The Mid-1990s EITC Expansion: Aggregate Labor Supply Effects and Economic Incidence

Abstract

A key attraction of the Earned Income Tax Credit (EITC) is that it encourages work. But EITC-induced increases in labor supply may drive wages down, permitting employers of low-skill labor to capture some of the intended transfer and negatively impacting workers in the same labor markets who are ineligible for the credit. I exploit variation in tax treatment across family types and skill levels to identify the e¤ect of a large EITC expansion in the mid 1990s on the female labor market, using a semiparametric reweighting strategy to decompose changes in the wage distribution into changes in skill-speci c prices and quantities. The EITC expansion induced many low- and mid-skill single mothers to enter the labor force. Contemporaneous technical change led to increases in wages, but these were smaller than they would have been with a stable EITC. Ceteris paribus, low-skill single mothers keep only 70 cents of every dollar they receive through the EITC. Employers of low-skill labor capture 72 cents, 30 cents from single mothers plus 43 cents from ineligible (childless) workers whose after-tax incomes fall when the EITC is expanded. The net transfer to workers is less than a third of the amount spent on the program.