1. THE EARNED INCOME TAX
CREDIT
A View Through the Volunteer Income Tax Assistance Program at
Colgate University
MAY 2, 2016
SPECIAL THANKS TO THE VITA PROGRAM AND NICOLE SIMPSON FOR PROVIDING DATA AND ASSISTANCE
Tobias Lescht
2. Lescht 1
Introduction
Ensuring a safety net for the nation’s poor and especially for its poorest children is of the
upmost importance. The Earned Income Tax Credit (EITC) has become the number one vehicle
for direct transfers and welfare in the United States. The credit is not a traditional welfare
program. It is implemented through the tax system and acts as a quasi-negative tax rate.
Designed to encourage work, while giving poor families additional disposable income, it is rare,
in that it is applauded by both conservatives and liberals. While many of those eligible for the
credit do not understand its structure, academics do not understand its full effects on the labor
market. Previous research has found a strong effect on the labor supply namely its
encouragement of single women to enter work, yet the credit’s effect on those already in the
workforce is disputed (Eissa and Hoynes, 2006; Meyer, 2002; Eissa & Liebman,1996; Neumark
& Wascher, 2000). Theoretically, if the income effect dominates, the EITC should decrease the
total number of hours worked as it supplements families and individuals budget constraint.
Evidence of this is lacking with many studies finding no change in labor intensity. The incentive
structure of the EITC affects income groups differently. This paper studies an interesting and
previously unstudied sample over time and, focusing on the incentives of credit, attempts to
discover income changes and bunching around the inflection points of the schedule. Bunching
around these points is observed throughout the sample and an econometric model finds evidence
of significant income effect changes at different sections of the EITC schedule.
Background
The Earned Income Tax Credit has enjoyed strong bipartisan support since its
introduction in 1975 as a modest work bonus. Today, it has grown to be the largest welfare
3. Lescht 2
program, excluding Medicare and Medicaid, costing the federal government $78 billion in 2011
(Simpson, 2014). In addition to the federal program, 28 states have implemented their own
EITC. These can be substantial; New York State, for example, provides an additional 30
percent. The cost of the federal EITC has ballooned since its introduction. In 1975, it cost the
equivalent of only 5 billion in 2009 dollars. The cost remained relatively flat until the passage of
the 1986 Tax Reform Act, which expanded the program and indexed it to inflation. Since then, it
has steadily grown and was expanded throughout the 1990s. The 1990 and 1993 Omnibus
Budget Reconciliation Acts added a separate schedule for families with two or more children and
the latter bill expanded the credit for childless tax filers. The Personal Responsibility & Work
Opportunity Act of 1996 (PRWOA96) reinforced the credit as the main form of federal welfare
by reducing traditional welfare rolls by 50 percent and pushing parents and individuals into work
by reducing out of work benefits. In 2010, the average credit was worth $2,805.
The intricacies of the earned income credit [EITC] can be complicated for many
taxpayers to understand (see figure 1). For very low income households (50 percent of Federal
Poverty Line (FPL)) with two children, the EITC results in an effective marginal tax rate
(EMTR) of -40 percent. At 75 percent of the FPL, the EMTR increases to 21.06 percent as the
EITC starts to phase out. At 140 percent of the FPL (around $35,000) the EITC combined with a
15 percent income tax bracket, pushes up the EMTR to 36.06 percent. This is higher than the 35
percent EMTR that households with incomes between $413,350 and $466,950 pay in federal
taxes. In addition to the Federal EITC, New York State implements an additional EITC
amounting to 30 percent of the federal EITC. A New York State income tax is also applied on
top of the federal rate, but does not follow the same inflection points.
5. Lescht 4
The relatively large marginal tax rate that is faced by low income households as the EITC
phases out will theoretically distort labor markets. The data should show a clustering of incomes
just before EITC phases out (140 percent of FPL) and as well as cluster at the point where the
EITC levels off (75 percent of FPL). Access to information about the EITC and its implications
on earnings may escape many low-income households. However, individuals should learn as
they file more taxes that their effective marginal tax rate increases greatly as their income
increases. Working more hours will result in a much lower payoff than is visible in the headline
income tax rate. Especially because the EITC is mainly for individuals with qualifying children,
they will likely choose to maximize their EITC as a percentage of their income while minimizing
hours worked. This allows them to work while spending significant time with their children.
The effect is maximized by the relatively low wages earned by those claiming the EITC. The
federal minimum wage of $7.25 an hour is the minimum wage for New York State in 2013;
however, this was raised to $8.00 in 2014 and to $8.75 in 2015. Those with an EMTR of 36
percent will only have a marginal wage of $4.64, in 2013, far below where many individuals
value their labor.
