Skip Navigation

Who Benefits from the Earned Income Tax Credit? Incidence among Recipients, Coworkers and Firms

May 1, 2010
By Andrew Leigh

This study, written by Australian National University economics professor Andrew Leigh and published by the Institute for the Study of Labor (IZA) in Bonn, Germany, examines the effects of the earned-income tax credit (EITC) on individuals’ earned wages.

tax documents

This study, written by Australian National University economics professor Andrew Leigh and published by the Institute for the Study of Labor (IZA) in Bonn, Germany, examines the effects of the earned-income tax credit (EITC) on individuals’ earned wages.

Using government labor, Leigh writes that EITC policy has an effect on individuals’ wages.

“Substantial changes in EITC policy parameters over the past two decades provide a useful opportunity to estimate the incidence of the credit,” Leigh wrote. “Understanding how wages respond to the EITC is also relevant for the study of taxation incidence more generally. Targeted at low-wage workers, the EITC has focused on achieving two major goals: distributing income towards low-wage workers, and increasing labor force participation rates, but there is most likely a tension between these objectives. If the EITC induces a net increase in labor supply, then unless labor demand is perfectly elastic, the equilibrium wage will fall.”

EITC has a “substantial” negative effect on individual hourly wages, Leigh writes.

“Although the negative effect of the EITC on hourly wages is substantial, it is entirely consistent with standard estimates of the elasticity of labor demand,” Leigh wrote. “Given that the previous literature has shown that the EITC induces a large increase in labor supply, it should be no surprise to learn that this increase in labor supply has the effect of reducing hourly wages. As other researchers have shown, boosting the EITC increases the gross income of poor families with children, reflecting the fact that the rise in labor supply more than offsets the fall in hourly wages. A clear implication of this paper is that the EITC may harm low-skilled workers who are ineligible for the EITC (or receive only a small credit). Because those with and without children will generally be paid the same equilibrium wage, high school dropouts without children probably experience a reduction in their after-tax earnings when the EITC increases. The indirect burden that the EITC imposes on low-income childless adults deserves greater consideration by policymakers.
Article Tags
Taxes Employment Economy