Earned Income Tax Credit recipients: income, marginal tax rates, wealth, and credit constraints.
Athreya, Kartik B. ; Reilly, Devin ; Simpson, Nicole B. 等
The Earned Income Tax Credit (EITC) has become the federal
government's largest cash-assistance program for low-income
families, making it the centerpiece of anti-poverty programs in the
United States. Approximately 15 percent of households nationwide now
qualify for the EITC (Hoffman and Seidman 2002). Moreover, unlike other
government programs, the EITC is administered through the income tax
filing process, which reduces any potential stigma associated with the
program, and aids in ensuring high participation rates (Smeeding,
Phillips, and O'Connor 2000). According to Eissa and Hoynes (2009),
approximately $43 billion was allocated to 22 million families in the
United States in 2007 through the federal EITC. This compares to $16.5
billion that was spent on more traditional welfare programs, such as
Temporary Assistance for Needy Children (TANF).
The EITC is designed to augment income while encouraging work: The
tax credit increases with earnings for low levels of household income.
The size of the credit is such that, for low-income households that
qualify, the EITC is a negative tax on earnings that often constitutes a
significant portion of after-tax wage income. The EITC does appear to
have been successful in both helping the working poor get out of poverty
and encouraging work. Neumark and Wascher (2001), Ziliak (2006), and
Simpson, Tiefenthaler, and Hyde (2009) provide evidence that the
combined federal and state EITC helps families rise above the poverty
line. In fact, the EITC has been estimated to have helped five million
people out of poverty in 2005, including 2.6 million children. (1) Hotz
and Scholz (2000) find that, compared to other poverty-reduction
programs, the EITC is effective in raising the standard of living for
low-income households, while keeping administrative costs relatively
low.
However, the EITC phases out with earnings, until eventually a
household no longer qualifies for it. The structure of the phase-out
means that families earning more than $41,000 in 2008 will not qualify
for the EITC, while all those earning less will. In addition, the credit
targets families with children, and increases in generosity with the
number of children in the household. For example, households with two or
more children (in tax year 2008) earning $15,000 could qualify for up to
$4,824 in federal earned income credits. In contrast, a childless single
filer can receive only one-tenth of this amount, or at most $438. Thus,
for those households with children and low earned income, the full
refundability of the EITC ensures that it will represent a substantial
addition to income.
In this article, we summarize the details of the EITC and describe
the population of EITC recipients. Using Current Population Survey data,
we estimate earnings and EITC benefits received by EITC recipients at
various ages. Naturally, we find that because of the eligibility
requirements, the earnings of EITC recipients are relatively similar
across the age of recipients, which makes them differ systematically
from non-recipients of the same age--whose earnings show a more
pronounced "hump shape" with age. We then discuss how the EITC
affects marginal taxes in the United States and summarize its
theoretical and empirical effects on household labor supply decisions.
Finally, we compare wealth levels of EITC recipients with non-recipients
using data from the Survey of Consumer Finances (SCF), and find
significant differences in their wealth distributions, with EITC
recipients being substantially poorer. The fact that EITC recipients
have relatively low wealth levels and low earnings relative to others in
their age group suggests that they may be more likely to be
borrowing-constrained than non-recipients. In fact, we find some
evidence for this in our analysis of SCF data.
1. HISTORY OF THE EITC
In Table 1, we briefly summarize the history of EITC legislation.
The EITC started as a modest program as part of the Tax Reduction Act of
1975. (2) The program was unique among tax credits as it was refundable
so that poor families could utilize its benefits even if they owed
little or no taxes. Unlike welfare programs such as Aid to Families with
Dependent Children (AFDC), single parents as well as married couples
were eligible for the program. The EITC went through minor changes in
subsequent years, the most important being when it became a permanent
provision of the Internal Revenue Code in 1978.
Table 1 History of EITC Legislation
Year Changes to the EITC
1975 Introduced temporary "work bonus" called the EITC
1978 Made EITC permanent
1986 General expansion (largest increase since its inception)
and indexed for inflation; part of the Tax Reform Act
1990 General expansion by doubling the maximum credit and
increased eligibility; added separate schedule for
families with two or more children; part of OBRA
1993 General expansion (larger expansion for families with
two or more children); added EITC for childless filers;
part of OBRA
1997 Provisions made to improve compliance; part of Taxpayer
Relief Act
2001 Changes to provide marriage penalty relief and promoted
simplification; part of EGTRRA
2009 Expansion for families with three or more children and
expanded eligibility for married couples; part of the
American Recovery and Reinvestment Act
Sources: Hotz and Scholz (2003); Holt (2006); Tax Policy Center (2009).
The Tax Reform Act of 1986 indexed the EITC to inflation and
liberalized the EITC, helping, by some estimates, to remove over six
million Americans from poverty (Ventry 2000). The Omnibus Reconciliation
Act (OBRA) of 1990 increased the credit and added separate schedules for
families with two or more children. The largest expansion of the EITC
occurred in 1993, as part of the OBRA, in which the EITC was increased
by an additional 25 percent. Families with two or more children
experienced the largest increase in the credit, and childless filers
could now qualify for the EITC. Both the size of the credit and the
eligible population have grown over time, and were fueled by the passage
of the Personal Responsibility and Work Opportunity Reconciliation Act
of 1996, which replaced AFDC with Temporary Assistance for Needy
Families (TANF). The United States experienced a 50 percent reduction in
welfare rolls between 1993 and 2000, and Grogger (2004) finds that much
of the drop is attributed to the EITC and reduction in welfare benefits.
Until 2001, the structure of the EITC was identical for single and
married filers. However, as part of the Economic Growth and Tax Relief
Reconciliation Act (EGTRRA) of 2001, married couples received larger
benefits for larger ranges of income levels than single filers. The
success of the federal EITC has led to the development of similar
programs in 23 U.S. states and the District of Columbia, totaling an
additional $2 billion (Levitis and Koulish 2008).
Finally, the American Recovery and Reinvestment Act of 2009
increased the credit for families with three or more children and
expanded eligibility for married couples. Families making up to $48,250
in annual earnings can now qualify for the tax credit, with the maximum
credit as high as $5,657 for a family with three or more children. This
EITC expansion is expected to help an additional 650,000 households and
1.4 million children. (3)
2. STRUCTURE OF THE EITC
The EITC acts as an after-tax wage subsidy for low-income workers
and depends on earned income, number of children, and marital status.
(4) Earned income includes wages, salaries, tips, and other employee
compensation; union long-term disability benefits received prior to
minimum retirement age; and net earnings from self-employment. However,
it does not include social security benefits, unemployment compensation,
welfare benefits, scholarships, worker's compensation benefits, or
pension/annuity income.
