Thursday, May 24, 2012
The earned-income tax credit is often said to encourage work, but it may do just the opposite. ... The chart below shows the credit’s schedules for the 2011 tax year as a function of annual earned income for a given family situation (other family situations have the same basic shape). The schedule shown illustrates the mountain-plateau pattern described above: an increasing portion for the lowest incomes, a flat portion, a decreasing portion and then finally a flat portion of zero.
... For the same reasons that the credit encourages more work among people who might otherwise earn close to zero during a year, it can also influence some people to work less — those with earnings at or slightly above the downward-sloping or “phase-out” portion of the schedule, where people lose about 20 cents of their credit for every additional dollar earned during a year. In other words, for households on the downward-sloping portion of the earned-income tax credit schedule, the credit acts as an extra 20% tax on the income they earn in that range. The work-encouraging potential of the credit occurs only on the upward-sloping portion. ... [I]t is more common for families to be on the part of the earned-income tax credit where it acts as a tax, rather than a reward to additional work.
Update: Linda Beale (Wayne State), EITC: Mulligan (economic theory) vs. Seto (empirical evidence)