Stepping Stone or Dead End? The Effect of the EITC on Earnings Growth

The Earned Income Tax Credit (EITC) has many complex provisions which could affect economic behavior.

Past research has analyzed data indicating that

EITC raises labor force participation rates among single mothers, especially those with little education

EITC does not reduce marriage rates (despite the large marriage penalty built into the EITC!)

EITC does not promote higher birth rates (despite the large tax benefits associated with claiming one or two "qualifying children" on a tax return.)

A new study published in the June 2009 issue of the National Tax Journal tackles a new question about the effects of the EITC:

[D]o single mothers who are pulled into employment by the EITC improve their labor market outcomes through increased earnings over time or do they remain stuck in low-earning jobs? On the one hand, we might expect increases in earnings over time. Evidence suggests that even among less-skilled groups, the returns to labor market experience are large (Gladden and Taber, 2000, 2006). On the other hand, we might not expect increases in earnings over time if the employment opportunities available to such single mothers are limited to ‘dead-end’ jobs that have with little potential for future earnings growth.

The authors' conclusion:

Using a panel of administrative earnings data linked to nationally representative survey data, we find no evidence that the EITC expansions between 1994 and 1996 induced single mothers to take “dead–end” jobs. If anything, the increase in earnings growth during the mid–to–late 1990s for single mothers who were particularly affected by the EITC expansion was higher than it was for other similar women. The EITC encourages work among single mothers, and that work continues to pay off through future increases in earnings.

Molly Dahl (Congressional Budget Office), Thomas DeLeire (University of Wisconsin, Robert M. LaFollette School of Public Affairs) & Jonathan Schwabish (Congressional Budget Office) Stepping Stone or Dead End? The Effect of the EITC on Earnings Growth.

hat tip: Taxprof Paul Caron

Tax incentives and the timing of births

Unless you’re a cynic, or an economist, I realize you might have trouble believing that the intricacies of the nation’s tax code would impinge on something as sacred as the birth of a child. But it appears that you would be wrong.--David Leonhardt New York Times 12/20/2006

As you are discovering in your study of tax law, many taxpayers, especially those in low-income working families, receive substantial tax benefits if they have children. A "qualifying child" born before midnight December 31, 2008 will qualify the family for a full year's worth of tax benefits. However, if the clock strikes midnight on New Year's Eve before the baby arrived, there will be no tax benefits at all for the parents on their 2008 tax return.

For a typical client at our Union College VITA site, the arrival of a child a few minutes before midnight on December 31 could mean up to almost $4,000 in additional combined federal and state Earned Income Tax Credit (EITC) refunds in early February. (The exact amount depends on income, filing status, and whether there are already children in the family. The refundable additional child tax credit may add to that amount as well.) For higher income families beyond the EITC eligibility levels, the tax benefit of a child is lower but still substantial. For example, an upper middle income family in the 25% tax bracket could realize a savings on Federal taxes of $1,875 due to the additional dependency exemption and the child tax credit for a child born before December 31.

Here is an abstract from a paper published in the Journal of Political Economy which attempted to measure the size of the tax incentive effect on behavior.

Because the tax savings of having a child are realized only if the birth takes place before midnight, January 1, the incentives for the "marginal" birth are substantial. Using a sample of children from the National Longitudinal Survey of Youth, we find that the probability that a child is born in the last week of December, rather than the first week of January, is positively correlated with tax benefits. We estimate that increasing the tax benefit of having a child by $500 raises the probability of having the child in the last week of December by 26.9 percent.

The complete text of the article is available on-line here:
Taxes and the Timing of Births, 107 J. Pol. Econ. 161 (1999), by Stacy Dickert-Conlin (Syracuse University, Center for Policy Research) & Amitabh Chandra (Harvard University, John F. Kennedy School of Government)

The Dickert-Conlin Chandra article is an excellent example of careful statistical analysis which had to deal with many potentially confounding effects (e.g., holiday and weekend effects, parental income, birth order--since first and second children confer much larger tax benefits for low-income parents than subsequent children, etc.)

As NYT columnist David Leonhardt pointed out, there is some potential deadweight loss associated with the distorting effects of the birth timing incentives:

Induced births and Caesarean sections are considerably more expensive than natural births on average. There are clearly cases when labor needs to be induced for a baby’s health or the mother’s. It’s much less clear, however, that the health care system should be subsidizing parents’ desire for a smaller tax bill.

The health effects of scheduled births are also murky. A big study led by a researcher at the Centers for Disease Control and Prevention found that voluntary Caesareans increase the risk of infant mortality. Another study found that weekday births are slightly more risky than weekend ones, all else equal, suggesting that a drug-induced birth can also cause health problems. The differences are small, but the stakes are big enough to take any change seriously.

“When you induce labor, you compress this long process into a few hours,” said Dr. Emmet Hirsch, the director for obstetrics at Evanston Northwestern Healthcare near Chicago. “When you do that, you can run into all sorts of problems.”

Source: NYT Dec 20, 2006 David Leonhardt: To Do List: Wrap Gifts, Have Baby

This is a simple and relatively straightforward example showing the unintended effects that tax incentives can sometimes have on behavior.

We'll learn about many more examples of the effects of taxes on behavior during our winter term class.