Theory
The nature of the credit greatly incentivizes single parents to enter the labor force by
heavily subsidizing their income. Those who were already in the labor force are likely to
decrease their hours as they can work less and still receive an income equivalent or higher than
they would have without the EITC. This is explained by figure 3 where line AB is an
individual’s budget constraint without the EITC. The phase in period (Line BD) highly
incentivizes single earners to enter the work force. Line CD represents the flat segment of the
EITC where the marginal effect of increased income is equivalent for both EITC and non EITC
6. Lescht 5
earners. The phase out segment CD explains how each extra dollar earned has a smaller
marginal effect on disposable income than it would without the credit. At all points along the
budget constraint the EITC increases after-tax income. Therefore, an individual at any point on
the AB “normal” budget constraint who becomes eligible for the EITC will be able to maintain
an equal or higher disposable income even if she decreases hours worked. For someone who is
not in the workforce, entering immediately increases her disposable income significantly as it is
subsidized by the EITC program. Those on line AC (the phase-out section) face a disincentive to
work compared to an individual without the credit. For every additional nominal dollar earned,
their after tax income increases at a reduced rate because their credit phases-out. This is
represented by the slope of line AC compared to the slope of line AB. Furthermore, an
individual on line BD (phase-in) faces opposite incentives to work as does an individual on line
AC (phase-out).
Figure 2. Theoretical Budget Constraint with EITC Distortion
7. Lescht 6
Literature
The EITC has strong effects on the labor market. Several papers have used difference–
in-difference models to examine the effect of the policy on single mothers who are most likely to
be affected as they receive the largest subsidy. For this group, employment rates rose from 73
percent in 1984 to 85 percent in 2003 as the EITC program was expanded. For other groups of
women, the employment rate remained mainly unchanged (Eissa and Hoynes 2006). Increases
compared to other cohorts were greatest right after expansions of the program in 1986, 1990, and
1993. Another approach recognizes individual variation in wages over time. Several studies
using this method find an increase in the participation rate for single mothers; however, it is
smaller, ranging from 2.8 percent to 5.9 percent. While the EITC program seems to encourage
single mothers to work, its effect on total hours worked is more nuanced.
There is evidence that bunching occurs around the kinks of the EITC schedule. Saez
(2010) finds that there is substantial bunching around the first kink of the EITC schedule for
those who self-report their income. This did not stand true for taxpayers who did not self-report
and there was no evidence of any clustering at any other kink point. The author reasoned that
this was due to the complexity of the tax code and a higher labor elasticity for lower income
cohorts compared with the middle and upper income cohorts of the EITC schedule. Those with
very low incomes are more likely able to reduce or increase hours worked than those who are in
higher income groups. Jones (2013) compares taxpayers just before and just after the kink with
the assumption that they should be similar to estimate the effect of the EITC on hours worked
and earnings. She finds that mothers who face a high EMTR reduce their hours worked in line
with economic theory. Yet these results were only significant for mothers with more than one
child implying that parenting responsibilities raise the opportunity cost of work.
8. Lescht 7
Most research shows that the EITC has had a significant effect on single mothers’ labor
force participation rate. There is overwhelming evidence that the credit encourages work among
single mothers but most research does not find that single mothers increase the number of hours
worked (Eissa & Hoynes, 2006). Athreya, Reilly, & Simpson (2014) estimate that without the
EITC, there would be a decrease of between 17 and 25 percentage points in the labor force
participation rates of young unskilled mothers. The extensive margin of labor supply relates to
the number of people in the workforce whereas the intensive margin describes how many hours
those individuals are working. The EITC has significant effects on the extensive margin.
Referencing the change in the generosity of the EITC from 1990-1996, Meyer (2002) estimates
that the credit induced a 7-10 percentage point increase in the labor force participation rate.
The EITC has a clear positive extensive effect on the labor force, yet its intensive effect
is more nuanced. Meyer (2002), studying the rollout in the credit until 1997, finds that there is
no change in the number of hours that single mothers worked before and after the EITC came
into effect (30.15 hours in 1990 versus 37.92 hours in 1997 for high school graduates; 39.28
hours versus 38.98 house for individuals with further education). In comparison to single
women without children (38.90 hours in 1990 versus 38.18 house in 1997 for high school
graduates; 38.77 hours versus 38.71 hours for individuals with further education), single mothers
work less if their education is limited to a high school degree but more if they have further
education. This is understandable as the opportunity cost of not working is higher for those with
a college degree than only a high school diploma. For both cohorts, the EITC has little to no
effect on hours worked by single mothers.