The EITC is structured in three phases: In the phase-in period, the
credit increases with earnings; in the plateau period, the credit
reaches a maximum and levels off; and in the phase-out period, the
credit falls as the claimant's earnings rise. At the eligibility
limit, the household earns no EITC. The EITC is separated into different
levels for claimants with no children, those with one child, and those
with two or more children. There are also different tax credits for
different types of filers: Married couples filing jointly are eligible
for slightly higher credit amounts in the phase-out period than single
filers and have slightly larger income eligibility ranges. Table 2
presents the details of the EITC for tax year 2008 for different filing
statuses (single or married) and number of children, and includes the
maximum credits and earnings limitations. In Figure 1, we plot the
amount of federal EITC that single and married households receive across
various income levels: single filers are depicted by the solid lines,
whereas married filers are depicted by the dashed lines. To calculate
the EITC in each phase, we use the equations in Table 3 along with the
EITC parameters in Table 2.
Table 2 EITC Parameters, Tax Year 2008
Single, No Single, One Single, Two+
Qualifying Qualifying Child Qualifying
Children Children
Phase-In Rate 7.65% 34.00% 40.00%
Phase-In Ends $5,720 $8,580 $12,060
Maximum Credit $438 $2,917 $4,824
Phase-Out Begins $7,160 $15,740 $15,740
Phase-Out Rate 7.65% 15.98% 21.06%
Eligibility Ceiling $12,880 $33,995 $38,646
Married, No Married, One Married, Two+
Qualifying Qualifying Child Qualifying
Children Children
Phase-In Rate 7.65% 34.00% 40.00%
Phase-In Ends $5,720 $8,580 $12,060
Maximum Credit $438 $2,917 $4,824
Phase-Out Begins $10,160 $18,740 $18,740
Phase-Out Rate 7.65% 15.98% 21.06%
Eligibility Ceiling $15,880 $36,995 $41,646
Source: Minnesota House Research Department.
Table 3 EITC Calculation by Phase
Phase EITC
Phase-In = Phase-In Rate * Income
Plateau = Maximum Credit
Phase-Out = Maximum Credit - Phase-Out Rate * (Income - Income
Where Phase-Out Begins)
[FIGURE 1 OMITTED]
As seen in Figure 1, the EITC significantly varies with the number
of children present in a household. Childless filers receive less than
one-eighth of the EITC than filers with one child and one-twelfth of
filers with two or more children. The federal credit can represent up to
34 percent and 40 percent of income for filers with one and two or more
children, respectively. In addition to the federal EITC, many states
supplement, or match, with additional credits. As a result, if the
taxpayer lives in a state that offers a state EITC, the total EITC
(federal plus state) could be much larger; for example, New York
residents receive an additional 30 percent of the federal credit. Also
interesting is that the slope of the EITC function is steeper in the
phase-in range than in the phase-out range. That is, an additional
dollar of earned income rewards households in the phase-in range by
giving them a credit, which can range from $0.07 (for childless singles)
to $0.40 (for married couples with two children). In the phase-out
range, an additional dollar of income results in a reduction in the
credit, from $0.07 (for childless singles) to $0.21 (for married couples
with two children).
The range of eligible income is much larger as the number of
dependent children rises. As of 2008, married households with two
children earning less than $41,626 qualify for the EITC, compared to
$15,880 for childless couples. The maximum EITC does not vary with
marital status, but the income eligibility ranges are slightly larger
for married couples. In addition, the range of eligible income is much
larger in the phase-out range so that more households are in the
phase-out range than in the phase-in range. In fact, recent evidence
suggests that married households are more likely to be in the phase-out
range than singles, since they are more likely to have higher household
income.
3. LABOR MARKET CHARACTERISTICS OF EITC RECIPIENTS
Using Current Population Survey (CPS) data from 2008, we analyze
the labor market characteristics of EITC recipients and compare them to
non-EITC recipients. We create household-level observations by matching
individuals who are married to each other, and we restrict the sample to
households where the household head is between the ages of 16 and 64
years. Households are classified into six different types, based on
marital status (married or single) and number of children (no children,
one child, two or more children). This classification is consistent with
the structure of the EITC, as discussed in Section 2. We find that
approximately 12.8 percent of households in our sample receive the EITC.
Table 4a reports the mean annual wage and salary income, education
level, and EITC amount for each household type, while Table 4b reports
the fraction of each type in the sample. All of the means represent
weighted averages using the household weights supplied by the CPS. It is
important to note that 2008 CPS data corresponds to the 2007 tax year
and that the CPS only reports estimated federal EITC and does not
include any state EITCs.
Table 4 EITC Recipients
4a: Labor Market Characteristics of EITC Recipient vs. Non-Recipient
Households
All Married, Married, Marri
No Kids One Kid ed,Two+
Kids
EITC Recipients:
Mean Household Income $15,194 $8,325 $18,700 521,212
St. Dev. of Household Income $16,132 $8,100 $10,590 $11,225
Percent of High School or 61.5% 70.5% 64.1% 68.5%
Less
Percent with Two Earners 26.3% 9.6% 24.6% 30.1%
Average EITC $1,782 $495 $1,812 $2,623
EITC as Percent of Income 11.7% 5.9% 9.7% 12.4%
Non-EITC Recipients:
Mean Household Income $47,235 $68,549 $83,372 $94,271
St. Dev. of Household Income $49,653 $67,884 $71,052 $79,822
Percent of High School or 39.7% 36.1% 34.2% 29.6%
Less
Percent with Two Earners 65.1% 56.8% 70.5% 71.3%
Single, No Single, One Single,
Kids Kid Two+ Kids
EITC Recipients:
Mean Household Income $7,024 $15,761 $17,421
St. Dev. of Household Income $5,894 $9,739 $10,409
Percent of High School or Less 60.0% 54.1% 58.3%
Percent with Two Earners n/a n/a n/a
Average EITC $423 $1,808 $2,728
EITC as Percent of Income 6.0% 11.5% 15.7%
Non-EITC Recipients:
Mean Household Income $23,696 $32,125 $31,723
St. Dev. of Household Income $32,305 $47,998 $51,997
Percent of High School or Less 43.4% 46.6% 48.3%
Percent with Two Earners n/a n/a n/a
4b: Distribution of Households in the CPS
Married, Married, Married, Single,
No Kids One Kid Two+ No Kids
Kids
EITC Recipients:
Percent of All Households 0.59% 1.21% 3.12% 3.15%
Percent of EITC Recipients 3.9% 9.6% 26.8% 19.8%
Non-EITC Recipients
Percent of All Households 14.60% 7.91% 12.40% 46.26%
Percent of Non-EITC 14.77% 10.57% 18.61% 48.16%
Recipients
Single, Single, Sum
One Kid Two+ Kids
EITC Recipients:
Percent of All Households 2.32% 2.45% 12.83%
Percent of EITC Recipients 19.4% 20.6% 100.00%
Non-EITC Recipients
Percent of All Households 3.81% 2.19% 87.17%
Percent of Non-EITC Recipients 4.91% 2.99% 100.00%
Notes: Household data constructed using 2008 CPS; 16-64-year-olds.
