The Earned Income Tax Credit and the Labor Supply of Married Couples

Over 18 million taxpayers are projected to receive the Earned Income Tax Credit (EITC) in tax year 1997, at a total cost to the federal government of about 25 billion dollars. The EITC is refundable, so any amount of the credit exceeding the family’s tax liability is returned in the form of a cash refund. Advocates of the credit argue that this redistribution occurs with much less distortion to labor supply than that caused by other elements of the welfare system. This popular view that the credit “encourages work effort” is unlikely to hold among married couples. Theory suggests that primary earners (typically men) would increase labor force participation, but secondary earners would reduce their labor supply in response to an EITC. We study the labor supply response of married couples to several EITC expansions between 1984 and 1996. Although our primary interest is the response to changes in the budget set induced by the EITC, our estimation strategy takes account of budget set changes caused by federal tax policy, and by cross-sectional variation in wages, income, and family size. We use both quasi-experimental and reduced-form labor supply models to estimate the impact of EITC-induced tax changes. The results suggest that EITC expansions between 1984 and 1996 increased married men’s labor force participation only slightly but reduced married women’s labor force participation by over a full percentage point. Overall, the evidence suggests that family labor supply and pre-tax family earnings fell among married couples. Our results imply that the EITC is effectively subsidizing married mothers to stay at home, and therefore have implications for the design of the program.

Differential mortality and wealth accumulation

An issue central to the life-cycle theory of consumer behavior, and to many policy questions, is asset accumulation and decumulation. One of the main implications of the life-cycle model is that assets are decumulated in the last part of life. Most empirical studies of asset accumulation use cross-sectional data to estimate mean or median wealth-age profiles, but the use of cross sections to estimate the age profile of assets is full of pitfalls. If, for example, wealth and mortality are related, in that poorer individuals die at a younger age, one overestimates the last part of the wealth-age profile when using cross-sectional data because means (or other measures of location) are taken over a population which becomes "richer" as it ages. In our examination of the effect of differential mortality on cross-sectional estimates of wealth-age profiles, we quantify the dependence of mortality rates on wealth and then use these estimates to "correct" wealth-age profiles for sample selection due to differential mortality. We estimate mortality rates as a function of wealth and age for a sample of married couples drawn from the Survey of Income and Program Participation (SIPP). Our results show that accounting for differential mortality produces wealth profiles with significantly more dissaving among the elderly.

Tax Rates and Work Incentives in the Social Security Disability Insurance Program: Current Law and Alternative Reforms

The Social Security Disability Insurance (SSDI) Program has long been criticized by economists for its apparent work disincentives stemming from the imposition of 100 percent tax rates on earnings. However, the program has been modified in recent years to allow recipients to keep some of their earnings for fixed periods of time. Moreover, additional proposals have been made for lowering the tax rate further and for providing various additional financial work incentives. We use the basic labor supply model to show the expected effect of these reforms on work effort. In addition, we provide a numerical simulation that shows the magnitude of the monetary incentives provided by the reforms for different categories of individuals. We find that the proposed reforms have ambiguous effects on work effort and could, contrary to perceived wisdom, possibly reduce work effort and increase the number of SSDI recipients. However, the simulations show that reforms based on earnings subsidies for private employers are more likely to increase work effort and to lower the caseload.

Does welfare play any role in female headship decisions?

During the last thirty years, the composition of white and black families in the United States has changed dramatically. In 1960, less than 10 percent of families with children were headed by a single mother, while in 1990 more than 20 percent of families with children were female-headed households. A large body of research has focused on the role of the U.S. welfare system, and in particular, the Aid to Families with Dependent Children (AFDC) program, in contributing to these dramatic changes in family structure. Most studies use cross-sectional data and identify the effect of welfare on female headship through interstate variation in the AFDC program. Recent research finds that controlling for state effects has a large impact on the estimated welfare effect. This paper examines why state effects matter for estimating the role of welfare in female headship decisions by examining the importance of individual effects and policy endogeneity. A natural explanation for why state effects matter is that the composition of the population across the states differs, and the composition is related to the generosity of the state's welfare program. If that is true, then controlling for individual effects should have the same result as controlling for state effects. Second, the endogeneity of AFDC policy is examined by including controls representing the determinants of state welfare generosity. The results show that after controlling for individual effects, there is no evidence that welfare contributes to increasing propensities to form female-headed households for either whites or blacks. Further, the results suggest that welfare-induced migration among blacks leads to an upward bias in the estimated welfare effect in previous studies.

