Implications-earned Income Tax Credit Versus Temporary Assistance for Needy Families

It must be emphasized that there will be savings realized for the government through increased productivity and output by reducing the unemployment rate. Okun’s Law can be used to estimate the size of the economic loss from unemployment.[1] The law states that for every 1 percent increase in the unemployment rate, a country’s Gross Domestic Product (GDP) will be about 2 percent lower than its potential GDP. This means that the increase in the unemployment rate from 4 percent to 4.8 percent in the early period of the 2001 recession cost the economy roughly 1.6 percent of GDP, or $173 billion in goods and services per year (in 2004 dollars).

As a result of the TANF, a considerable number of women have not made a good transition to regular paid work and in several instances are marginally or markedly worse off. Moreover, this number has been increasing since 2000 and there has also been a gradual upward trend in the number of families in poverty between 2000 and 2004.[2]

In contrast to the TANF, the EITC succeeds to a great extent in encouraging labor force participation among the low-income population. There are studies that utilize the natural experiment that happened when the EITC program went through significant enlargements in 1986 and 1993.[3] These studies have used a before-and-after technique and found that increased benevolence of the EITC program leads to more labor force participation especially among single women and married men. But, there is a detrimental effect on the labor supply of married women.[4] The fact that married men decide to increase their labor supply and married women reduce their labor supply when the EITC program is expanded signifies the joint decision making within the household.[5]

EITC families see non-market time of each adult member as substitutable and a rise in the take-home market wage offers family members the chance to specialize in the activity in the labor/leisure model in which they have a comparative advantage. The model captures the fact that the majority of the low-income population does not have this privilege by focusing on single mothers.

In a 1996 Business Week article, Nobel laureate Gary S. Becker commended the EITC for supporting low-income families without lowering labor force participation by reducing hours worked and growing dependence on public assistance. Becker wrote that the EITC “rewards rather than penalizes poor families with working members. . . . Empirical studies confirm the prediction of economic theory that the EITC increases the labor force participation and employment of people with low wages because they need to work in order to receive this credit.”[6]

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[1] See David Romer, Advanced Macroeconomics (New York: McGraw-Hill, 2001). Also see Donald G. Freeman, “Panel Tests of Okun’s Law for Ten Industrial Countries.” Economic Inquiry 39 (October 2001): 511-23. Jesus Crespo Cuaresma, “Okun’s Law Revisited,” Oxford Bulletin of Economics and Statistics 65 (September 2003): 439-51, presents evidence that the relationship between unemployment and loss in GDP.

[2] Douglas Besharov, “The Past and Future of Welfare Reform,” The Public Interest (Winter, 2003), pp. 4 – 22.

[3] See Nada Eissa and Jeffey B. Liebman, “Labor Supply Response to the Earned Income Tax Credit,” Quarterly Journal of Economics (May 1996): 605-37;These provide a review of many more analyses of the impact of the EITC on labor supply behaviors among the poor.

[4] See Nada Eissa and Hilary Williamson Hoynes, “Taxes and the Labor Market Participation of Married Couples: The Earned Income Tax Credit,” Journal of Public Economics 88 (2004): 1931-58.

[5] Phillips, K. (2001). The Earned Income Tax Credit: Knowledge is Money. Political Science Quarterly,116, 413-424.

It shows that EITC encouraged work among single mothers and demonstrates the substitution effect in the labor/leisure model which I intend to use.

[6] Gary S. Becker, “How to End Welfare ‘As We Know It’ — Fast,” Business Week, June 3, 1996.

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