2008 dollars. Means are weighted using the household weight "hhwt."
Approximately 60 percent of EITC recipient households are single,
with an equal distribution of single households having zero, one, and
two or more children. This contrasts to married couple households, where
the majority of EITC recipient households have two or more children. The
amount of EITC varies significantly across household types. Single
households with two children receive the most EITC ($2,728), which
constitutes the largest share of their annual income, at 15 percent.
Households without children receive much less EITC, constituting only 6
percent of their annual income.
Much of the variation in the EITC across household types is because
of differences in annual income. Not surprisingly, married households
earn more than single households since there is the potential for two
earners. It is interesting to note, however, that the share of married
households that have two earners is quite low for EITC recipients,
compared to non-recipients. For example, approximately 30 percent of
married households with two children who receive the EITC have two
earners, while 71 percent of non-recipients have two earners. This could
be due to the fact that the majority of two-earner households surpass
the income qualifications of the EITC. Or, it could be that
EITC-recipient households choose not to have a second income since they
receive the EITC.
Another interesting feature is that household earnings for EITC
recipients increase with the number of children, and this occurs for
both married couple households and single parent households. The
difference in annual income between childless households and households
with children is much larger for EITC-recipient households than for
non-recipient households.
Even though single households that receive the EITC earn less than
married households, they tend to be more educated (for married
households, we use the education level of the household head).
Approximately 10 percent fewer single households have a high school
degree or less compared to married households and this is independent of
the number of children. This is not the case for non-recipient
households: Single households that do not receive the EITC are more
likely to only have a high school education than married households.
Thus, the EITC likely has the largest impact on households with
children since the EITC is much larger for these households as a share
of their annual income and more than 75 percent of EITC recipient
households have children. Single households represent the majority (60
percent) of EITC recipient households, and tend to be more educated than
married EITC households, which contrasts with the general population.
EITC recipient households are much less likely to have two earners than
non-recipient households.
4. EITC AND INCOME BY AGE
We now analyze how the EITC changes across recipients of different
ages. Since the EITC targets low-income families, it will
disproportionately affect younger households of child-rearing age.
However, households may qualify for the EITC at any stage of their life,
as long as they have earned income that is below the income limit.
Importantly, there is no limit to the amount of benefits received over a
lifetime nor is there a time limit.
We analyze the pool of EITC recipients between 1992-2008 and
catalog how the EITC varies across households of different ages in a
shortened panel. Specifically, we estimate the average income/EITC (in
2008 dollars) for each household at each age in each year of the CPS
(using the household weights supplied by the CPS). Then, we calculate
the average income/EITC across the panel by age; to do this, we account
for the distribution of households at each age across the panel. This
yields an estimate for income/EITC, conditional on receiving EITC, at
each stage in the lifecycle for the typical household in the CPS.
While the preceding is useful, it is an imperfect measure of the
effect of EITC on lifetime earnings. It abstracts from any cyclical
effects that individuals experience in earnings (such as business
cycles, changes in skill premium, or occupational transitions) that
occurred prior to 1992 for older cohorts (for example, changes in
earnings profiles for individuals born before 1974 are not accounted for
prior to 1992). However, our method accurately accounts for the drastic
changes that occurred in the EITC during this period. In addition, our
estimates provide a sense of how the EITC changes by age and what
households can expect as they age, should they qualify at later dates.
In Figure 2a, we plot the average EITC for households that receive
the EITC at each age between 18-64 using 1992-2008 CPS data (the age of
the household head is used); we also plot the EITC as a percent of
earnings (labor earnings and EITC) in the same figure. A few interesting
findings emerge. The EITC is high for households headed by very young
adults (age 18-25), relatively constant for households in their thirties
(at approximately $2,000 in 2008 dollars), and then declines
precipitously as we look at households in their late thirties and
beyond. By the time households are in their fifties and sixties, the
average amount of EITC is just over $500. Thus, the amount of EITC that
households receive declines over the course of their lifetimes. However,
the interaction of the qualification requirements and the structure of
benefits ensure that the EITC remains a relatively constant fraction of
recipients' earnings, at approximately 15 percent, for most of
their lives. While the typical EITC transfer is largest for the youngest
recipients in our sample, the EITC represents a significant fraction of
annual earnings (at least 15 percent) throughout most of a
recipient's working life. In addition, the EITC represents an even
larger proportion of the income of older EITC recipient households. For
example, for EITC recipients in their late fifties, the EITC increases
as a percent of earnings to approximately 18 percent. This is likely due
to the fact that households that qualify for the EITC at this age have
very low incomes since they likely face the income thresholds applicable
to those with no children.
[FIGURE 2 OMITTED]
The patterns in EITC receipt across different age groups arise from
two factors: child-rearing stages and fluctuations in income over the
lifetime. A typical lifetime earnings profile exhibits a hump shape,
where earnings are low early in life, increase dramatically through the
twenties and thirties, level off through the forties, and start to
decline in the fifties and sixties. This is exactly what we observe for
non-EITC recipient households in the CPS sample. In Figure 2b, we plot
household earnings (wages and salary) profiles for non-EITC recipients
and EITC recipients. By construction of the eligibility requirements for
EITC, however, those receiving it at various ages are much more similar
to each other than are non-recipients of differing ages. Amongst
recipients, the highest levels of benefits accrue to the young,
typically around age 25. Older recipients generally earn smaller
amounts, primarily as the number of dependents they may claim falls.
5. MARGINAL INCOME TAX RATES
The EITC represents a negative income tax for households that
qualify for it. Thus, for low income levels, marginal income tax rates
are negative. Using data from TAXSIM version 9.0 from the National
Bureau of Economic Research, (5) we calculate the marginal income tax
rates for all single and married households with no children, one child,
and two children (i.e., dependents exemptions) for tax year 2008. (6)
The marginal income tax rate is for adjusted gross income only and does
not include Federal Insurance Contributions Act (FICA) contributions
(i.e., Social Security and Medicaid).
