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.
http://ataxingmatter.blogs.com/tax/2012/05/eitc-mulligan-economic-theory-vs-seto-empirical-evidence.html
“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.”
You just had to get that in, didn’t you? The sneer at Uncle Milt?
‘Fraid it doesn’t work: the EITC was in fact Uncle Milt’s idea.
Don’t you think you should know these things before writing about them?
As to Mulligan’s basic point: the EITC is, as it’s intended to be, a negative income tax on low incomes from working. It encourages people into work as you can see: Hurrah! Incentives work and tax rates matter!
That high marginal tax rates, such as the EITC withdrawl, act as disincentives is not eactly a hugely surprising thought…..
Tim
but doesn’t Muligan’s thesis that on the downslope EITC acts as “a 20% tax and so discourages work” strike you as absurd?
that it is not a “hugely surprising thought” just testifies to the power of propaganda over common sense.
I can tell you that no real human being is ever discouraged from taking a dollar for working because he will lose twenty cents worth of welfare.
and if you know anyone who is so rich that “high marginal tax rates” such as the EITC?? acts as a disincentive, i say fine. let the poor boy sit on his hands. i can find someone else who will be glad to do the work.
a saner way to think about this is forget about the pre-tax income, look at the after tax income: “am I willing to do this for that much money?” if yes, go ahead. don’t worry about the taxes. if no, then don’t. either someone else will, or the price will go up, or it isn’t worth doing.
i guarantee no worker ever thinks about “will this reduce my EITC” when he considers working harder or longer or getting a better job.
if there is anything wrong with EITC it is that it subsidizes bosses who pay too-low wages.
but Worstall would never see it that way.
I think, as Linda notes with the second study, that the only people who have the “luxury” of the option of deciding they don’t need that extra penny would the EITC have the effect Mulligan implies.
I don’t know or anyone, even a couple who with a total income of $21K start thinking they will work less.
Miltion et al’s work in total is completely based on the money from money crowd think. Even with that, darn few of the rich stop wanting to make more. If it were true, then the marginal rates of old (my post on the 1936 tax table) would have distroyed the economy do to those at the top not wanting to make any more money.
Idiots!
Becker
not sure about that.
if those millionaires stopped wanting to make more money it could save the country.
If “[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.” is an accurate statement, why aren’t these families working less? Surely they must realize that they are being disincentivized to work more. Or maybe they think that having 80% of more income is better than having 100% of less income. We need a word to describe someone with a negative IQ.
but doesn’t Muligan’s thesis that on the downslope EITC acts as “a 20% tax and so discourages work” strike you as absurd?
No, of course not. There is always a disincentive to a tax.
Might not be important, might be overwhelmed by other effects, sure, all of that is possible.
We can argue about the total effect: but the basic one? Sure a tax is a disincentive.
You’d think a credentialed economist would know the difference between simple “more” (the flat part on top), increasingly more (the ramp on the right) and decreasingly more (the right slope).
In any case, workers get more money for each hour worked. Think that’s an incentive?
So Mulligan has indicated that there should be no reduction in the EITC with increasing income. Any problem with that? 😉
Tim
funny thing happens to me. when they tax my income, i have to go out and make more money.
i think you are confusing the real world with whatever it is you read in the Journal editorial section.
Min
it’s quite true, the less you tax poor people the harder they work. that’s where rich people come from.
funny thing happens to me. when they tax my income, i have to go out and make more money.
That’s the income effect. There is also the substitution effect which is what Mulligan is exploring. We all know that the real world is a combination of these two effects.
But in order to work out which effect predominates at what levels of income/taxation (which is what we actually want to know, what is the balance of these two effects) then we have to explore each separately.
Which is what Mulligan is doing…..
Tim
sometimes i feel bad about being mean to you. but some of the things you say sound like they came out of a can and look ludicrous to someone who sees the world from my perspective and experience.
No one making 20k or 30k is going to think of a reduction in their EITC as a “tax.” They will think they are climbing out of welfare and be glad.
coberly:
It would be called a transfer
Slightly off topic but somewhat relevant yesterday I endured yet another NPR Week in politics conversation between the odious David Brooks and EJ Dionne. Wherein I was treated to this little gem:
Brooks: “…The fundamental fact about education is people learn from people they love, and if you’re not dealing with the individual relationship between a teacher and a student, you’re avoiding the core issue. And I think it’s time for a second generation of education policies that focus on getting really great teachers in there.”
I guess it’s up to the listener to reconcile Brooks desire for “really great teachers” with the apparently equivalent aim of wiping out the teacher’s unions. Maybe the free market fairies will guarantee they get paid for their greatness. Or perhaps that’s one of the sine qua nons of really great teaching – a willingness to work for subsistence wages. Robert Siegel and Dionne weren’t much help as far as I could tell.
Transcript here if you’re up to it: http://www.npr.org/2012/05/25/153723295/week-in-politics-romney-and-obama-on-education
I recommend having strong drink nearby. Or something.
am soc
sadly, the really great teacher that Brooks loved taught “economics.”
run
i don’t understand.
i wanted to add to my ms to Tim, I think that when rich people are disincentivized to work by high taxes, it’s not really the taxes. What it is is that they have enough money so the marginal value of more money is not great enough to incentivize them to “work”. and they also have enough so they can afford to sulk.
as for any poor person who won’t take a ten dollar an hour job because he’d “lose” two dollars an hour worth of tax cuts… well, that’s insanity. poor people can’t afford to be insane.
of course if what he is saying is… for ten dollars i can afford to spend the hour working. but for only eight dollars, i would be better off spending the time selling dope… then maybe Worstall has an argument.
for which we turn to the empirical data…
i’m not sure why the economists don’t look at “working” above the EITC bend point as “taking a higher paying job.”
i suspect the answer is that they have a deep psychological need to see taxes… even “imputed taxes” as a “jobs destroyer.”
Coberly:
Tim proposes a non sequtor in saying people will not work more if they make $21,000 with the ETIC. If you read the other documentation, it takes ~$48,000 for a family of 4 just to get by based upon where they live. If you look at the CHPS program for children, the cutoff is $80 something thousand in New Jersey and quite a bit less (and not below $21,000) in North Dakota. If you are a family of 4, you are screwed in New Jersey and not so screwed in North Dakota.
Tim is full of himself besides other things and is reaching for extremes which is basically Reagan’s Pink Cadillac story. Don’t give him credance by acknowledging his BS.