Behavioral Responses to Taxes: Lessons from the EITC and Labor Supply

Abstract

Twenty-two million families currently receive a total of $34 billion in benefits from the earned income tax credit (EITC). In fact, the EITC is the largest cash-transfer program for lower-income families at the federal level. An unusual feature of the credit is its explicit goal to use the tax system to encourage and support those who choose to work. A large body of work has evaluated the labor supply effects of the EITC and has generated several important findings regarding the behavioral response to taxes. Perhaps the main lesson learned from the evidence is the confirmation that real responses to taxes are important; labor supply does respond to the EITC. The second major lesson is related to the nature of the labor supply response. A consistent finding is that labor supply responses are concentrated along the extensive (entry) margin, rather than the intensive (hours worked) margin. This distinction has important implications for the design of tax-transfer programs and for the welfare evaluation of tax reforms.

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