In Figure 3, we plot the marginal tax rates across income levels
for single and married filing status earning up to $100,000 and
differentiate households based on the number of children they claim as
dependents. As you can see in the first panel for married households
with two or more children, for low levels of income, the marginal tax
rate is -40 percent for both single and married filers, which represents
the phase-in rate for the EITC. As incomes reach $13,000, the marginal
rate is 0 percent (in the plateau region). For households with income
above $13,000, the marginal tax rate becomes positive and gets quite
large quickly. For married households with incomes between approximately
$19,000--$25,000, the marginal tax rate jumps to 21 percent, which
represents the EITC phase-out rate. That is, at the margin, these
households are experiencing a 21 percent reduction in their EITC for any
additional income they earn in this range. For married households with
incomes between approximately $25,000-$40,000, the marginal income tax
rate increases to 31 percent, which represents the EITC phase-out rate
plus the lowest income tax bracket of 10 percent. For married households
with two children earning $41,000, they face the phase-out rate and the
next highest tax bracket of 15 percent, making their marginal tax rate
36 percent. Thus, the phasing out of the EITC leads to dramatic
increases in the marginal income tax rates for these households. For
married households above $41,000, they no longer qualify for the EITC;
hence, they face significant reduction in their marginal tax rates, at
15 percent (in the second income tax bracket). As household income
approaches $90,000, the marginal tax rate increases to 25 percent for
married filers. (7), (8) Single taxpayers with two children experience
similar jumps in the marginal income tax rates, but for lower levels of
income than married households.
[FIGURE 3 OMITTED]
The second panel in Figure 3 shows the marginal income tax schedule
for married and single households with one child. The figure is similar
for those with two or more children, however, the marginal rates are
slightly lower across all income levels. For example, the poorest
households with one child face a marginal tax rate of -34 percent
(compared to 40 percent for households with two or more children). In
addition, marginal tax rates for those earning between $20,000-$40,000
are approximately 5 percentage points lower for those with one child,
because of differences in the slope of the phase-out rate (the phase-out
rate is steeper for those with more children, as documented in Table 2).
As households go beyond EITC eligibility, the marginal income tax
schedule does not vary with the number of children. Once again, these
households experience significant reductions in their marginal tax rates
as soon as they are ineligible for the EITC.
In the last panel of Figure 3, the income tax schedule is quite
different for those with no children compared to those with children.
Recall that the EITC is much less generous for childless households.
Thus, the negative marginal rates are quite low (in absolute value
terms) for the poorest households. Also notice that the increases in the
marginal rates are not as extreme for childless singles; as a result,
these households do not experience significant reductions in their
marginal tax rates as they become ineligible for the EITC (for incomes
above $15,800 for married households). Beyond EITC eligibility, they
face the same marginal income tax rates as households with children.
Our analysis of the marginal income tax schedule for EITC
recipients uncovers a few interesting points. First, the very poorest
households with children (those earning below $12,000) experience large
negative income tax rates (in absolute value terms) because of the EITC.
Second, single parent households that receive the EITC face some of the
highest (positive) marginal income tax rates in the United States
(Ellwood and Liebman 2000); for example, a single mother with two
children earning $35,000 pays a marginal income tax rate of 36 percent
(in 2008). These high marginal tax rates can be attributed to the
phasing out of the EITC and the progressive income tax schedule (Romich
2006). Married households with children face slightly lower marginal tax
rates than single households with children. Third, once households with
children no longer qualify for the EITC, their marginal income tax rates
drop significantly, and once they surpass EITC eligibility, marginal
income tax rates no longer depend on the number of children in the
household.
6. LABOR SUPPLY RESPONSE TO EITC
As a wage subsidy, the EITC has the potential to affect both the
decision to work (i.e., the extensive margin) and the number of hours
worked (the intensive margin). In a static labor-leisure model, the EITC
increases the marginal value of working (i.e., the after-tax wage rate).
Thus, in theory, the EITC will increase labor market participation
because of the substitution of work for leisure. However, the effects of
the EITC on hours worked are theoretically ambiguous. We follow the
formulation in Eissa and Hoynes (2009) in extending the labor-leisure
model to include the EITC.
Consider a representative household within the traditional
labor-leisure model, where the household unit decides how much to work.
The household could constitute one or more workers, where the tradeoff
to working is household leisure. The budget constraint (without the
EITC) is depicted by: c = [~.w] * n, where c represents consumption,
[~.w] represents after-tax wages, and n represents labor hours.
Households have T units of time to devote to labor (n) and leisure (l);
T = n + l. The slope of the budget constraint, and hence the cost of
pursuing an additional unit of leisure, is [~.w] units of consumption.
In Figure 4a, we plot the budget constraint with leisure on the x-axis
and consumption on the y-axis ([BL.sub.A]). Plotting an indifference
curve on this graph (with all of the standard assumptions for utility)
provides the equilibrium quantity of leisure ([l.sub.A]) and consumption
([c.sub.A]), at point A. If after-tax wages rise because of a reduction
in the marginal income tax rate, the budget line gets steeper (rotates
to [BL.sub.B]). For the same household, the equilibrium quantity of
leisure/labor may rise or fall because of the tax cut. The substitution
effect reduces leisure, and hence raises labor supply. The income effect
raises leisure and lowers labor. The net effect depends on the relative
size of each effect. In the diagram, the income effect dominates such
that labor supply falls (leisure increases) in response to a tax cut
([l.sub.B] > [l.sub.A]).
[FIGURE 4 OMITTED]
The EITC changes the after-tax wage rate ([~.w]) for different
levels of leisure/labor. For low levels of labor, when the household
receives a tax credit (i.e., a negative tax) for each additional unit of
labor, the after-tax wage is [~.w] = w (1 + [t.sub.s]), where [t.sub.s]
> 0 is the phase-in rate. For higher levels of labor in the plateau
region, the after-tax wage is simply w since the EITC is constant in
this range; that is, [~.w] = w where households receive a transfer, Tr.
During the phase-out region, the after-tax wage is [~.w] = w (1 -
[t.sub.p]); the EITC falls for each additional unit of labor at the rate
[t.sub.p] > 0. For very high levels of labor, the after-tax wage
returns to w once again. Thus, the budget constraint is as follows: c =
w (1 + [[tau].sub.p]) * n for n [member of] (0, [n.sub.1]); c = w * n +
Tr for n [member of] [[n.sub.1], [n.sub.2]); c = w (1 - [t.sub.s]) * n
for n [member of] [[n.sub.2], [n.sub.3]); c = w * n for n [member of]
[[n.sub.3], T); where Tr is the maximum EITC and [n.sub.i] represents
different quantities of labor. The EITC budget constraint, as plotted in
Figure 4b, is kinked at each quantity of labor [n.sub.i] in which [~.w]
changes.
By comparing the budget constraint with and without the EITC in the
various ranges of labor supply, we can determine the theoretical effects
of the EITC on hours worked. First notice that for households that do
not work (l = T), the EITC is 0 and has no effect on the
household's budget constraint. However, for those households that
choose to work very little (i.e., n = [epsilon], where [epsilon] [member
of] (0, [n.sub.1])), the slope of the budget line gets steeper. Here,
there is a positive substitution effect and no income effect. Thus, the
EITC may influence some households to enter the labor force, leading to
a positive effect on the extensive margin.