The above finding is contrary to the theoretical framework which predicts that the EITC
program should decrease hours worked as the credit subsidizes wages. Other papers focusing on
9. Lescht 8
the rollout of the credit observe mixed results for the number of hours worked by single women
who were previously in the labor market. Eissa & Liebman (1996) and Neumark & Wascher
(2000) find no intrinsic marginal effect for single mothers. Dickert, Houser, and Scholz (1995)
observed a small yet significant decrease. These studies each have issues with endogeneity as
their data is non experimental and could be potentially spurious (Neumark & Wascher, 2000).
Athreya, Reilly, & Simpson 2014 use modern data and a more suitable model estimating that the
EITC program reduces the number of hours worked by single mothers with one child by
approximately 10 percent and suggest that this is partly caused by the high marginal tax rate
faced as the EITC phases out. Hotz and Sholz (2003) observe that around 77 percent of EITC
recipients fall within the flat or phase out range explaining why there is a negative effect on
hours worked. Individuals in the phase in range are incentivized to earn more.
The external validity of many papers that use the rollout of EITC from 1993-1996 as an
experimental control should be questioned. Changes in the EITC were rolled out slowly and did
not account for a credit as valuable as today’s. Additionally, the credit replaced traditional
welfare payments affecting how individuals, especially single mothers, transitioned. Athreya,
Reilly, & Simpson 2014 shed light on this problem and go on to explain the decision facing
single mothers in today’s EITC paradigm: “Recall that in our analysis, single mothers are
deciding whether or not to enter the labor force by comparing a tax credit of 40 percent (for those
with two children) compared with a tax rate of 0 percent with no EITC. Thus, the high phase-in
rates of the EITC encourage many single mothers to enter the labor force, and especially for
those who are closest to the borrowing constraint” (Athreya, Reilly, & Simpson 2014). Most of
the literature focuses on the rollout period of the EITC as it is easily dissected; however, this is
problematic as it does not replicate the decisions being faced by modern recipients.
10. Lescht 9
Some research shows that many individuals do not react rationally to the EITC or are
unaware of the schedule. This could be an explanation of some of the conflicting results on the
intensive effect of the program. Chetty & Saez (2012) ran an experimental design on 40,000
EITC claimants by assigning 1400 H&R Block professionals to a treatment group where they
explained the EITC schedule to their clients or a control group where no advice was given.
Comparing the treatment group to the control group, there is very small and hardly significant
increase in the following year’s credit size for those individuals. The authors conclude that
giving information about the credit cannot influence the intensive margin of the labor market.
Complicating their finding, they observed strong heterogeneity. Half of the treatment effect saw
significant EITC increases the following year and bunching around the first kink of the schedule
(see figure 1). This was due to a group of tax preparers who had an outsized influence on
earnings compared to their colleagues. This suggests that EITC earnings can be manipulated but
that proper knowledge and conveyance of the information is essential.
Tax professionals may not be the best resource for knowledge of the EITC. Chetty,
Friedman, and Saez (2012) find that EITC has very different effects across neighborhoods
around the country with very similar income profiles. They suggest that this is due to variation
in residents’ knowledge about the credit and the shape of the schedule. Additionally, those who
move from low knowledge and low bunching neighborhoods to high ones increase their EITCs
and are more likely to bunch around the kinks. This suggests that peer to peer knowledge may
be more influential in changing behavior than one to one information sessions. While even those
who are made aware of the credit may not adjust their income, in many instances low earners are
savvy enough to adjust their earnings to best fit the EITC schedule.
11. Lescht 10
Much of the research on the intensive effects of the Earned Income Credit investigates
total hours worked as income levels are different across much of the country and minimum wage
laws make analysis more difficult. Income is more interesting as the federal credit is based on
earnings and not on hours worked. Furthermore, there is a large differential in hourly wages that
may be lost in hourly data. Grogger (2003) uses data from the March Current Population Survey
(CPS) and observes that there is no pre-tax income effect on the intensive margin of the labor
market due to the EITC. In a Meta-analysis, Nichols and Rothstein (2015) observe that each
additional dollar of EITC spending results in a 35 cent increase in earnings for the whole cohort
of single mothers. This is tempered by a decrease of 31 cents in earnings due to the increase in
the labor supply and fewer hours worked leading to a net individual 4 cent increase in pre-tax
earnings for single women with children Using existing data sources, it has been very hard to
parse out the earnings effect of the EITC credit as employer surplus, downward pressures on
wages, and macroeconomic trends all interfere with the analyses.
