Threatening to 'Reform' the Earned Income Tax Credit

Devoted readers know that I'm careful not to shoot everything that moves, but the more I hang around the DC tax debate, the more I'm exposed to deeply misguided thinking that seems largely motivated by the conviction that poor people -- in this case, the working poor -- have too much money and the wealthy have too little.

That's the lesson from a report by the Tax Foundation on the "benefits" of getting rid of the Earned Income Tax Credit -- a wage subsidy for low-income workers -- and giving everybody else a tax break.

BTW, an interesting wrinkle here is that the Tax Foundation claims to "not advocate policy positions," at least according to The Hill newspaper. It's just that they happen to mention that if we were to get rid of the EITC if would free up enough revenue to lower tax rates by almost 6 percent. To paraphrase: "We're not saying anyone should do that, of course... we're just sayin'... and by the way, according to our BS dynamic scoring model, that would add a zillion jobs... but we're not sayin' anything... we're just sayin'... "

As my CBPP colleagues show here, across-the-board rate cuts are highly regressive, ergo the "rich need more, poor need less" policy goal that this idea would promote, if the Tax Foundation promoted policies... which they don't... really.

The EITC has historically been an extremely popular anti-poverty program, and not just among Democrats. Reagan viewed it as highly effective in no small part because, as much research has shown, it successfully incentivizes work. How then, does the TF come up with the claim that it discourages work?

That's because they're emphasizing the "substitution effect" in the phase out range of the credit. But of course the question is the net impact -- the impact on work incentives across the full program, not just one piece of it (you don't describe the results of a ball game by just telling us how many runs your team scored).* And here the research has been clear that the EITC both promotes labor supply and makes sure that once you include the tax credit, low-wage work is much more likely to lift a family out of poverty. (I will add the full employment/demand side piece here: it's a great program but it won't help if there aren't enough job slots.)

Finally, a central theme here at On The Economy has been the extent to which inequality is dampening the upward economic mobility of kids stuck on the have-not side of that equation. Well, we now have enough longitudinal data to examine the long-term impact on kids whose families benefited from the tax credit (or similar subsidies) versus those who didn't get the extra income. In fact, such research has uncovered long-lasting benefits including healthier babies, better school performance, and higher earnings and hours of work later in life.

I've held for a while now that this is an inauspicious moment to engage in tax reform -- I just don't think this Congress is up to meeting the necessary criteria of additional revenues and at least no lessening of progressivity. Numerous developments thus far have reinforced this fear, threatening a "tax-reform trap" where policy makers want to pay for lower rates with a broader base, but seem to agree only on the lower rates, not the broader base. This cooked research on the EITC provides another great example of the type of tax reform we'd be much better off without.

*That pro-work result on net is what I'd expect: on the up-slope of the credit both substitution and income effects incentivize more work. On the down slope, the substitution effect flips but the income effect, while diminished, still points toward more work. Interestingly, the research tends to find the work incentive has a much larger impact on the extensive versus the intensive margin. That is, the tax credit is more likely to move non-workers into paid work than it is to lead workers to adjust their hours. It's a reminder that the microeconomic assumption that workers -- especially low-wage workers -- can seamlessly adjust their work hours in response to marginal changes in tax incentives is... um... fanciful.

This post originally appeared at Jared Bernstein's On The Economy blog.