However, the effects of the EITC on the intensive margin are more
complicated. In the phase-in range, the slope of the budget constraint
is higher with the EITC ([~.w] > w since [t.sub.s] > 0); thus, a
negative income effect and a positive substitution effect are both at
play, making the effects on hours worked ambiguous. Those in the plateau
region receive the same amount of credit if they earn more income, and
hence a pure income effect occurs in which higher income reduces the
incentive to work. In the phase-out range, the slope of the budget
constraint is flatter than without the EITC ([~.w] < w since
[t.sub.p] > 0). Here, a negative substitution effect influences
households to substitute leisure for hours worked. In addition, a
negative income effect may reduce hours worked even more. Thus,
households in the phase-out region unambiguously reduce hours worked.
Since a majority of EITC recipient households fall in the flat or
phase-out region, it is likely that the overall effects of the EITC on
hours worked are negative (Hotz and Scholz 2003). For those with income
beyond the phase-out region (n [member of] [[n.sub.3], T)), their return
to an additional hour of work is w, so that some of them may choose to
restrict labor hours to be eligible for the EITC, once again leading to
a negative extensive margin effect.
Of course, the magnitude of these responses depends on the
elasticities of labor supply. High elasticities lead to larger labor
supply responses, and labor supply elasticities vary across different
types of people. For example, the uncompensated elasticity of labor
supply is higher for women than for men and the elasticity on labor
force participation is larger than the elasticity of hours (Evers,
Mooij, and Van Vuuren 2008). Thus, the quantitative effects of the EITC
on both the extensive and intensive margins of labor supply decisions
depend critically on the presumed elasticities of labor supply.
There is a large empirical literature that examines the effects of
the EITC on labor supply, with most of the work focusing on single
mothers. For a more detailed summary of this literature, refer to Holt
(2006) and Hotz and Scholz (2003). The evidence indicates that the EITC
does in fact increase labor force participation, especially for single
mothers (Meyer 2001), leading to positive effects on the extensive
margin. In fact, the EITC has led to a dramatic increase in employment
rates for single mothers during the 1980s and 1990s (Eissa and Leibman
1996; Meyer 2001; Grogger 2004). However, the effects of the EITC on the
intensive margin are less clear in the data, with most studies not
finding a significant change in hours worked because of the EITC. The
most relevant work here is that of Cancian and Levinson (2005), who
study a natural experiment arising from the fact that one U.S. state
(Wisconsin) altered the generosity of its matching of the federal EITC.
They argue that there is essentially zero effect on hours. There is some
evidence, however, suggesting that single mothers may work more in
response to the EITC since they are likely to be in the phase-in region
where marginal income tax rates are negative (Eissa and Liebman 1996).
Married women, however, who typically fall in the phase-out range, may
work fewer hours as a result of the EITC rates (Ellwood 2000; Eissa and
Hoynes 2004).
Very few studies analyze the labor market effects of the EITC on
married couples; notable exceptions include Eissa and Hoynes (2004,
2009). They find that the EITC has small negative effects on both the
extensive and intensive margins for married couples. However, the EITC
has differential effects on primary and secondary earners. For example,
increases in the EITC lower both the participation rates and hours
worked for secondary earners since these households are usually being
phased out of the EITC, where the returns to working more are relatively
low.
There seems to be some consensus in the empirical literature that
the EITC has positive effects on the extensive margin for households and
little to no effect on the intensive margin. Studies have shown that the
labor supply of low-income households is generally unresponsive to high
marginal tax rates (Keane and Moffitt 1998; Gruber and Saez 2002); this
compares to high-income workers who are quite responsive to tax rates.
Perhaps low-income workers cannot adjust their work hours because of
their job structure (Romich 2006). Or perhaps these workers do not
realize the high marginal tax rates because of the complexity of the
income tax and benefits structure in the United States. Recent
theoretical work in a separate but related context suggests that a
central force may be that low-income households are typically low-wealth
households. As a result, these households will often be close to a
borrowing constraint. Consumption theory predicts that such households
will work in a manner insensitive to current wages, as the value of
lowering the likelihood of a binding borrowing limit (by working and
reducing consumption) will be high. The work of Pijoan-Mas (2006)
suggests that this may be exactly the case, as he is able to rationalize
a relatively high willingness of households to substitute labor
intertemporally, with a low aggregate correlation between wages and
hours. In ongoing work, Athreya, Reilly, and Simpson (2010) utilize this
insight and embed households into a setting in which they face
uninsurable risks and liquidity constraints, and find that, indeed, the
disincentives to labor supply arising from the EITC are not strong.
7. WEALTH DISTRIBUTION OF EITC RECIPIENTS
As documented above, EITC recipients earn much less over their
lifetimes than the general population. This will have important effects
on their wealth holdings. In addition, their wealth level may affect
their labor supply decision, as discussed above. In this section, we use
the 2007 SCF to compare the distribution of wealth for EITC recipients
and non-recipients, and then analyze differences across the six
different types of households. Wealth is defined as household net worth,
which is the difference between total assets and total debt.9 The SCF
does not report anything related to the EITC. However, we calculate the
imputed EITC level that households would have received in tax year 2006
using the household structure and wage/salary income reported by the
SCF. That is, we feed the parameters of the federal EITC program into
the SCF to generate a proxy for the amount of EITC each household is
eligible to receive. However, it should be made clear that we cannot
observe directly if each household received the EITC--we know only
whether or not they qualified for the EITC and, if they qualified, how
much EITC they should have received.
All of the usual caveats apply when using the SCF data, in that it
is a small sample and is not representative of the U.S. population at
large. Our sample of the 2007 SCF contains 3,458 households compared to
86,259 households in the 2008 CPS (recall that we restrict the analysis
to household heads between 16 and 64 years old and use the
individual-level data in the CPS to create household-level
observations). It is well-known that the SCF over-samples wealthy and
married households. For example, when comparing the distribution of
household types between the CPS (reported in Table 4b) and the SCF (in
Table 5b), it is evident that married households are oversampled in the
SCF compared to the CPS and that single households are undersampled (and
especially childless singles and single parents with one child).
