Labor Supply and Income Effects of the Earned Income Tax Credit and Welfare Programs

This paper examines the effect of the Earned Income Tax Credit (EITC) and welfare programs on the labor supply and income of single mothers. We characterize the nonlinear budget constraint under these programs using a piecewise linear approximation and estimate nonparametrically a structural labor supply function. Employing a flexible functional form, we show that the EITC effect on hours of work is heterogenous. An EITC expansion increases the hours of poor single mothers whose tax credits increase with earnings and decreases the hours of those not so poor whose tax credits decrease with earnings. These two effects cancel each other, which explains why the EITC is found to have little effects on the average hours of work. Despite its disincentive effect on part of the population, the EITC effectively increases the family income of all affected groups. ∗Department of Economics, University of Guelph, Guelph, Ontario, Canada, N1G 2W1; email: [email protected]. Labor Supply and Income Effects of the Earned Income Tax Credit and Welfare Programs