Earned Income Tax Credit
Here we have an application of
government policy that alters the
budget of the individual. Without the
policy we have the straight line
budget as usual (assuming no
nonlabor income.)
I will explain the
numbers more on the
next slide or 2. Note
for now we do not
worry about the exact
amount of leisure
On the normal budget line we see what happens in the absence of government
policy. The Earned Income Tax Credit is a policy that assists people by making
early dollars they earn worth more than a dollar to them.
As the individual starts to give up leisure (at the leisure intercept) a movement
along the normal budget shows an income level 11,000. What the government
will do for folks who qualify is give them a 40% tax credit on their income up to
11,000. Essentially this means that for every dollar they earn at work the
government gives them 40 cents. The new budget shows a segment up to
11,000(1 + .4) = 11,000 + 4400 = 15,400. So the government will give the
individual up to 4400 when they start working.
Then when the individual on their own makes between 11,000 and 14,370 the
individual can still get the whole credit of 4400, so their real budget is between
15,400 and 18,770. This is the segment parallel to the original budget.
Now, after the individual makes 14,370 on their own the credit is reduced 21.06
cents for every additional dollar earned. How many 21.06 cents are in $4400?
20,893! So this many dollars above 14,370 is where the new budget crosses
back and hits the original budget (at 35,263).
The earned income tax
credit helps an individual
who does not work take on
work because it takes every
dollar of pay and makes it
1.40 (up to 11,000, of
Seems to me the aim of the
policy at this stage is make it
hard to take leisure – or very
enticing to work – move from
A to B.
For the person who is
already working, the plan
may entice the person to
work more or less. We can
not predict for sure what
will happen. But if the
income effect is greater
than the sub. effect the
individual will work less
(and end up to the right of
the vertical line).
For the person who is already
working a great deal of time, the
plan has a disincentive to work (A
to B means less labor supplied).
But there is also still the possibility
that the person’s consumption
amount will be greater under the
plan than without the plan.
Two major conclusions of the economic view of this program:
1) The economy would get more labor market participants because individuals
have to work to make it in the program,
2) The hours worked of those already in the labor force before the program
would change.
The author suggests there is evidence that 1) has actually happened.
Table 2-5 in book has a table with the following information:
Unmarried women with children eligible for the program had an increase in
participation in the market from 72.9% before the program to 75.3% after the
Now, the thinking is that maybe something else accounted for the increase in
participation – maybe a strong economy lead them to enter the workforce. So,
we need a control group to compare against the above group. Unmarried
women without children would not be eligible for the program. Their
participation rate stayed the same at 95.2% both before and after the program.
So if other factors where at work we would have expected to see that here and
we did not.
The difference in the eligible group rate was 2.4% and the non-eligible group
was 0. The difference in differences is then 2.4% - 0% = 2.4%
Essentially what is happening here is that whatever difference we saw in the
non-eligible group was netted out from the eligible group. Any difference
remaining is due to the program. It thus appears that the earned income tax
credit program has lead to an increase in labor force participation.

Earned Income Tax Credit