Can The Earned Income Tax Credit (Mostly) Pay For Itself?

The most obvious reason for the Earned Income Tax Credit is to raise the level of household income for poor and near-poor workers. A secondary reason is to encourage such workers to enter the workforce and remain connected to jobs. But there's another potential benefit as well. Jacob Bastian Katherine Michelmore consider "The Long-Term Impact of the Earned Income Tax Credit on Children’ s Education and Employment Outcomes" (Journal of Labor Economics, October 2018, pp. 1127-1160, ungated version here). It suggests that the EITC can be viewed not just a transfer of income, but also as an investment in human capital with a corresponding payoff.

A lot of economists and policy wonks, myself included, are enamored of the EITC as a way of helping low-wage workers. Unlike raising the minimum wage, it doesn't risk the potential unwanted side effects of telling employers to pay more. At a more subtle level, it's designed so that those who work more don't immediately have the benefit clawed back from them. Here's a useful figure from the Tax Policy Center to illustrate the structure. The different lines show families with different numbers of children. Thus, the top line shows that a worker in a family with three children would receive a payment equal to 45% of earnings up to a total income of $14,290, for a total credit of $6,431. That total credit stays fixed as income rises to $18,660, and then phases more slowly, with a loss of 21.06% of the credit for each dollar earned until the credit is eliminated at total earnings of $49,104.

It's easy to spot some potential difficulties with the EITC. The small line at the bottom shows that it provides very little benefit for those without children. The tax credit is "refundable," which means that it doesn't just reduce the tax liability of low-wage workers to zero, but provides direct payments to the payments. The slow phase-out of the subsidy means that the payments don't only go to the poor, but also to those above the official poverty line. The total cost of the EITC is more than $60 billion (which is about twice the cost of the Temporary Assistance to Needy Families "welfare" program). It adds complexity to the tax returns of low-wage workers, and there can be problems of fraud (for example, if the number of children actually living with someone is overstated).

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