The Earned Income Tax Credit and Transfer Programs: A Study of Labor Market and Program Participation

Abstract

The cornerstone of the Clinton administration's welfare reform agenda is a large expansion of the earned income tax credit (EITC), a refundable tax credit directed primarily toward low-income taxpayers with children. This paper reviews existing studies and provides new evidence on the degree to which policies, like the EITC, that alter after-tax wages affect hours of work, labor market participation, and transfer program partici pation. Simulations based on recent labor supply estimates suggest that the overall effect of the EITC expansion on hours of work from those in the labor market will be negative but fairly small. We then examine the effect of the EITC on labor market participation. We use a detailed SIPP-based microsimulation model of the tax and transfer system to accurately characterize families' budget constraints. Our empirical model relates labor market and program participation decisions to budget constraint variables and other characteristics. We find that the positive effect of the EITC on labor market participation offsets and, depending on the hours and weeks worked by new labor market participants, can exceed the EITC on labor market participation offsets and, depending on the hours and weeks worked by new labor market participants, can exceed the negative effect of the EITC on hours worked by those already in the labor force. We also show that transfer program participation is nega-tively correlated with after-tax wages, which should, over time, lower the cost of the EITC.