Surprisingly, the SCF just slightly oversamples households that are
eligible for the EITC; they represent 12.8 percent of the CPS sample and
16.4 percent of the SCF sample. Also, the SCF does surprising well in
capturing an accurate distribution of EITC recipients across household
types and their mean income and EITC levels, compared to the CPS. This
provides support to our use of the SCF to analyze EITC recipients. All
of the reported means are reported in 2007 dollars and are weighted
using the replicate weights produced by the SCF. (10)
Table 5 Balance Sheets of EITC Recipients and Non-Recipients
5a: Assets, Debt, and Net Worth of EITC Recipient vs. Non-Recipient
Households
All Married, No Married. Married,
Kids One Kid Two+ Kids
EITC Recipients:
Mean Net Worth $103,753 $284,403 $204,918 $118,468
Mean Assets $149,507 $359,963 $255,239 $179,050
Mean Debt $45,755 $75,560 $50,321 $60,582
Mean Household Income $17,593 $6,199 $21,818 $22,502
Mean (Imputed) EITC $1,778 $231 $1,440 $2,409
Mean Age 38.5 46.6 37.2 37.5
Non-EITC Recipients:
Mean Net Worth $580,245 $803,447 $621,345 $737,654
Mean Assets $708,564 $929,270 $790,176 $933,762
Mean Debt $128,319 $125,823 $168,830 $196,108
Mean Household Income $76,686 $87,916 $95,962 $105,640
Mean Age 44.3 46.9 43.6 41.3
Single, No Kids Single, Single,
One Kid Two+ Kids
EITC Recipients:
Mean Net Worth $67,574 $56,102 $49,837
Mean Assets $86,545 $89,365 $96,465
Mean Debt $18,971 $33,263 $46,628
Mean Household Income $6,990 $18,903 $19,070
Mean (Imputed) EITC $277 $1,720 $2,726
Mean Age 37.1 40.4 38.1
Non-EITC Recipients:
Mean Net Worth $275,437 $351,416 $223,309
Mean Assets $334,930 $448,206 $296,280
Mean Debt $59,493 $96,790 $72,971
Mean Household Income $38,071 $50,373 $35,849
Mean Age 44.8 47.2 41.5
5b: Distribution of Households in the SCF
Married, Married, Married, Single,
No Kids One Kid Two+ No Kids
Kids
EITC Recipients:
Percent of All Households 0.97% 2.20% 4.88% 2.53%
Percent of EITC Recipients 5.9% 13.4% 29.7% 15.4%
Non-EITC Recipients
Percent of All Households 25.47% 12.66% 22.68% 17.42%
Percent of Non-EITC 30.47% 15.15% 27.13% 20.84%
Recipients
Single, Single, Sum
One Kid Two+ Kids
EITC Recipients:
Percent of All Households 2.46% 3.38% 16.42%
Percent of EITC Recipients 15.0% 20.6% 100.00%
Non-EITC Recipients
Percent of All Households 2.83% 2.52% 83.58%
Percent of Non-EITC Recipients 3.39% 3.02% 100.00%
Source: Authors' calculations using the 2007 SCF.
Means
are weighted, in 2007 $.
In Table 5a, we report mean net worth (i.e., wealth), assets, debt,
and income across household types. Not surprisingly, households that
qualify for the EITC have much less net worth, assets, and debt than
non-recipient households, and the difference is astounding. Mean net
worth of EITC recipients is $103,753 (in 2007 dollars) compared to
$580,245 for non-recipients. Some of the difference in net worth between
EITC and non-EITC recipients can be explained by differences in income
and age: EITC recipients earn 23 percent of what non-recipients earn, on
average, and are almost six years younger. Somewhat interesting is that
mean debt level for EITC recipients is $45,755, which represents 2.6
times their annual salary, compared to non-recipients whose
debt-to-income ratio is approximately 1.7. Thus, debt-to-income ratios
are quite high for households that qualify for the EITC.
In Table 6, we report mean wealth by quartiles for both EITC and
non-EITC recipients. First, notice that households in the lowest
quartile of EITC recipients have average negative wealth of--$16,617. In
fact, 18.4 percent of households in the EITC sample have negative net
worth. However, there is a significant amount of heterogeneity in the
first quartile, as evidenced by the large standard deviation. This
compares to the lowest quartile of non-EITC recipients, whose mean
wealth level is $1,899 and standard deviation is $324. Second, notice
that the wealth distribution for EITC recipients is much tighter than
for non-recipients. The ranges of wealth in each quartile are much
smaller and the standard deviations are generally lower (with the
exception of the first quartile of EITC recipients). Third, the majority
of EITC recipients hold very little wealth; those in the third quartile
of wealth hold on average only $24,038 in net worth, compared to
non-recipients in the third quartile who hold more than $250,000. Only
the top quartile of EITC recipients has a significant amount of wealth.
In fact, only 20.3 percent of EITC recipients hold more than the average
wealth level for EITC recipients ($103,753). This compares to
non-recipients, where 41 percent hold more than the average wealth level
of $580,245 and 69 percent have more wealth than the average EITC
recipient.
Table 6 Wealth Distributions: EITC Recipients vs. Non-Recipients
Mean St. Dev. Min.
EITC Recipients:
Bottom Quartile -$16,617 $1,860 -$473,700
Lower Middle Quartile $3,489 $85 $190
Upper Middle Quartile $24,038 $531 $7,630
Upper Quartile $404,272 $24,215 $52,120
Non-EITC Recipients:
Bottom Quartile $1,899 $324 -$118,999
Lower Middle Quartile $75,329 $697 $24,130
Upper Middle Quartile $253,637 $1,467 $141,520
Upper Quartile $1,991,197 $33,646 $396,300
Max. Mean Income Mean Age
EITC Recipients:
Bottom Quartile $170 $14,938 34.0
Lower Middle Quartile $7,560 $15,919 33.7
Upper Middle Quartile $51,400 $20,507 38.6
Upper Quartile $615,000,000 $19,014 47.7
Non-EITC Recipients:
Bottom Quartile $24,120 $34,055 37.9
Lower Middle Quartile $141,500 $51,829 42.6
Upper Middle Quartile $396,210 $76,599 46.5
Upper Quartile $806,000,000 $144,308 50.4
Source: Authors' calculations using the 2007 SCF.
Means are weighted, in 2007 dollars.
There is significant variation in wealth across household types, as
illustrated in Table 5a. Married households have three times as much
wealth as single households, with the largest difference for households
with no children. It is likely that most of the wealth held by married
households with no children is comprised of housing wealth since this
group is relatively old. In addition, mean household wealth is smaller
for households with more children despite higher earnings, and this
effect is particularly large for married households. Thus, mean wealth
levels for single households are quite low but are not that different
for those with and without children. For married households, households
with children have higher earnings but significantly less wealth
compared to those without children. This is partially explained by age
differences across married households--those without children are
approximately nine years older than those with children. In addition,
single households without children earn the least income of any group,
but are not the poorest type of household in terms of net worth. Single
households with two or more children have the lowest net worth in both
the EITC and non-recipient samples.
