EITC: Mulligan (economic theory) vs. Seto (empirical evidence)

by Linda Beale
EITC: Mulligan (economic theory) vs. Seto (empirical evidence)

TaxProf today noted the article in the New York Times about the EITC: Casey Mulligan, Do Tax Credits Encourage Work? New York Times ( 2012). Mulligan, an econ prof at the University of Chicago (home, of course, to Milt Friedman’s “free” market theories) noted that the EITC “could” discourage work.

The earned-income tax credit is often said to encourage work, but it may do just the opposite. …
The chart below shows the credit’s schedules for the 2011 tax year as a function of annual earned income for a given family situation (other family situations have the same basic shape). The schedule shown illustrates [a] mountain-plateau pattern … an increasing portion for the lowest incomes, a flat portion, a decreasing portion and then finally a flat portion of zero.

… For the same reasons that the credit encourages more work among people who might otherwise earn close to zero during a year, it can also influence some people to work less — those with earnings at or slightly above the downward-sloping or “phase-out” portion of the schedule, where people lose about 20 cents of their credit for every additional dollar earned during a year. In other words, for households on the downward-sloping portion of the earned-income tax credit schedule, the credit acts as an extra 20% tax on the income they earn in that range. The work-encouraging potential of the credit occurs only on the upward-sloping portion. … [emphasis added]

Now, Mulligan surely knows that this theory about whether the credit encourages or discourages work is just that–a theory. Much of the assumptions about when people will stop working and substitute leisure don’t seem to hold up in practice, partly because there are so many other factors at work besides the rather simplistic assumptions in freshwater economics (such as the joy of working, status of work, self-esteem of work, etc.). Nonetheless, Mulligan can’t help adding another line that makes the overall comment suggest that he thinks the EITC will on the whole discourage work.
[I]t is more common for families to be on the part of the earned-income tax credit where it acts as a tax, rather than a reward to additional work.

Of course, when economists talk, policy makers often listen. This is a good example of when they should say–huh? and get a second opinion. What we should care about as a tax policy matter–which, I remind you, is distinct from what we might care about purely as a question of economic “efficiency”–is whether the EITC will generally work to encourage those who otherwise have tended to be left out of the work force but should be in it and whether the potential negative effect at the drop-off would be likely to be genuinely detrimental to that group or rather impact groups for whom the difference may not matter so much.
Ted Seto, a fellow tax prof in sunny California, commented on the Tax Prof item to point out the important empirical evidence that the EITC is mostly working as we want it to.
For a useful summary of recent empirical work, see Nada Eissa & Hilary W. Hoynes, Behavioral Responses to Taxes: Lessons from the EITC and Labor Supply, published in 2006 by NBER…

“The overwhelming finding of the empirical literature is that EITC has been especially successful at encouraging the employment of single parents, especially mothers. There is little evidence, however, that the EITC has reduced the hours worked by those already in the labor force. The empirical literature on married women is somewhat smaller but again consistent in its findings. The studies show that the EITC leads to modest reductions in the employment and hours worked of married women.”

The latter problem — the one area identified in which the EITC does seem to have a negative effect on paid work — is not an EITC problem at all. It’s the same secondary worker problem Ed McCaffery has written about, (Taxation and the Family: A Fresh Look at Behavioral Gender Bias in the Code, 41 UCLA LAW REVIEW 983 (1993)), and it affects secondary workers up and down the income range.