Most papers study the EITC’s effects by using the historical expansions of the credit as
points of inflection. While this is valuable, there is a significant difference in the reaction of
individuals immediately becoming eligible for the EITC because of a legislative action and of
those who are able to plan and understand the credit before they have children. Additionally, the
rollout of the EITC was gradual changing how many react to the credit. A few recent papers
have estimated the effects of the credit using modern data, but results are conflicting. Part of the
problem is that many studies use the IRS Statistics and Income reports and March CPS data
which provides detailed data on populations but does not track individuals making it impossible
to see how a single person behaves in years before and after receiving the credit.
12. Lescht 11
Data
The Volunteer Income Tax Assistance program (VITA) is sponsored by the IRS and was
founded in the early 1970s to provide free tax filing for low income individuals and families.
The service in the Madison, Oneida, Chenango, and Onadonga counties of New York state is run
by the Upstate Institute of Colgate University. Tax filers are requested to fill out a survey before
they bring their tax information to be filed. The survey is extensive and collects data on children
and earnings. The data is in panel form following individuals from tax years (TY) 2006-2013.
There are a total of 2329 observations for 1154 taxpayers. For the entire dataset, the average
income is $17,037 ranging from 0 to $50,600 and a standard deviation of $16,251. There are
1565 observations where the taxpayer has at least one child leaving 892 in which there are no
dependents. This is similar in number to the total observations where an EITC was filed (1573
taxpayers). The average Federal EIC amounted to $1758 and an additional state top off of $487.
Overall, the sample is poorer than the average for the country and for EITC recipients nationally.
The data was trimmed to create a robust and focused data set. First, all incomes were
adjusted to be in 2014 dollars. Only those who received EITCs for at least one year during their
participation in the program were included. This resulted in 1462 observations for 752 families.
The mean income was $16,286 (in 2014 dollars). For single filers, average income was $13,024
for the entire sample and $9,151 for those without children. Married filers earned on average
$23,943. The distribution is skewed rightward with a majority of the sample falling below
$17,830, the point at which the EITC credit begins phasing out (See Figure 3).
13. Lescht 12
Figure 3. Income Distribution for Entire Dataset
Graphical Analysis
It is difficult to see any effect from the EITC using the income distribution of the entire
EITC sample as married and single taxpayers have different thresholds at which the credit phases
out ($5,430 higher – this stays constant in real terms over time). Looking at figure 3, there does
seem to be a steep drop off in income density at point E ($13,870). This corresponds to the point
where the EITC levels out for those with two and three children. The marginal credit received
drops from 45 and 40 percent respectively to zero. Here, the credit no longer incentivizes work
and workers should theoretically respond to the incentives created by the ordinary tax system.
Point E is also worth noting. This is where the EITC phases out completely for single taxpayers
with no children. This EITC is far less generous compared with that for those with children
paying out a maximum of only $496 in 2014.
14. Lescht 13
Parsing apart married and single filers makes it easier to see if there is any noticeable
income effect from the EITC. Figure 4 compares the income distribution for single and married
taxpayers who earn the EITC credit. There is no real apparent income drop off for taxpayers.
While couples receive the EITC, literature suggests it is likely to have a smaller effect on them
than on single parents as couples are able to share care responsibilities and have two income
streams that are taxed together. This is the reason that most research focuses on single parents,
especially single mothers for whom the credit changes their budget constraint. It should be noted
that for single parents who partly rely on a second earner, to whom they are not married, the
credit is likely to have a large impact on the second earner as their taxes are filed separately. For
single taxpayers, there is a steep drop off in incomes at point B where the credit stops subsidizing
wages for those with two or more children as described above. This suggests that incomes bunch
around at least one of the kink points of the EITC schedule. It is clear that as incentives
disappear, there is a large disincentive for single parents to earn additional dollars. While this
cannot be conclusive as it is only circumstantial evidence, it seems likely that single taxpayers
are responding to the EITC schedule as would be theorized while the effect on married taxpayers
is not discernible.