Our analysis documents several interesting findings about the
wealth holdings of EITC recipients. Not surprisingly, we find that EITC
recipients hold very little wealth: EITC recipients, on average, hold
only one-fifth of the wealth of non-EITC recipients. In fact, the bottom
quartile of EITC recipients hold negative wealth on average, while the
bottom quartile of non-recipient households have small, positive wealth
holdings. However, debt-to-income ratios of EITC households are
significantly higher than those of non-recipients (2.6 compared to 1.7
on average). We find that married households that are eligible for the
EITC hold more wealth than single households, and wealth holdings
decrease with the number of children in the household.
8. EITC AND CREDIT CONSTRAINTS
Based on the data presented in Figure 2b, the EITC increases
earnings for recipients during every year of their working life and more
so in early life. In a typical lifecycle model of savings and
consumption, a household would save in periods when income is high, and
borrow when income is low. As a result, the EITC allows low-income
families to smooth consumption over their lifetimes. At higher
frequencies, such as within a given year, the EITC can help, even though
most families receive the EITC in lump sum when they file their tax
returns. (11) In addition, households may borrow against their EITC,
knowing that they will be receiving it later. Alternatively, households
may save their EITC for future consumption.
The ability of households to smooth (bring forward) an expected
EITC lump-sum payment that is made at the time of one's annual
income tax payment depends on the household's ability to borrow.
For those who can borrow, the EITC may act as insurance against income,
employment, or health shocks, for example. If, on the other hand,
households face significant borrowing constraints, they may not be able
to borrow against their EITC, and so, while the EITC still provides low
frequency smoothing, it may not assist consumption smoothing efforts
within shorter periods, for example one calendar year.
Direct evidence on the extent to which EITC recipients are credit
constrained is not possible, given current data limitations. Moreover,
credit constraints are generally very difficult to identify. Typically,
the measurement of credit constraints in any given study relies on a
particular theory of consumption to identify consumption or savings
movements that appear "anomalous," such as the large
"excess sensitivity" literature on the 1980s for the path of
aggregate consumption (see Deaton 1992). A handful of articles find
evidence that suggests that those who share demographic characteristics
with the EITC recipients are likely to be credit constrained. For
example, the results of Jappelli (1990) indicate that lower income,
wealth, and age are all associated with higher likelihoods of being
credit constrained, all key features of the EITC population as
documented above. Souleles (1999) finds that households that receive tax
refunds and are liquidity constrained experience significant increases
in nondurable consumption at the time of refund receipt. Barrow and
McGranahan (2000) discover a seasonality of consumption behavior that is
consistent with the timing of the receipt of the EITC, especially for
durable goods. Berube et al. (2002) discuss the proliferation of paid
tax preparation services and refund loans (at relatively high interest
rates) for EITC recipients, suggesting that these households lack
financial services and, hence, access to credit. Finally, Elliehausen
(2005) analyzes survey data from households that use refund anticipation
loans (RALs). He finds that EITC recipients who use RALs are less likely
to use various types of credit (including car loans, bank and retail
credit cards, and mortgages) than other RAL households. In addition,
Elliehausen (2005, 52) reports that:
Nearly half of EITC recipients that obtained RALs reported being
turned down or limited by a lender in the last five years, and a
little more than half said that they had thought about applying
for credit but did not because they thought that they would have
been turned down. These percentages are more than two times the
percentage of all households experiencing turndowns or
limitations and more than three times the percentage of all
households perceiving limitations in credit availability.
However, no study has provided direct evidence of the extent to
which ETTC recipients are credit constrained.
Using 2007 SCF data and following Jappelli (1990), we use a set of
questions from the SCF that provide a sense of the severity of credit
constraints that EITC recipient households face. We use the following
four measures:
1. Bad credit: For households that do not have a checking account,
the SCF asked why. If the response was because of credit problems,
bankruptcy, and/or does not meet qualifications for an account, then a
value of 1 was assigned.
2. Credit card balances: This is the total value of credit card
balances held by households. Credit card balances consist of the amount
outstanding on all credit cards and revolving store accounts after the
last payment. Balances do not include purchases made since the last
account statement.
3. Late payment for 60+ days: This was assigned a value of 1 if the
household had any debt payments more than 60 days past due in the last
year.
4. Has no checking account: This was assigned a value of 1 if the
household did not have a checking account.
Certainly, these four measures are not perfect predictors of being
credit constrained. For example, some households choose not to have a
checking account for reasons that are unrelated to their credit status.
However, not having a checking account will undoubtedly lead them to
have less access to credit in the future; without a checking account,
many banks are not willing to issue personal loans and/or mortgages.
That is, the causality between these measures and the likelihood of
being credit constrained is unclear; however, if we find some
correlation between these measures and the EITC, it may shed some light
on the extent to which EITC households are or will be able to borrow.
Similarly, credit card balances are an imperfect measure of credit
constraints; lower balances may imply less willingness to use credit
cards and/or acquire debt, and not less ability to borrow. But it may
also indicate that they have lower credit limits, suggesting tighter
borrowing constraints. Of the four measures above, having bad credit and
late payments are perhaps the most accurate measures of credit
constraints since both will lead to lower credit scores and, hence,
worse credit terms.
In the analysis that follows, we compare these four measures for
households that receive the EITC versus non-recipient households. As we
document in Section 1, EITC-recipient households are younger, less
educated, and have more children than non-recipient households; as a
result, they are poorer. Obviously, having fewer current and,
especially, future resources to borrow against will make it more
difficult for EITC-recipient households to borrow. Nonetheless, it is
useful to know the extent to which any household is likely to be
constrained as suggested by the criteria above. We therefore do not
condition on all possible household characteristics since they would
likely explain away any differences between EITC recipients and
non-recipients. Instead, we attempt to document the extent to which
households that fit the EITC profile face borrowing constraints.
In Table 7, we report the means and standard deviations of these
four measures for EITC recipients, non-recipients, and across household
types. (Recall that EITC recipients in this context are defined as those
who qualify for the EITC.) EITC recipient households report being denied
a checking account because of bad credit more frequently than
non-recipients (2.3 percent versus 0.5 percent for non-recipients). They
also have lower credit card balances ($2,131 compared to $4,174); this
could indicate that these households have lower credit limits, or are
less willing to use acquire debt, or are less willing to use credit
cards. EITC households are twice as likely to have late debt payments as
non-recipients (11.2 percent compared to 5.4 percent), which would lead
to having less access to credit. In addition, EITC households are three
times more likely to not have a checking account (28 percent versus 7
percent).
Table 7 Measures of Being Credit Constrained
7a: Measures of Being Credit Constrained: EITC Recipients vs.
Non-Recipients
Mean St. Dev.
