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Labor Supply and Earned Income Tax Credit

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  1. Introduction
  2. Changes on the classic labor supply model
  3. The history of the earned income tax credit
  4. EITC
  5. Requirements imposed on recipients of the EITC
  6. Conclusion

Poverty has long been an economic and political issue in the United States of America. Throughout the last century, several anti-poverty programs have been established. One of the most principal of these programs is the earned income tax credit, or EITC for short. The program has an interesting story and has created its own strong effect on the labor supply in the United States of America.

The earned income tax credit creates some changes on the classic labor supply model. In the graph to the right, the classic labor supply model is shown to view the changes that the EITC program has on individual work incentives. Here, the standard budget line is seen with the new slopes and indifference curves attached. EITC follows a pattern of going up a hill, traveling along a plateau, and then going back down the hill more slowly than it went up. The phase-in range at slope 3 depicts that for each additional hour, the worker earnings increase by the amount equal to the wage $w. With EITC, every dollar gained is surpluses with a subsidy of s.

Hence, there is a gain of $(1+s)*w. Then, for the plateau section at slope 2, each additional hour of work increases the earnings by wage $w but has no effect on any EITC payment. The slope here is simply ?w. Lastly, for phase-out section seen at slope 1, earnings increase by $w for every additional hour, but the filer has every additional dollar reduced by $t. Therefore, net income for each hour is simply $(1-t). To complete the graph, point A is where the EITC is concluded, showing that the new budget line is equivalent with the original one. This is called the break-even point. The graph below demonstrates this with an example for a single filer with two children.

[...] Web Oct Laing, Derek. "Policy Application: The War on Poverty." Labor economics: introduction to classic and the new labor economics. New York: W.W. Norton & Co Print. Hotz, V Joseph, and John Karl Scholz. "The Earned Income Tax Credit." NBER Working Paper Series 8078 (2001): 10. Print. [8]"Policy Basics: State Earned Income Tax Credits Center on Budget and Policy Priorities." Center on Budget and Policy Priorities. N.p., n.d. Web Oct Earned Income Tax Credit: Participation, Compliance, and Antipoverty Effectiveness?. 2010-07-24. [...]


[...] Web Oct Earned Income Tax Credit: Participation, Compliance, and Antipoverty Effectiveness?. 2010-07-24. Laing, Derek. "Policy Application: The War on Poverty." Labor economics: introduction to classic and the new labor economics. New York: W.W. Norton & Co Print. Laing, Derek. "Policy Application: The War on Poverty." Labor economics: introduction to classic and the new labor economics. New York: W.W. Norton & Co Print. Ibid. Hotz, V Joseph, and John Karl Scholz. "The Earned Income Tax Credit." NBER Working Paper Series 8078 (2001): 21. [...]


[...] "The Earned Income Tax Credit." NBER Working Paper Series 8078 (2001): 10. Print. Laing, Derek. "Policy Application: The War on Poverty." Labor economics: introduction to classic and the new labor economics. New York: W.W. Norton & Co Print. Marr, Chuck, Jimmy Charite, and Chye-Ching Huang. " Earned Income Tax Credit Promotes Work, Encourages Children's Success at School, Research Finds Center on Budget and Policy Priorities." Center on Budget and Policy Priorities. N.p Apr Web Oct "Policy Basics: State Earned Income Tax Credits Center on Budget and Policy Priorities." Center on Budget and Policy Priorities. [...]


[...] For the first time, the EITC became a policy linked exclusively to Democrats.[7] Subsequently, several highly partisan arguments over the credit have been waged. Most recently, the EITC was temporarily expanded in the 2009 American Recovery and Reinvestment Act for married couples & families with three or more children. The current program is run both federally and with several states working in supplement. Anybody can apply to the federal government for the tax credit. Furthermore, there are currently 25 states have created their own EITCs with local money and federal grants. States without an income tax can offer an EITC. [...]

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