Does the Earned Income Tax Credit Create Disincentives?
Mickey Kaus thinks so:
Earned Income Tax Credit does send cash to low income earners, but again you need to earn at least some money to get it. And it’s already pretty big. We probably can’t increase it much higher without running into cost and disincentive problems when the credit is phased out in the mid-income ranges (i.e. workers will end up losing–in phases-out EITC payments – a good chunk of any extra dollars they earn).
What is up with Mickey Kaus and Michael Lind as to the EITC issue? Max Sawicky counters:
As for disincentives, there is no empirical evidence of ‘harmful’ effects. The effect in question, boils down to a family with children supplying 50 hours of work a week of 75. Is this really a problem? The impact on full-time labor force participation for the primary earner in a family is unambiguously positive.
EITC is a form of Negative Income Tax, which can be designed to lessen the disincentives to work. As Wikpedia notes:
Under traditional welfare, a dollar-for-dollar decrease of benefits corresponded to an increase in earnings. Standard indifference curve analysis shows that this creates a “spiked” budget constraint of OABC, making it very likely that an individual’s utility maximizing bundle includes no work. The EITC, in contrast to traditional welfare, creates a “smoother” budget constraint of OABCD, making it theoretically much more likely that an individual’s utility-maximizing bundle will include some hours of work.
Wikpedia even provides the graphs displaying their indifference curve analysis.
Speaking of graphs, Max Sawicky provides his graph on the Incidence of the Earned Income Tax Credit. I provide a somewhat different variation of the theme, but the point is still the same – if the elasticity of labor supply is less than the elasticity of labor demand, then most of the benefits from the EITC accrue to workers as the reduction in wage rates (W0 to W1) is modest relative to the size of the subsidy.