15. Lescht 14
Figure 4. Income Distribution for EITC Recipients: Married versus Single Filers
The dataset was trimmed further to focus in on those most affected by the EITC, namely
single parents. All those who filed a joint tax return with their spouse or indicated on the survey
that they were married were removed. Lastly those who had filed taxes with VITA for less than
three years were removed so as to properly understand any effect of the credit and to ensure that
income changes were not one off or spurious. Three years was decided upon as it still left a large
number of observations and provided insight beyond the one and two year view. This left a total
of 363 observations and 78 taxpayers. See table 1 for descriptive statistics of the database
sample. While this dataset is much smaller than the original one, it is focused and provides an
excellent addition to the existing data on the EITC by allowing one to track single parents over
time and measure their reactions to the earned income credit. It also provides an insight into a
demographic not often studied consisting of largely rural white low income single parents. The
16. Lescht 15
demographic profile of the sample is 94 percent white, 71 percent female, and has ages ranging
from 17-63 with a mean of 41. While not representative of the entire country, the sample still
provides insight into the EITC and its effects on intensive margin of the labor force.
Table 1. Basic Income and Tax Information for Working Sample
VARIABLES N Mean Std.
Dev.
Min Max
Income 363 $16,331 $11,134 $0 $59,414
Federal EIC 346 $1,890 $1,572 $0 $6,175
State EIC 328 $517 $476 $0 $2,693
HRS Worked 46 32.6 12.6 9 80
Total Federal Refund 369 $3,438 $2,531 $-172 $9,437
Total State Refund 365 $946 $772 $-48 $3,054
Previous papers focus on the differences in incomes between single parents with one
child versus those without. This allows for an empirical comparison to see any effects of the
EITC. Previous research has either used survey or nationwide tax data which is limited by the
lack of ability to track individuals over time. It is logical to see how having a child as a single
parent could have a negative or positive effect on income. The extra mouth to feed and the
various expenses related to the child will encourage a parent to work more hours and earn a
higher income in order to provide for the child. On the other hand, a newborn will require care
and assistance that in many cases can only be provided by the parent if she or he does not have
family members able to take on some of the burden and cannot find or afford day care services.
The opportunity cost of working will increase greatly and in many cases it may not make
economic sense for a parent in such a situation to earn. The EITC changes the incentive
structure drastically. As shown in previous research, the credit is associated with a large increase
in the number of single mothers in work; however, there is no definitive conclusion on how the
credit affects the intensive margin of the labor market. Tracking individuals over time and
17. Lescht 16
focusing on how they react to the addition of an eligible child to their tax return, greatly
increasing their credit and changing their budget constraints, will help to answer this important
question.
There is evidence of income bunching for single earners who receive the EITC. Figure 5
graphs the income distribution of this entire sample. The schedule overlay marks the kink points
on the EITC schedule. The credit starts at the first additional dollar for earners with zero, one or
two children and continues to increase until $9720 for those with one child and $13650 for those
with two or more children after which it begins to phase out at $17830. It appears that there is a
steep decrease in earners around the first kink in the EITC schedule. At this point those with one
child stop earning the wage subsidy of 35 percent (see figure 1). This decrease in the number of
earners is dramatic. The other interesting section of the graph is the second hump around
$30,000 where the trend of decreasing density reverses and increases slightly. $38,511 is the
point at which the credit ends for single earners with one child. This bulge extends into the
region right before the end point. While not conclusive, it could suggest that relatively high
earners, for this sample, are bunching around the end of the EITC schedule in order to still retain
some of the credit.
18. Lescht 17
Figure 5. Income Density for entire sample of EITC earners
Deconstructing the dataset to observe taxpayers with one child versus those without any
children allows for a closer investigation of the distortional nature of the credit’s incentives.
There is a large difference in the incomes of single earners with no children for which the
average income is $12,937 compared with those with a single child for whom average earnings
are $18,971. This is apparent in figures 6 and 7. The single earners income distribution is far
lower than those with one child. For the sample, it is clear that single parents with one child earn
significantly more than their childless counterparts. It appears for this group of taxpayers that
either the additional needs of the child or the incentives created by the EITC spur income growth
as childless earners only qualify for the credit if they earn very little. If the EITC is causing at
19. Lescht 18
least part of the difference in earnings, we would expect for income levels to cluster around the
kinks of the credit schedule. For those with a single child, the greatest income density occurs
within the flat area of the schedule. The EITC phase-out begins at $17,830. After this point,
single parents of one child are facing a phase out rate of 15.98 percent on top of a 15 marginal
tax rate bringing their effective marginal tax rate up to 30.98 percent. It appears that single
parents are maximizing their income while avoiding the phase out and flat sections of the EITC
schedule. Incomes are clustered just before the phase-out would take effect.
A comparison of the income density graph for single parents of one child to single
taxpayers without children is revealing. Not only are incomes much lower, but they bunch
around the optimal income amount for single childless taxpayers to earn the maximum credit.
