Expanding New York State's Earned Income Tax Credit Programme: the effect on work, income and poverty

Abstract

Given its favourable employment incentives and ability to target the working poor, the Earned Income Tax Credit (EITC) has become the primary antipoverty programme at both the federal and state levels. However, when evaluating the effect of EITC programmes on income and poverty, governments generally calculate the effect using simple accounting, where the value of the state or federal EITC benefit is added to a person's income. These calculations omit the behavioural incentives created by the existence of these programmes, the corresponding effect on labour supply and hours worked, and therefore the actual effect on income and poverty. This article simulates the full effect of an expansion of the New York State EITC benefit on employment, hours worked, income, poverty and programme expenditures. These results are then compared to those omitting labour supply effects. Relative to estimates excluding labour supply effects, the preferred behavioural results show that an expansion of the New York State EITC increases employment by an additional 14 244 persons, labour earnings by an additional $95.8 million, family income by an additional $84.5 million, decreases poverty by an additional 56 576 persons and increases costs to the State by $29.7 million.

Keywords:

• poverty
• EITC
• labour supply

JEL Classification::

• I38
• J22
• H24

Notes

¹ Unless otherwise noted, all figures are in 2004 dollars.

² See Hotz and Scholz (2003) for a review of papers examining the labour supply effects of the EITC.

³ Though Eissa and Hoynes (2004) find evidence that increases in the EITC result in modest reductions in the employment and hours worked of married women, these effects are so small that they are unlikely to affect the results of this simulation.

⁴ Calculated by the author using the CPS ASEC, 2005.

⁵ Many families that receive the EITC also receive in-kind benefits, such as food stamps, which are phased out as income increases. Hence, changes in the EITC programme that increased countable income in these programmes, reducing their value would affect the implicit marginal tax rate faced by a worker. However, the EITC benefit itself is not counted in the calculation of in-kind benefits. But any labour earnings increase caused by a change in the EITC benefit rules would be affected because labour earnings are countable income in such programmes. The denominator used to calculate the per cent change in the marginal tax rate here does not include the implicit tax rates on labour earnings from lost benefits from these in-kind programmes. The microsimulation required to capture those rates is beyond the scope of this article. However, given the relatively small change in labour earnings the simulation produces, the addition of these implicit taxes is unlikely to substantially affect the results presented here.

⁶ Unless the value of the state EITC supplement exceeds a person's total tax liabilities, the net state tax variable will show a positive amount of taxes owed. The value of the state EITC supplement is not provided as a separate variable. Therefore it is necessary to impute the value of the state EITC supplement from the value of the federal EITC, which is reported.

⁷ See Dalaker (2005) for a more detailed description of the alternative poverty measures.

⁸ Based on the assumptions specified for persons not in the labour force who enter the labour force in response to the EITC increase, a single mother with one child would have a family income of $13 912 and a single mother with two children would have a family income of $16 378 with an expansion of the NYS EITC to 45%. With an expansion of the NYS EITC to 45% of the federal credit, 7017 single mothers with one child and 7227 single mothers with two children would enter the labour force. Based on the CPS, the average family income in the CPS of a single mother with one child not in the labour force is $8047 and the average family income of a single mother with two children is $9124. Taking the difference between average incomes in and out of the labour force and multiplying these values by the respective number of people who enter the labour force yields an aggregate increase in family income of $93.757 million.