Work, Welfare, and Family Structure: A Review of the Evidence

Support for reforming the welfare system in the United States is widespread, as evidenced by legislative action by many states and, most recently, the federal government. Although part of the interest in reform is fiscally motivated, interest also exists in making significant changes to address two prominent criticisms of the current system of public assistance in the United States: (1) the system has significant, adverse, work incentives; and (2) the system discourages the formation of two-parent families and is responsible in major part for the high and rising rates of female headship and out-of-wedlock births. This paper uses the available empirical evidence to explore the validity of these criticisms and to evaluate the impact of various reforms. The programs examined include Aid to Families with Dependent Children, Food Stamps, and Medicaid. The paper relies on evidence based on three sources of variation in welfare policy: cross-state variation, over-time variation, and demonstration projects at the state level. The conclusions are that current reforms aimed at reducing female headship and nonmarital births, such as "family caps," eliminating benefits for teens, and equal treatment of one- and two-parent families, are unlikely to generate large effects. Changes in implicit tax rates and benefit formulas may increase work among current recipients, but overall work effort may not be affected. These predictions should be accompanied by a word of caution: many of the proposed changes have never been implemented at the state or federal level and require out-of-sample predictions. Current state experimentation may help fill this gap.

Local Labor Markets and Welfare Spells: Do Demand Conditions Matter?

This paper examines the role of local labor markets in determining how long families receive benefits from the Aid to Families with Dependent Children (AFDC) program. Given the current policy emphasis on devolution and reducing the AFDC caseload through employment, understanding the role of local labor demand is important. The study uses a unique data set, based on administrative data, that has detailed information on welfare spells for over 100,000 AFDC cases. The empirical work is based on estimates of a duration model where the hazard rate is a function of demographic characteristics, local labor market variables, neighborhood characteristics, county fixed effects, and time effects. Several alternative measures of local labor market conditions are used; the results show that higher unemployment rates, lower employment growth, lower employment-to-population ratios, and lower wage growth are associated with longer welfare spells. On average, a typical employment fluctuation over the business cycle, if permanent, would lead to an 8 10 percent reduction in the AFDC caseload. Typical changes in real quarterly earnings generate somewhat smaller effects. The combined effect of these two changes, if permanent, would lead to sizeable reductions in the caseload, on the order of 15 percent. The estimated labor market effects are robust to including county-level fixed effects and time effects. AFDC-UP participants, blacks, and residents of urban areas are more sensitive to changes in economic conditions while teen parents and refugee groups are found to be much less sensitive to changes in local labor market conditions.

Interactions Between Policy Effects, Population Characteristics and the Tax-Benefit System: An Illustration Using Child Poverty and Child Related Policies in Romania and the Czech Republic

We investigate the impact of the Romanian and Czech family policy systems on the poverty risk of families with children. We focus on separating out the effects of policy design itself and size of benefits from the interaction between policies and population characteristics. We find that interactions between population characteristics, the wider tax benefit system and child related policies are pervasive and large. Both population characteristics and the wider tax-benefit environment can dramatically alter the antipoverty effect of a given set of policies

Estimating Hispanic-White Wage Gaps Among Women: The Importance of Controlling for Cost of Living

Despite concern regarding labor market discrimination against Hispanics, previously published estimates show that Hispanic women earn higher hourly wages than white women with similar observable characteristics. This estimated wage premium is likely biased upwards because of the omission of an important control variable: cost of living. We show that Hispanic women live in locations (e.g., cities) with higher costs of living than whites. After we account for cost of living, the estimated Hispanic-white wage differential for non-immigrant women falls by approximately two-thirds. As a result, we find no statistically significant difference in wages between Hispanic and white women in the NLSY97