This is shown in figure 7 by the EITC schedule; the first kink, at $6,480, marks where the
minimum wage needed to obtain the max subsidy and the point at which the marginal effect of
the credit becomes flat. This rate is much smaller at only 7.65 percent so it is interesting to note
that the income decline seems much steeper than the corresponding decline in figure 6. These
graphs are instructive and seem to suggest a strong response to the EITC both for single
taxpayers and single parents with one child. The difference between the figures is stark and
incomes cluster around their relevant kink points as would be suggested by theory. Some
previous research has found that incomes do bunch around these points but no one has definitely
concluded that the EITC has a significant effect on the intensive margin of the labor market.
While these graphs cannot conclude this they provide rich support for such a claim. Numerical
data is needed for any definitive statement.
20. Lescht 19
Figure 6 (Left). Income Distribution for Single Parents with One Child
Figure 7(Right). Income Distribution for Single Taxpayers without Children
Graphical evidence suggests that incomes of single parents and single earners are
sensitive to the incentives created by the EITC. Single parents appear to avoid the phase-out
region and to cluster around the section of the schedule that provide the largest credit.
Additionally, those with higher incomes cluster towards the end of the phase-out section possibly
to maintain a small credit. This analysis is descriptive in nature but provides interesting insights
into earnings of those receiving the EITC and lays the groundwork for further analysis. An
empirical model would help complete the picture by separating the subjects into three distinct
groups facing opposing incentive structures.
Model
For this analysis, the sample of single taxpayers with either 0 or 1 child was broken into
three groups based on income. The first split was made at $17,830, the point at which the EITC
starts to phase out for single earners with one child. Earners in the top section should react
differently when they have their first child than those on the lower half of the spectrum. Higher
One Child
EITC Schedule
21. Lescht 20
earners will face a high immediate effective marginal tax rate of at least 30.98 percent when they
have their first child. Lower earners will have a completely different effective tax rate. If
taxpayers fall in the flat region between the $17,830 cutoff and $9,720, the EITC will not affect
their EMTR. Below $9,720, their EMTR will be will be strongly positive at 35 percent. Those
below $17,830 receive either an incentive to increase their income or hold their income within
the flat band from $9,720 to $17,830 as opposed to a negative incentive on further earnings. The
effect on EMTRs of having a child is drastically different for those who fall either side of the
phase-out point.
A simple fixed effects model was used to calculate whether having a child changes
incomes for those facing opposing incentives created by the EITC. Equation 1 was used to
model the effect that moving from zero to one child has on pretax incomes. Those with two or
more children were excluded as this results in an incremental increase in the credit instead of the
large jump a first child has. Additionally, married filers were excluded as the incentives are less
clear and there were too few of them to maintain robustness. As explained in detail previously,
these groups face extensively different incentives in earnings after their first child. Time fixed
effects were not included as the model investigates how income changes over time.
Additionally, controlling for demographic indicators was not seen to be necessary due to the
homogeneity of the sample and the use of the individual specific fixed effects. The strength of
the model is in its simplicity due to the nature and quality of the data.
(Eq. 1) 𝐼𝑛𝑐𝑜𝑚𝑒𝑖 = 𝛽0 + 𝛽1
̂ 𝐶ℎ𝑖𝑙𝑑1𝑖 + 𝑢 𝑖
22. Lescht 21
Results
The results are striking and show significant differences in the effect of having a first
child at different levels of the EITC schedule (see Table 2). For a single parent earning more
than $17,830, having one’s first child had significantly decreased his or her income by an
average of $5,681.65 with a 95 percent confidence interval between -$8506 and -$2857. This
result is significant to the 1 percent level and has a P-value = 000. For the income group below
$17,830, a single parent’s first child had no discernable effect on income increasing earnings by
an average of $761.62 with a 95 percent confidence interval from $-645 to $2168. This result
was not statistically significant and has a P-value = .289. The lowest income group (less than
$9,720) also lacked a noticeable income change due to having one’s first child. On average, the
birth of a single parent’s first child was associated with a decrease in earnings of $27.00 with a
95 percent confidence interval ranging from -$1167 to $1113. The result is not statistically
significant and has a P-value = .963. These results show the marginally intensive effect that the
EITC has on single parents’ earnings.
