There has been a longstanding debate in the United States about how to assist low-income families. The Earned Income Tax Credit (EITC) is designed to augment income while encouraging work: The tax credit increases with earnings for low levels of household income, but declines and ultimately is phased out as incomes rise. The EITC appears to have increased labor force participation but its effects on hours worked is ambiguous. Given the low levels of net wealth of most EITC recipients, it is likely that many are credit constrained and unable to smooth their consumption patterns.Credit

Aaron Steelman

Kartik B. Athreya

English

Research Papers in Economics

The Earned Income Tax Credit (EITC), originally 
introduced in 1975 and made permanent in 
1978, has become the federal government’s 
largest cash-assistance program for low-income 
families. Approximately $43 billion was allo-
cated to 22 million families in the United 
States in 2007 through the federal EITC. This 
compares to $16.5 billion that was allocated 
through more traditional assistance programs 
such as Temporary Assistance for Needy Fami-
lies (TANF).1 Indeed, during the period when 
TANF replaced Aid to Families with Dependent 
Children as a result of welfare reform in 1996, 
the United States experienced a 50 percent 
reduction in welfare rolls; one study suggests 
that much of that drop can be attributed to 
the EITC and reduction in welfare benefits.2 The 
perceived success of the federal EITC has led 
to the development of similar programs in 23 
states and the District of Columbia.3 Moreover, 
the American Recovery and Reinvestment Act 
of 2009 increased the credit for families with 
three or more children and expanded eligibil-
ity for married couples. 
March 2011, EB11-03
Economic Brief
EB11-03 - The Federal Reserve Bank of Richmond
The Earned Income Tax Credit: Recipients, Labor 
Force Participation, and Credit Constraints
By Kartik B. Athreya and Aaron Steelman
There has been a longstanding debate in the United States about how to  
assist low-income families. The Earned Income Tax Credit (EITC) is designed  
to augment income while encouraging work: The tax credit increases with 
earnings for low levels of household income, but declines and ultimately is 
phased out as incomes rise. The EITC appears to have increased labor force 
participation but its effects on hours worked is ambiguous. Given the low 
levels of net wealth of most EITC recipients, it is likely that many are credit 
constrained and unable to smooth their consumption patterns. 
Page 1
EITC Structure and Recipients
In practice, the EITC functions as a negative 
income tax—that is, people with earnings below 
a certain level do not pay taxes on their wages 
but instead effectively receive a subsidy. The 
program is structured in three stages, depend-
ing on the recipient’s income. In the phase-in 
stage, the credit increases with earnings; in the 
plateau stage, the credit reaches a maximum and 
levels off; and in phase-out stage, the credit falls 
as the recipient’s earnings rise. Both households 
with children and those without are eligible for 
the EITC. In a recent paper, one of the authors of 
this Economic Brief (Athreya) and two co-authors, 
Devin Reilly of the Richmond Fed and Nicole B. 
Simpson of Colgate University, used data from 
the Current Population Study to examine how 
the structure of the EITC program affects house-
holds of varying characteristics.4 For example,  
for households with two or more children and 
low levels of income, the marginal tax rate is  
-40 percent for both single and married filers, 
which represents the phase-in stage of the EITC. Page 2
As incomes reach $13,000, the marginal tax rate is 
zero, meaning it has reached the plateau stage. And 
as incomes increase beyond $13,000, the marginal 
tax rate becomes positive and rises quickly. A similar 
pattern emerges for married and single households 
with one child, but for childless households the 
negative income tax effect is not as large and the 
increase in marginal tax rates is not as extreme. 
The EITC benefits are relatively high for households 
headed by young adults (ages 18-25), fairly constant 
for households in their 30s, and then decline sharply 
for households in their late 30s and beyond. By the 
time households are in their 50s and 60s, the aver-
age amount of the EITC is slightly more than $500. 
The interaction of qualification requirements with 
the benefit structure, however, ensures that the EITC 
remains a relatively constant fraction of recipients’ 
earnings for most of their lives, approximately 15 
percent. Perhaps surprisingly, the EITC represents an 
even larger proportion of the income of older EITC 
recipient households, roughly 18 percent for those 
in their late 50s. This is perhaps due to the fact that 
households that qualify for the EITC at this age have 
very low incomes since they likely face the income 
thresholds applicable to those with no children.
