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

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  • 1 January 2005
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Abstract
Twenty-two million families currently receive a total of $34 billion dollars in benefits from the EarnedIncome Tax Credit (EITC). In fact, the EITC is the largest cash transfer program for lower-incomefamilies at the federal level. An unusual feature of the credit is its explicit goal to use the tax system toencourage and support those who choose to work. A large body of work has evaluated the labor supplyeffects 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 areimportant; labor supply does respond to the EITC. The second major lesson is related to the nature of thelabor supply response. A consistent finding is that labor supply responses are concentrated along theextensive (entry) margin, rather than the intensive (hours worked) margin. This distinction hasimportant implications for the design of tax-transfer programs and for the welfare evaluation of taxreforms.
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