The Earned Income Tax Credit (EITC) is a refundable tax credit provided to low- and moderate-income workers in the United States. In 2017, the EITC had a budget of $73 billion and provided assistance to 28 million families. The EITC was first created in 1975 and has undergone a number of expansions in the decades since. Using plausibly exogenous variation in EITC eligibility over three decades, Bastian and Jones (2021) compute the MVPF of an expansion of the EITC to low-income mothers.

Using data that links the 1990–2017 Current Population Survey’s Annual Social and Economic Supplement (CPS ASEC) to administrative tax data from the IRS, the paper studies the EITC’s effect on labor supply, taxes paid, and other government transfers received. The paper finds that EITC participation increases labor supply and taxes paid, and reduces government transfers received through other programs. The paper estimates that a $1,000 increase in the maximum possible EITC benefit led to a $349 increase in average EITC benefits, with bigger effects for unmarried than married women ($527 vs. $272). The inputs to the MVPF calculation are based on this estimated $349 average increase.

MVPF = 3.2

The net costs are composed of direct costs and fiscal externalities. The direct cost of a $1 dollar expansion of the EITC is $1.

The fiscal externality in this setting has two components: (i) changes in tax revenue due to changes in labor supply and earnings, and (ii) changes in transfers from other government programs. For (i), the paper estimates that a $349 increase in EITC transfers leads to a $48 increase in net tax revenue. This is composed of a $22 increase in sales and UI taxes and a $70 increase in payroll taxes. As payroll taxes are partially used to repay workers’ own pension benefits, the paper estimates that 37% of each dollar increase in payroll taxes results in an increase of government revenue. Therefore, the total net increase in tax revenue is $22 + ($70 x 0.37) = $48. This corresponds to a $0.14 increase in taxes collected for each $1 increase in transfers.

For (ii), the paper estiamtes that a $349 increase in EITC transfers is associated with a $243 reduction from other cash transfers (e.g., TANF/SNAP/AFDC). This corresponds to a $0.69 decrease in other government transfers for each $1 increase in EITC transfers.

As a result, the net cost per $1.00 increase in transfers is $1 – $0.14 – $0.69 = $0.17. As the confidence interval for the fiscal externatliy is (-infinity, -$0.42), the confidence interval for the net cost is (-infinity, $0.58).

$0.2
Net Cost

0.6 Upper Margin
-1.0 Lower Margin

The paper considers two groups of beneficiaries when computing the willingness to pay for a marginal increase in EITC transfers: (i) those who are already working and simply face an increase in income, and (ii) those who were out of the labor force and are induced to work due to the EITC expansion.

The paper argues that, by the envelope theorem, the members of group (ii) have a willingness of pay of zero. This is because, at the margin, they are indifferent between not working and working and receiving the increased EITC transfer.

Members of group (i) value an additional $1 of EITC transfers at a dollar-for-dollar rate. Therefore a $1 increase in EITC will generate a total willingness to pay equal to the fraction of beneficiaries in group (i). The paper estimates this fraction in two ways. The first is to use the average fraction of individuals in the study sample that receive the EITC. 19 percent of the full sample received the EITC, so the mechanical cost of increasing the maximum EITC benefit is about $190. This is 54% of the $349 increase in average EITC benefits, or a willingness to pay of $0.54 for a $1.00 increase in EITC.

The second approach relies on a simulated instrument to estimate the fraction of EITC recipients who enter the labor force. This approach yields a willingness-to-pay estimate of $0.72 cents for a $1.00 increase in EITC transfers.

$0.5
WTP

0.7 Upper Margin
0.5 Lower Margin

The paper reports two MVPF values based on the two alternative willingness to pay estimates: $0.54 / $0.17 = 3.18 and $0.72 / $0.17 = 4.23.

The upper bound on the confidence interval for the fiscal externality yields an MVPF estimate of 1.29 (= $0.54 / $0.42, while the lower bound yields an MVPF of infinity. The paper notes that their MVPF estimate is based on short-run (one year) effects and does not account for numerous documented positive spillovers from EITC transfers (e.g., improved health, reduced crime recidivism). The authors argue that accounting for these spillovers could lead to an infinite MVPF estimate.

The EITC MVPF can also be expressed in terms of the labor force participation elasticity (\varepsilon) and the change in the average tax wedge \left( \frac{ATR^1}{1-ATR^0} \right), where ATR^0 is the average tax rate (participation rate) before the EITC reform and ATR^1 is the average tax rate after the reform. The formula is then:

MVPF = \frac{1}{1-\varepsilon \frac{ATR^1}{1-ATR^0}}

This is useful to compare MVPFs across EITC reforms because elasticities do not depend on the size of the reform. The main estimate above is associated with \varepsilon=0.33 and \frac{ATR^1}{1-ATR^0} =2.08 for the same MVPF of 3.18.

3.2
MVPF

1.3 Lower Margin

Bastian, Jacob E. and Maggie R. Jones (2021). Do EITC Expansions Pay for Themselves? Effects on Tax Revenue and Goverment Transfers. Journal of Public Economics 196 104355. https://doi.org/10.1016/j.jpubeco.2020.104355

- Category
- Taxes
- Sub-Category
- Cash Transfers
- Beneficiary Type(s)
- Adults, Mothers and pregnant women
- Average Age
- 41
- Average Income
- 26000
- Country of Implementation
- United States
- Empirical Method
- Difference in Differences
- Research Type
- Primary
- Peer Reviewed
- No
- MVPF Publication Link
- doi.org/10.1016/j.jpubeco.2020.104355