Is the EITC as Good as an NIT? Conditional Cash Transfers and Tax Incidence

From Jesse Rothstein:

The EITC is intended to encourage work. But EITC-induced increases in labor supply may drive wages down. I simulate the economic incidence of the EITC. In each scenario that I consider, a large portion of low-income single mothers’ EITC payments is captured by employers through reduced wages. Workers who are EITC ineligible also see wage declines. By contrast, a traditional Negative Income Tax (NIT) discourages work, and so induces large transfers from employers to their workers. With my preferred parameters, $1 in EITC spending increases after-tax incomes by $0.73, while $1 spent on the NIT yields $1.39.

About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar.
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1 Response to Is the EITC as Good as an NIT? Conditional Cash Transfers and Tax Incidence

  1. Matthew says:

    I suspect Rothstein’s findings are merely a short-run effect. In the long run, the steady state capital stock should adjust such that changes in labor supply do not affect wages. In the steady state we always remain on the linearly homogeneous portion of the aggregate production function, so that steady state wages depend only on technology and time-preference, not on labor supply.

    In a footnote of his original 1971 taxation paper, James Mirrlees proposed an EITC-like addition to the tax schedule. The result of incorporating hours worked into the tax function along with total labor income is to increase the amount of welfare-improving redistribution that is possible, by partially offsetting (but not reversing) the disincentive that the negative income tax creates for labor supply. To get that result, you only need for what I said above to be true: that steady state marginal product of labor is independent of the aggregate supply of labor.

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