Answer to Question #300985 in Microeconomics for 1820

Question

1. Consider the Earned Income Tax Credit policy described. All else equal, what is the implication for labor supply if:

a. The EITC supplement rate increases from (about) 30% to 60%?

Answer 1

Earned Income Tax Credit (EITC) is a kind of federal tax credit applied mostly for working people with low and moderate income. It encourages and tends to reward work and at the same time offsets federal income taxes. In the given EITC structure, the first part, during the phase-in range, EITC recipients receive an additional 30% of their income for each dollar earned up to a maximum of a given amount of credit say, a value of $2,000 credit. Thus, in this portion, the line showing EITC will be upward-sloping till a maximum of a $2,000 credit which, for 20% return, becomes eligible at an income of $10,000. Then, it will remain the same for some income level, say an income of $15,000. Afterwards, phase-out range, begins when they start earning $15,000 or more and the credit reduces by a certain percentage, say 10% until it reaches $0.

a. The EITC supplement rate increases from (about) 30% to 60%, will increase the income in phase-in range so it might increase the income too enough so that income effect outweighs the substitution effect. Hence labor supply might bend backwards