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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, December 10, 2011

Johnston: The EITC Worsens Poverty

EITC LogoReuters, A Tax Credit That Worsens Poverty, by David Cay Johnston:

In nearly all 34 countries with modern economies, inequality is rising, a new study by the Organization for Economic Cooperation and Development shows. The gap is especially pronounced in the United States where the country's largest program to alleviate poverty may be adding to the problem, not alleviating it.

The United States ranks fourth in income inequality after Chile, Mexico, and Turkey. In the U.S. the best-off 10% make on average 15 times the incomes of the poorest 10th, compared to a six to one ratio in the Nordic countries, Austria, Hungary and Switzerland.

The OECD report, published on Monday, cites the U.S. earned income tax credit as an explanation for a sharp increase in the hours worked by low-wage Americans. The tax credit, the largest U.S. program to alleviate poverty, is meant to be an incentive to work, but it may also contribute to poverty, effectively holding down wages of all low-skilled workers. Now how is that?

Imagine that more people whose skills limit them to low paid work decide to work more hours so they can get the credit. Add in people who have the skills for better-paid work but cannot find it and so take lower-paid jobs because of the implicit supplement to their wages provided by the earned income tax credit.

The result is more workers seeking more work, allowing employers to hold back wage increases or even reduce wages because of the enlarged supply of labor. The employers benefit. The American median wage, in 2011 dollars, has hovered at just above $500 for more than a decade. ...

A pernicious problem in America is people who work but whose wages are too low for them to afford a decent life. ...

The data indeed show that the flood of low-income workers, especially single mothers, is depressing the wages of all low-skill workers. One of four Americans with a job earns less than $15,000 and average income is less than half that. ...

The earned income tax credit has grown rapidly and now benefits 26 million low-income individuals and families, primarily single parent households. The annual cost is approaching $60 billion. ...

If the earned income tax credit, combined with the end of welfare as we knew it, hold down wages for low-skill workers then it is time to find smarter ways than Chicago School theories to reduce poverty for those who work.

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It's true that the benefit of any government subsidy for a transaction (in this case, employment) ends up being split between the buyer and the seller. In the case of Cash for Clunkers, the sellers pocketed most of the benefit as buyers flooded formerly empty showrooms. In the case of the EITC, the seller (employer) seems highly unlikely to be pocketing much of the benefit: the increase in supply (of employees' hours) is a small fraction of the previous total. DCJ has a novel perspective here, but there's no fire here and precious little smoke.

The real problem with the EITC and similar low-income benefits is that they inevitably create confiscatory tax rates in the range of income where the benefit phases out. This barrier to upward mobility probably suppresses reported taxable earnings in the lower middle class more than any other single factor.

Posted by: AMTbuff | Dec 10, 2011 9:26:51 AM

Why does this article begin with a statement about income inequality when it purports to examine the effect of EITC on the lowest income earners? Whether and why an individual or household can or cannot improve his/its own income situation has absolutely NOTHING to do with income inequality.

This country needs to get off the income inequality bandwagon: income inequality is not what's driving our economy into a ditch or provoking our destructive entitlement culture.

Posted by: ColoComment | Dec 10, 2011 12:38:38 PM

I wonder about the EITC. Maybe it would be better to raise the minimum wage.

We ought to at least recognize that anyone who pays wages at the EITC level has a government subsidized payroll.

Posted by: jim harper | Dec 10, 2011 12:53:49 PM

"Imagine that more people whose skills limit them to low paid work decide to work more hours so they can get the credit. "

I doubt the author knows many low income workers. or has ever been poor.

People do not manipulate their work hours to maximize tax credits, they increase their work hours to pay the rent and feed the kids.

Posted by: save_the_rustbelt | Dec 11, 2011 5:31:03 AM

Ironically, the real "relation" between income inequality and the EITC is that all these forms of non-wage compensation accruing to the lower quintile(s) tend to get ignored from the muckraking "studies" purporting to show growing inequality. Non-wage compensation (which includes transfer payments and employee benefits), but which should also include all other forms of consumption assistance(governmental such as rent subsidies, or private sector such as financial aid, etc) has allowed the lower quintile(s) to grow their consumption far more than plain income stats would suggest.

Posted by: MG | Dec 11, 2011 5:49:33 AM