EITC Recipients:
Bad Credit 2.3% 0.3%
Credit Card Balance (2007$) $2,131 $140
Late Payment for 60+ Days 11.2% 0.6%
Has No Checking Account 27.9% 0.9%
Non-EITC Recipients:
Bad Credit 0.5% 0.1%
Credit Card Balance (2007$) $4,174 $91
Late Payment for 60+ Days 5.4% 0.2%
Has No Checking Account 7.0% 0.3%
7b: Measures of Being Credit Constrained by Household
Type
Married, Married, Married, Two+
No Kids One Kid Kids
EITC Recipients:
Bad Credit 0.0% 0.0% 2.2%
Credit Card Balance (2007S) $2,541 $2,966 $2,092
Late Payment for 60+ Days 1.9% 13.6% 13.1%
Has No Checking Account 28.7% 25.6% 25.7%
Non-EITC Recipients:
Bad Credit 0.2% 0.3% 0.0%
Credit Card Balance (2007$) $4,497 $4,946 $5,502
Late Payment for 60+ Days 3.7% 3.9% 5.3%
Has No Checking Account 5.0% 4.1% 2.1%
Single, No Kids Single, Single,
One Kid Two+ Kids
EITC Recipients:
Bad Credit 3.0% 3.3% 3.1%
Credit Card Balance (2007S) $2,419 $1,456 $1,933
Late Payment for 60+ Days 7.0% 10.8% 13.5%
Has No Checking Account 31.6% 27.3% 29.3%
Non-EITC Recipients:
Bad Credit 1.3% 0.0% 1.3%
Credit Card Balance (2007$) $2,693 $3,509 $1,401
Late Payment for 60+ Days 6.5% 11.7% 8.5%
Has No Checking Account 11.7% 13.2% 25.7%
Source: Authors' calculations using the 2007 SCF. Means
are weighted.
When looking across households types, we can see that several
interesting facts emerge. First, single households have lower credit
card balances; they are generally more likely to have late payments; and
they are less likely to have a checking account than married households
(holding constant the number of children). However, the differences
between single and married households are larger for non-recipients than
for EITC recipients. For example, married households have much larger
credit card balances than single households in the non-EITC sample, but
the difference is smaller for married and single EITC recipients.
Second, married households with children that qualify for the EITC
report very high late payment frequencies compared to their
non-recipient counterparts. Approximately 13 percent of married
households with one child have a late repayment, compared to just 5
percent of non-recipients. We do not observe significant differences
between single-parent EITC recipients and non-recipients. Thus, EITC
recipient households that are married with children will undoubtedly
have worse credit statuses and lower borrowing limits than their
non-recipient counterparts.
Third, for married households, credit does not seem to be more
restricted for those with more children. However, single households seem
to be more credit constrained as the number of children increases, and
this is true for both EITC recipients and non-recipients. As documented
above, the net worth of single households falls as the number of
children increases (from Table 5a).
Our analysis suggests that EITC recipients use credit markets
differently than non-recipients, possibly as a direct consequence of
their income being currently and perhaps temporarily low, and this may
have important implications on their ability to borrow. For example,
EITC recipients are less likely to have a checking account and have
lower credit card balances. They also more frequently have late debt
repayments and are denied checking accounts than non-EITC recipients.
Thus, it seems that at the time of receipt of the EITC, households are
closer to limits on their ability to borrow than households that do not
receive the EITC, and much of this is because of differences in income
and household structure between the two groups.
9. CONCLUSION
In this article, we have studied several aspects of the Earned
Income Tax Credit (EITC) that have been previously overlooked, including
the income of EITC recipients at various ages, their wealth holdings,
and the extent to which they are credit constrained. Naturally, we find
that average annual earnings for those who receive the EITC are much
lower than for non-EITC recipients at every age. In addition, younger
households receive more EITC, and the amount of EITC received by these
households suggests that the EITC increases lifetime earnings
non-negligibly. The EITC in all likelihood provides a nontrivial
mechanism for young, working households to smooth their consumption over
their lifetimes.
The EITC acts as a negative income tax for recipient households.
Specifically, we show that it has important implications on the marginal
tax rate that low-income households face at various levels of earned
income. Because of the phasing out of tax credits and income-support
programs (such as TANF, food stamps, etc.), marginal income tax rates
are much higher for low-income households than for middle- and
high-income households in the United States. In particular, the marginal
tax rate is negative for low levels of income, very high for those with
moderate incomes that still qualify for the EITC, and then falls once
households no longer qualify. We find that single-parent households that
receive the EITC face some of the highest marginal income tax rates in
the United States.
We then consider the theoretical and empirical effects of the EITC
on the extensive and intensive margins of household labor supply. The
EITC has undoubtedly increased labor force participation, but the
effects on hours worked are ambiguous. This can be partly explained by
the fact that low-income/low-wealth households that face borrowing
constraints are insensitive to changes in the returns to working.
Existing empirical work supports this conclusion.
Lastly, using data from the Survey of Consumer Finances, we
estimate the wealth distribution of EITC households and measure the
extent to which EITC households are credit constrained. Not
surprisingly, we find that EITC-recipient households are very poor in
terms of net worth: The average household has less than 20 percent of
the average wealth of the average non-recipient household. In addition,
EITC recipients are more likely to have bad credit and are more likely
to have late debt payments than the average U.S. household, suggesting
that they are more credit constrained.
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(1) Center on Budget and Policy Priorities:
www.cbpp.org/cms/?fa=view&id=2505.
(2) For a more detailed history of the EITC, refer to Hotz and
Scholz (2003).
(3) Tax Policy Center (2009).
(4) Many of the poorest families are ineligible for the EITC since
their earnings are too low to qualify and/or they do not have children
(Hoffman and Seidman 2002).
(5) www.nber.orgrtaxsitn/taxsim-calc9/index.html.
(6) We follow the methodology of Hotz and Scholz (2003), Romich
(2006). and Eissa and Hoynes (2009) in generating the marginal tax rate
schedule.
(7) Marginal tax rates in the United States increase up to 35
percent for household incomes up to $357,000 (in 2008). However, we
focus on income tax rates for low- and middle-income households.
(8) If we were to include FICA contributions, the entire marginal
lax curve would shift upward by 7.65 percentage points across all income
levels.
(9) We use the SCF definition of net worth, as used in various
Federal Reserve Bulletin articles, including Bucks et al. (2009).
(10) For a full discussion of the importance of weights in the SCF,
refer to Kennickell (1999).
(11) The advance EITC allows them to receive their EITC throughout
the year in their paycheck, but very few households participate in this
option (Romich and Weisner 2000).
Athreya is a senior economist at the Federal Reserve Bank of
Richmond. Reilly is a former research associate at the Federal Reserve
Bank of Richmond. Simpson is an associate professor of economics at
Colgate University. The views expressed in this article are those of the
authors and not necessarily those of the Federal Reserve Bank of
Richmond or the Federal Reserve System. E-mails:
kartik.athreya@rich.frb.org; nsimpson@colgate.edu.
