Model for Explation – Earned Income Tax Credit Versus Temporary Assistance for Needy Families

This theory can be made use of to examine an individual’s choice about how much leisure time he or she wants. After all, leisure time has utility like any other good or service. Additionally, it has a definite price for its use.

The TANF program results in a budget constraint shown by the line segment ACDB in figure 1.[1] The budget constraint in the absence of the TANF program is AB. Given the preferences I1, the worker will choose to work H1 hours. If we assume, the level of disregard (the sum of money that a person can earn without having the benefit deducted) is zero, the budget constraint becomes ACDB. This is because at zero hours of work, total income will be $300 at point C. This can be interpreted as the income guarantee which is the sum of money that is paid monthly to a worker if the worker has no income from work.

The budget constraint between point C and the point D is a result of the implicit tax rate and the break-even point features of the TANF. If the wage is $7.50 per hour and the implicit tax on earnings is .50, an hour of work will raise total income by a net amount of $3.75 as labor income increases by $7.50. The budget constraint between point C and point D, which is the break-even point, will have a slope of just -3.75 as a result. An additional issue is that the guarantee is reduced by $3.75. In this case, the break-even point is $0 + $300/.5 = $600.[2]

Above the break-even point, a person is not in the TANF program, and this makes the budget constraint match the earlier one from point D to point B. The resulting budget constraint ACDB sees the individual maximizing utility at point S, where the indifference curve I2 is just tangent to the budget constraint. At point S, hours of work have fallen to H2. This shows that the TANF sets off a reduction in hours worked among recipients.

Incorporating the budget constraint AEFGB that is caused by the EITC program in figure 1 results in figure 2. The segment AE shows the income supplement with the benefit going up as income rises; the segment EF is how much income can rise without losing out on the benefit; and at point G is where the income supplement phases out and goes to zero.