The US Earned Income Tax Credit has been described as one of the most successful elements of US antipoverty public policy, especially as it directs benefits towards the working poor. For the 2010 tax year, the EITC worked approximately as follows. Low-wage workers received additional income from the federal government depending on how much they earned and how many children they had. Consider
an individual with one child:
There was no credit if nothing was earned
The credit equaled $0.34 per dollar earned, and peaked at around $3050, when worker earned $8950.
It remained at $3050 until the worker earned around $16450.
It was phased out gradually by $0.16 per dollar earned, until eliminated completely if the worker earned $35,535 or more per year.
a) Assuming the worker faces no other taxes, graph the budget constraint for a typical worker earning a wage of W per hour.
b) Analyze how the imposition of the EITC affects hours of labour supplied. Assuming the substitution effect is larger than the income effect for a low-wage worker, does the credit increase hours worked for all those who are eligible? Why or why not?
c) Analyze the impact of the EITC on an individual's labour force participation assuming that the individual was not working in the absence of the EITC.
d) The Canadian EITC-type program is called the Working Income Tax benefit (WITB). The WITB provides no credit until labour earnings reach a minimum of $3000. The benefit is then calculated on the basis of "earnings minus $3000". Illustrate how this feature changes the budget constraint.
e) What would happen to the work incentive effects of the EITC if a similar $3000 threshold was added to the EITC (holding everything else constant)?