Table 2. Results from Fixed Effects Model Comparing the Effect of Having a First Child on Income
for Different Regions of the EITC Schedule
(1) (2) (3)
INCOME Phase-out Range
(>$17,830)
Below Phase-out Range
(<$17,830)
Phase-in Range
(<$9,720)
First Child -5,681.65*** 761.62 -27.00
(1,441) (717.6) (582.1)
Constant 31,785*** 7,944*** 5,282***
(1,461) (537.7) (357.2)
Observations 89 181 117
Number of Taxpayers
Taxpayer Fixed Effects
47
YES
73
YES
57
YES
Standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
23. Lescht 22
Combined graphical and numerical evidence presented in this paper makes it difficult to
reject the distortional effects the EITC has on the incomes of single parents. This group is most
heavily affected by the credit as their lower earning potential compared to married couples places
a large number of them within the EITC band. Additionally, the increased burden of caring for
children that is unique to single parents makes the incentives generated by the credit more
distortionary. The results presented in table 2 show that those who face drastically different
effective marginal tax rates react very differently to the increased burden of having their first
child. Those who are in the phase-out range decrease their earnings by an average of $5,681,
implying that the opportunity cost of work increases when faced with parenthood. The results fit
the theoretical model. For every dollar an individual decreases their income by in the phase-out
range of the EITC, they lose around 70 percent of their after tax income after accounting for the
phase-out rate and their marginal tax bracket. Their incentive to maintain their income level is
15 percent less than it would be without the EITC. The combined effects of the need for care
giving and the lower incentive to maintain income levels for single parents falling in the phase-
out range of the EITC schedule, is observed with a significant decrease in earnings after the birth
of a first child.
For those who are below the reduction region of the EITC, incentives are drastically
different resulting in no decrease in earnings after the birth of a first child. Single parents with
incomes of less than $17,830 reacted to their first child with no discernable income growth or
decrease. The results were insignificant and if anything saw an increase in earnings. It must be
assumed that these individuals face equal or lower care giving support from family and friends as
those with higher incomes and that the opportunity cost of work, without the EITC, is somewhat
equal if not lower. The drastic difference in the change of income for those above versus those
24. Lescht 23
below the $17,830 mark is strong evidence that the EITC shapes earnings for single parents after
the birth of their first child.
The group in the phase in section of the EITC schedule with incomes less than $9,720
face a large increasing wage subsidy. The insignificant results of the effect of a first child on
income suggests that there is little to no change in earnings. Theory would predict that after their
first child, single parents within this income range would increase their pretax to take advantage
of the 35 percent income subsidy and to maximize their EITC credit. While results from this
paper do not show an income increase, this could be due to various reasons. Extremely low
income individuals may be relying on financial support from friends and families that is not
declared in their taxes. Additionally, they may not have the care giving support network of their
wealthier counterparts. Importantly, those with incomes at such low levels may lack the skills
and experience to increase their earnings potential even if there is a large incentive to do so and
even if they are capable of increasing their incomes may face a large childcare burden. Lack of
knowledge about the credit, especially for this income group, could be yet another potential
reason. While this result does not exactly fit the theoretical model, comparing it to the large
negative change in income for those in the EITC phase-out region reinforces the findings of this
paper
There may be external variables not captured in the model that explain part of the
findings, but referring to graphical evidence makes this unlikely. Medicaid eligibility should not
be a factor as New York provides Medicaid up to 150 percent of the FPL for single parents and
200 percent for pregnant women, much higher than the kinks of the EITC bracket. The strongest
of the challenges to these results is that those with incomes below the phase-out range of the
EITC credit could possibly be making only enough to provide essentials and therefore earning
25. Lescht 24
less is not an option. While this is a possibility, the opportunity cost of work should be lower for
this income group than those earning above $17,830 as their hourly wage is likely lower. Saez
(2010) points out that lower income groups have higher wage elasticity due to the temporary
nature of much of their employment. Furthermore, referring to the graphical evidence presented
in this paper, bunching around the kink points of the EITC spectrum was universal suggesting
that while low earners may have less room to adjust their earnings, they still respond to the
incentives of the EITC.
