Aug. 1, 2014 SIGN IN | REGISTER
Roll Call

Expanded EITC May Offer New Lessons in Labor Economics

Bill Clark/CQ Roll Call File Photo
The earned income tax credit is still one of the few government social welfare programs that is popular with both Democrats and Republicans. Rubio is working on legislation in the Senate to alter the program but leave its basic structure intact.

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.

The EITC dates back to the 1970s, when it was enacted during the administration of President Gerald R. Ford. Over the years, it has found support on both sides of the aisle, which prompted expansions of the program in the Reagan and Clinton administrations.

More recently, the 2009 stimulus boosted benefits, which were extended in early 2013 under the fiscal-cliff deal.

Today, the EITC is one of the few government social welfare programs that is still in the good graces of both Democrats and Republicans. In his enumeration of government anti-poverty programs released this week, Ryan singled out the EITC as “an effective tool for encouraging and rewarding work among lower-income individuals, particularly single mothers.”

Sen. Marco Rubio, R-Fla., in a speech on poverty in January, focused on the idea of encouraging people to work, a longtime Republican priority. Rubio is working on legislation to alter the EITC program, but the outline he gave in his speech suggests he would leave its basic structure largely in place.

“We know that by promoting work over dependence, this reform would increase work-force participation in struggling communities and, in turn, would have numerous social, economic and cultural benefits to areas hardest-hit by the Great Recession,” Rubio said.

The remarks drew a relatively warm response from Democrats, a sharp contrast with the usual partisan barbs launched between the parties.

President Barack Obama in his fiscal 2015 budget plan released this week, sought to build on that consensus by calling for a dramatic expansion of the EITC to make it more widely available to childless single people, a step that could bring more men into a program that until now has mostly been targeted at women with children.

“This is a concept that has bipartisan support,” Gene Sperling, a top economic policy adviser to the president, said in a briefing with reporters this week. “And for those who are serious about not just talking the talk, but walking the walk on reducing poverty and helping low-income working families, they should support this.”

Economists have generally found the EITC successful in getting people into the workforce and keeping them out of poverty. That’s not unexpected.

But the studies also found, perhaps surprisingly, that people keep working even as they lose their tax credit when their incomes increase.

“There is overwhelming evidence the EITC encourages work among single mothers but little evidence that eligible-working women adjust their hours of work in response to the EITC,” economists Nada Eissa and Hilary Hoynes wrote in a 2005 paper, a trend they called “a consistent and somewhat puzzling finding.”

By contrast, the authors found married women with children, who often represent the second earner in their household, do adjust their work schedules to take advantage of the tax credit.

Eissa and Hoynes speculate that single mothers may not respond to the loss of their tax credit because they have relatively little say in how many hours they work.

Most jobs are either part-time or full-time, which makes it hard for employees to shave off just a few hours to claim bigger tax benefits. And because EITC recipients get their tax credit in one lump sum a year, they probably are not familiar with how small changes in their work life could affect their tax rates.

Rubio’s legislation is expected to spread the tax credit throughout the year.

An earlier paper by Eissa and Jeffrey Liebman found the 1986 expansion of the EITC caused single women with children to increase their labor force participation but had no effect on the hours worked of single women with children who were already in the workforce.

Ryan’s report on the War on Poverty did not directly address this phenomenon. But administration officials have recently been highlighting those findings when talking about other government programs, such as the 2010 health care law.

Administration officials have been casting doubt on recent CBO findings that the law will reduce labor force participation by the equivalent of up to 2.5 million workers in 2024.

“The best economic research is where people look at actual behavior,” Sperling said recently. “In the earned income tax credit, they found that people don’t make those kind of precise trade-offs because they’re not just acting like these purely rational economic actors with 100 percent information. They’re real, live parents who are struggling to provide security for their family, and they’re going to keep working harder and looking to do well because they want to do better for themselves and their family.”

Despite the findings of researchers, there is reason to believe that Ryan’s “poverty trap” may be a real concern, said Elaine Maag, a senior research associate at the Tax Poverty Center.

Many of the EITC studies have focused solely on the effects of phasing out the credit. What happens to people’s labor participation when all tax and transfer programs are phased out simultaneously remains unknown. It may be that people are willing to keep working despite losing their EITC benefits, but taking away other assistance programs such as food stamps at the same time may undercut their willingness to work more hours.

“If you look at the EITC, you’re losing a little bit of money — either 19 cents or 21 cents for each dollar of additional earnings —when you’re in that phase out,” Maag said. “But if you’re also earning food stamps when you’re in that phase out, you might be losing 70 cents altogether.

“We don’t really know how many people are in that situation of losing all their benefits at once,” she added. “That’s definitely the next phase of the research.”

comments powered by Disqus

SIGN IN




OR

SUBSCRIBE

Want Roll Call on your doorstep?