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The White House decision to include an expansion of the earned income tax credit in its fiscal 2015 budget proposal added to the growing attention the credit has gained this year as lawmakers and policymakers search for ways to address the country’s widening income gap.
Both Democrats and Republicans see an expansion of the EITC as an important tool, even if they disagree on whether the expanded tax credit would replace or merely complement other actions, such as raising the minimum wage.
But the renewed focus on the credit may shine a spotlight on one of its most perplexing and significant features. Although EITC benefits have attracted praise from both sides of the aisle for their role in nudging people into the workforce, policymakers have given less attention to what happens on the other end, when those benefits are slowly drawn back.
Traditional economic theory suggests that when the government gives vulnerable populations tax credits such as the EITC as an incentive to work, people will respond by getting jobs. That has been borne out by research.
But that thinking also suggests that once an individual’s income starts to rise enough that they are no longer eligible for the tax credit, they will stop wanting to work more hours in order to avoid the tax hit.
In essence then, the EITC risks encouraging people to get jobs, then leaving them in what House Budget Chairman Paul D. Ryan, R-Wis., calls “a poverty trap” as “the federal government effectively discourages them from making more money.”
That’s the classic criticism of many federal anti-poverty programs: that beneficiaries will not want to risk losing the benefits for the marginal growth in income that comes from moving up the economic ladder.
And yet, in the case of the EITC it doesn’t seem to work out like that, at least not in a uniform, predictable way. Several studies have found that many people, single mothers in particular, do not change their work hours as their tax credits phase out.
The reasons behind that are still poorly understood. Still, those results could hold a lesson for other government subsidy programs, including the 2010 health care overhaul (PL 111-148, PL 111-152).
The Congressional Budget Office nodded to the issue in its recent report on the labor impact of the health care law, saying the availability of health coverage outside the workplace would encourage some workers to limit their hours or withdraw entirely from the workforce, leading to tighter labor supply.