where these families live. A money multiplier is simply the measure of how much the money supply increases in response to a change in the monetary base. In this case, for every $1 dollar in EITC received, $1.50 to $2.00 ends up being spent. This is likely what is driving the modest increase in job creation in Nashville.

Similarly, a 2006 working paper out of the National Bureau of Economic Research which examined the employee effects of the EITC by using a unique dataset created by matching administrative data from TANF records, unemployment records, and federal tax returns for California residents -- in other words looking explicitly at the people who were likely to or had previously made use of TANF services and used four tests to assess the EITC's effects on employment, which ranged from comparing the employment rates for two-or-more child families should grow relative to the employment rates of one child families, as credit amounts available to these groups of families diverged over the 1990s, comparing employment differences ) between families with two children and families with three or more children, since the EITC did not change differentially for the latter two groups (Hotz, Mullin, & Scholaz, 2006). Their findings heavily suggest that the EITC has a substantial positive effect on the employment of families who have used or will use welfare (Hotz, Mullin, & Scholaz, 2006).

A 2004 report on the effect of the Earned Income Tax Credit for the City of Baltimore echoes the NBER's findings stating that research completed by Jeffrey Leibman noted that from

1984 to 1996 the labor force participation rate of single women with children increased from 73% to 82% (the Jacob France Institute, 2004). The EITC was responsible for 60% of this increase, thus inducing induced 20% of single women with children not previously working to begin working (the Jacob France Institute, 2004). The EITC expansion of 1993 is estimated to have increased the labor force participation rate of single parent families by over 3% due to the EITC impact on net wages while also increasing the net wages of low-income, single parents by a… READ MORE

How to Reference "Effect of the Earned Income Tax Credit EITC Program on Labor Supply" Research Paper in a Bibliography

Related Research Papers:

Earned Income Tax Credit Research Paper

Earned Income Tax Credit

Earned Income Tax

The earned income credit is a refundable tax credit that working families and individuals with lower income can use. The amount of the… read more

Research Paper 5 pages (1634 words) Sources: 5 Topic: Economics / Finance / Banking

---

Should Welfare Be Limited by Time Essay

Welfare be Limited by Time

Welfare at one time was almost becoming an epidemic. Families would be on welfare and their children would grow up and their families would get… read more

Essay 4 pages (1275 words) Sources: 2 Topic: Family / Dating / Marriage

---

Welfare Reform Term Paper

Welfare Reform

What exactly is Welfare reform, and what led to its development? Welfare Reform can be defined as the movement that was brought in, with a great amount of… read more

Term Paper 8 pages (3094 words) Sources: 1+ Topic: Family / Dating / Marriage

---

View 100+ more related papers  >>