Discussion
Previous research has found significant positive extensive effects of the EITC on the
labor force especially for single women, while the intensive effect is still contested. Most early
research focusing on the rollout of the EITC in the early 1990s, found that the credit did not
influence how many hours single mothers worked even if it pushed many of them into the
workforce. Some later papers such as Athreya, Reilly, & Simpson (2014) using more modern
data and a model based research approach observed that the credit resulted in single mothers
working around 10 percent fewer hours. There has been no conclusion so far on the actual effect
of the EITC credit on hours worked or income. Nearly all the previous research has used hours
worked as the measure for the intensive effect as wages and standards of living vary around the
county. This is logical but the earned income credit is based on income not hours worked. The
data used for this paper taken from four relatively uniform counties in Upstate New York allows
income to be used as the main measure. Results offer insight into why the intensive effect of the
EITC has not been found previously. For those single parents in the phase-out region of the
EITC income dropped dramatically after their first child. This did not happen for those in the
phase in or flat region of the schedule offering contrary results and confounding papers looking
26. Lescht 25
at all EITC recipients. Using the incentives the EITC generates as the main motivation, allows
for the credit to be broken down into three distinct regions.
Some previous papers looking into clustering around the kinks of the schedule have used
a similar approach but have not approached conclusive evidence. This may be due partly to the
lack of EITC knowledge on behalf of the recipients (Chetty, Friedman, and Saez (2012). These
authors found that in neighborhoods where knowledge about the credit was common, bunching
was more likely to occur. Those involved in the VITA program are likely to be somewhat savvy
as they seek out the service instead of falling for the large advertising campaigns of tax service
companies such as H&R Block. While preparers in the VITA program are not allowed to offer
tax advice, many observe a significant transfer of knowledge about EITC. Indeed, significant
bunching was observed across the entire sample. If the individuals in this sample are more
informed than other EITC recipients, the external validity of the paper may come into question.
Another takeaway seems that programs, like VITA, which are good at providing people with
their rightful information allow individuals to make better informed decisions to raise their
utility.
Conclusion
This paper provides a valuable, new and unique insight into the intensive effects of the
earned income tax credit. Its main strength is the data taken from the Volunteer Income Tax
Assistance program in Upstate New York. The data allowed for individuals to be tracked over a
period of time to see income changes after the birth of a first child to a single parent. Previous
research has used metadata collected from various nationwide institutions such as the March
CPS and the IRS. Observing individuals’ real life reactions presented strong evidence for the
27. Lescht 26
distortional nature of the EITC. Clustering around the kink points was graphically apparent
throughout the sample. Those who fell in the phase-out region of the schedule and for whom the
credit presented a negative incentive for work, reduced their income significantly after having a
first child. This was not the case for those with lower incomes and a positive incentive.
Findings in this paper uncover new inefficiencies in the EITC schedule not previously
discussed. The finding that cohorts within the credit schedule react differently to its incentives
has been theorized but lacks evidence in previous empirical studies. Properly understanding this
is crucial to creating a fair and efficient tax transfer scheme to help the nation’s poor. The EITC
is relatively efficient compared to other welfare programs, yet motivates low earners in
potentially negative ways. While more research is needed to successfully pinpoint its effect on
income, results from this paper suggest that reducing the marginal rates at which the credit
phases out would increase the efficiency of the program. Furthermore, extending the EITC
benefit for single workers would reduce the step up experienced by those who have their first
child. Smoothing this transition may better prepare single parents for the hours of work the
EITC requires for a maximum credit. Creating a more efficient program should be a priority for
researchers and politicians.
There is much future research that should be completed using this data. A more robust
and complicated econometrics model may be able to estimate the dollar amount by which the
EITC changes individuals’ pre-tax income. Similar studies should be completed using a more
demographically diverse population to determine the external validity of this sample.
Furthermore, as the credit ages, a longitudinal study of people who received the credit and their
children should be completed to value any positive outcomes it may have induced. If results
from this paper are to be believed, the credit significantly alters single parents’ way of life. It
28. Lescht 27
would be neglectful not to study the long term impact of the credit. The EITC provides a
valuable cash top up that many families and individuals have come to rely on. In 2011, the credit
raised 9.4 million people, including 4.7 million children, above the poverty line (Simpson, 2014).
Yet, critics point out that it has forced many single mothers into work resulting in worse
outcomes for their children. Results from this paper also suggest that the poorest single parents
may spend more time working because of the credit than they otherwise would. The costs and
benefits of the credit are complicated but deserve extensive analysis, particularly as the credit has
become the largest part of the nation’s welfare program. The starting point of such analysis
should be to determine how the earned income credit affects tax payers that fall into different
income groups, as this paper has sought to do. Further and more extensive research is needed.
This paper adds to the existing literature by taking a novel and effective approach that finds
evidence of bunching around the kinks of the schedule and individual responsiveness to the
EITC’s incentive structure leading to previously unfound economic inefficiencies in the
program.
29. Lescht 28
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Simpson, N. (2014). VITA at Colgate: The Earned Income Tax Credit (EITC)[PowerPoint
slides]
