Association for Public Policy Analysis & Management

The Earned Income Tax Credit (EITC) is the largest cash transfer program in the United States and has the dual goal of lowering the tax burden and raising employment of low-income families. The program encourages work by offering a wage subsidy in the form of refundable tax credit. A large body of evidence argues the program succeeded at raising employment of unmarried mothers during the mid- to late-1990s. This paper examines whether the employment effect is due to increased work entry among non-workers or decreased work exit among workers.

In the traditional static labor supply framework, the EITC raises employment only by inducing some people to enter the labor market when they otherwise would not have. However, the benefits of the EITC may largely be unknown by those out of the labor force and thus have little effect on them. On the other hand, workers may have better knowledge of EITC benefits—they have received the tax credit and know the effective increase in the wage. Therefore, the EITC could affect the decisions of people who are already working by giving them an increased incentive not to exit the labor market following, for example, a plant closing or the birth of a child.

Differentiating the entry and exit effects of the EITC is important for improving employment policies and for understanding the low-skilled labor market more generally. The entry effect is likely to be smaller (and the exit effect larger) if the hard-to-employ population are less likely to know about the EITC or if they have sufficiently high reservation wages, or have inelastic labor supply, that wage subsidies have little effect on their decisions.

To measure the effect of the EITC on work entry and exit, I use a difference-in-difference identification strategy that exploits variation in the generosity of the program by family size arising from the 1993 EITC expansion. Using data from the March Current Population Survey and the Survey of Income Program Participation, I find employment went up by six percentage points for unmarried mothers relative to unmarried childless women after the major policy reform. Approximately half of the employment increase can be attributed to fewer labor market exits and half from additional labor market entry. Notably, all of the reduced exit from the labor market is among women whose family income is sufficiently low that they are indeed eligible for the EITC, which provides evidence of the validity of the research design.  

I also study the effects of welfare reforms that were implemented during the same period. These results suggest that for a family with children living in a state that adopted AFDC waiver or TANF, relative employment increased by 5.6 percentage points. Time limits on welfare receipts and work requirements were major features of welfare reform. Consistent with this, I find that the employment effect of welfare reform was entirely through increased entry.