Academic journal article Economic Inquiry

Income Mobility and the Earned Income Tax Credit

Academic journal article Economic Inquiry

Income Mobility and the Earned Income Tax Credit

Article excerpt

I. INTRODUCTION

According to the Committee on Ways and Means (1993, 1052) the original purposes of the Earned Income Tax Credit (EITC) were to target tax relief to low-income families with children, offset Social Security taxes to these families, and improve incentives to work. The EITC, which began in 1975 as a minor program, has grown to become a central part of the federal government's antipoverty program. (1) Technically a refundable tax credit, the EITC provides an income transfer to low earning families. (2)

The EITC is made up of three ranges: the phase-in range, the maximum credit range, and the phase-out range. In the phase-in range, the EITC acts as a wage subsidy; as the family earns more the transfer increases. In the maximum credit range, the EITC acts as a lump-sum subsidy; the transfer is the same regardless of earnings. In the phase-out range, the EITC acts as a negative income tax; as the family earns more, the tax credit is reduced. Both lump-sum subsidies and negative income taxes discourage work effort. (3)

The EITC as a whole and especially the wage subsidy in the phase-in range have received wide support from economists. (4) However, the upper limit on the phase in range is so low that it is unlikely that the program has much positive work incentive because most people will end up in either the flat or the phase-out ranges, both of which have work disincentives. (5) For example, a person working full-time at a minimum wage job will earn $10,300 ($5.15 * 40 hrs * 50 weeks), which is more than the 2001 phase-in threshold of $10,020 for families with two or more children.

This article has three purposes. The first is to calculate the dynamics of EITC receipt. Previous studies have not discussed the dynamics of eligibility or receipt for the EITC. (6) Examining the dynamics of participation and eligibility for income transfer programs, such as the EITC, is critical to obtain a full understanding of what the programs do and who they serve. This article helps close this gap.

My second purpose is to determine if the importance of the phase-in range is exaggerated by annual data. Annual data shows that about 27% of EITC recipients are in the phase-in range in a given year. (7) However, as discussed, the upper limit on the phase-in range is so low that most people will end up in the maximum credit or the phase-out range, both of which have work disincentives.

The third purpose of this article is to determine why families move in and out of the EITC. Do families move in and out because of changes in the number of children, changes in family structure (such as the loss or gain of a spouse), or some other reason?

II. CHANGES OVER TIME IN THE EITC PARAMETERS

The parameters used in this article were taken from the Committee on Ways and Means, Overview of Entitlement Programs (1998). Table 1 shows the EITC parameters from 1975 to 2001. (8) As mentioned above, the EITC is made up of three ranges: the phase-in range, the maximum credit range, and the phase-out range. For example, in the 1990 phase-in range, eligible families could have received a wage subsidy of 14% (column [2]) of their earnings up to $6,810 (column [3]). This means that in the phase-in range, when a family earned an extra $1000 they could receive a tax credit of $140 (0.14 * 1000). (9) In the 1990 maximum credit range, families with earnings between $6810 (column [3]) and $10,730 (column [7]) could have received a lump sum-subsidy of $953 (column [5]). (10) In the 1990 phase-out range, the EITC was phased out at a rate of 10% (column [6]) until the benefit was zero at $20,264 (column [8]). (11)

Column (4) of Table 1 shows how much the family would earn if they had one person working full time (2000 hours a year) and earning the minimum wage. If only one spouse earned the minimum wage and worked full-time for a year, the family earned too much to be in the phase-in range. …

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