In-Work Tax Credits and the Safety Net

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...the EITC serves as an automatic stabilizer for married couples with children but not for households with a single parent and children...

Subsidies to improve the welfare of low-income families in the United States increasingly take the form of transfers that are linked to employment. The Earned Income Tax Credit (EITC) is now the most important cash transfer program for lower income working families. In 2010, almost 20 percent of tax filers received the EITC, at a total cost of $60.9 billion. The goal of these programs is to raise the incomes of families at the bottom of the income distribution. In Do In-Work Tax Credits Serve as a Safety Net? (NBER Working Paper No. 19785), Marianne Bitler, Hilary Hoynes, and Elira Kuka evaluate the extent to which the EITC addresses variation in economic need over the course of the business cycle.

The defining feature of the EITC is that it requires positive earnings for eligibility. Given that requirement, the dynamic pattern of EITC benefits over the business cycle is theoretically ambiguous. On the one hand, a downturn may lead to higher rates of EITC participation if downturn-induced decreases in earnings move taxpayers into income ranges that make them eligible for the EITC. On the other hand, a downturn could reduce the rate of EITC participation if the associated decline in employment results in some individuals, who previously had low earnings and qualified for the EITC, falling to zero earnings.

Using administrative data from the Internal Revenue Service for years between 1996 and 2008, the authors exploit differences in the timing and severity of economic cycles across states. Their estimates suggest that the net effect of economic fluctuations on EITC beneficiaries varies by family types. A higher aggregate unemployment rate is associated with an increase in the number of EITC recipients and in the total dollar amount of credits for married couples, but the effects are insignificant for single earners. This suggests that an adverse labor market shock reduces the earnings of married couples, leading to more participation in the program, but does not lead many households to lose earnings entirely. Meanwhile, job loss for a single earner eliminates family earnings altogether, leading to a reduction in EITC participation. The authors find similar patterns, using more aggregate data, during the Great Recession. The results suggest that the EITC serves as an automatic stabilizer for married couples with children but not for households with a single parent and children, who constitute the majority of recipients.

-- Claire Brunel