EITC recipients tend to have not only relatively low 
annual income, but also relatively low net worth. 
Using data from the Federal Reserve Board of Gov-
ernors’ Survey of Consumer Finances, Athreya, Reilly, 
and Simpson find that EITC recipients, on average, 
hold only one-fifth of the wealth of non-EITC recipi-
ents. In fact, the bottom quartile of EITC recipients 
hold negative wealth on average, while the bottom 
quartile of non-recipients have small, positive wealth 
holdings. In the second quartile, EITC recipients hold 
$3,489 in net wealth, compared to $75,329 for non-
EITC recipients; in the third quartile the comparison 
is $24,038 to $253,637; and in the top quartile, the 
comparison is $404,272 to $1,991,197. Only in the top 
quartile do EITC recipients hold significant wealth, 
with those recipients tending to be older and often 
homeowners. Also noteworthy, married households 
that are eligible for the EITC hold more wealth than 
single households, and wealth holdings decrease 
with the number of children in the household.
The EITC and Labor Force Participation
While the EITC is designed to encourage work among 
low-income households, there are two relevant 
dimensions of that decision to examine: (1) whether 
to enter the workforce at all, and (2) how many hours 
to work. On the first dimension, it appears that the 
EITC does, in fact, increase labor force participation, 
especially among single mothers; that was especially 
true in the 1980s and 1990s.5 On the second dimen-
sion, the evidence is less clear. This is due, in part, to 
the structure of the EITC program. 
Remember, as income increases, the EITC benefits 
decrease or are even phased-out altogether. Thus, 
households must decide how much to work. At low 
levels of income, the benefits of work (income re-
ceived both from labor and from the EITC) are unam-
biguously positive. This is not true at higher levels of 
income. Households must make decisions about la-
bor output as they reach the plateau and phase-out 
stages: On the margin, are more hours worked worth 
the diminished amount of EITC benefits received? 
How households respond is ambiguous not only 
theoretically but also empirically. One study suggests 
that since most households receiving the EITC fall in 
the plateau or phase-out region, it is likely that the 
overall effect of the EITC on hours worked is nega-
tive.6 However, other studies have shown that while 
higher-income households are sensitive to marginal 
tax rates, lower-income households are less so.7 This 
may be due to lower-income workers holding jobs 
that do not permit them to easily adjust their work 
hours.8 If it is true that lower-income workers are not 
particularly responsive to marginal tax rates, the EITC 
probably has little or no effect on their number of 
hours worked, a finding that seems to be generally 
held among labor economists. 
Credit Constraints and EITC Recipients
As noted above, EITC recipients, on average, tend 
to have relatively low levels of net wealth. In addi-
tion, they are more likely than non-EITC recipients to 
frequently have late debt repayments and relatively 
low credit scores. These factors, by themselves, likely 
constrain their ability to borrow and thus smooth 
their consumption of goods relative to non-EITC 
recipients. The EITC may mitigate this issue to some degree, as it would be relatively clear to lenders that 
this benefit is forthcoming and the loan could be re-
paid. But that may be true for only a segment of EITC 
recipients—those who do not possess characteristics 
that typically make lenders wary of extending credit. 
On balance, it would appear that EITC recipients have 
different access to credit markets than non-recipients 
and hence use those markets in ways (probably more 
limited) than the population more generally.
Conclusion
Economists and policymakers have long considered 
ways to assist low-income people. On net, there  
is a strong presumption among economists that  
the most efficient way to accomplish this goal is  
to simply allocate lump-sum payments to those 
households who would qualify and let them use  
the payments in ways they deem most effective  
in meeting their goals. For a variety of reasons,  
however, such a proposal seems unpalatable to 
many and, hence, other policies have been pursued. 
The EITC, which links assistance to work, appears  
to not only have gained widespread acceptance  
but also to have been relatively effective at assisting 
those in need. There are still open questions, how-
ever, about how sensitive the supply of labor among 
EITC recipients is to the way benefits are structured. 
In addition, it appears that EITC recipients, like most 
of the poor or relatively poor, do not have similar 
access to credit markets as non-EITC recipients. To 
the extent that such differential access is undesirable 
and improvements can be made without distorting 
credit markets, policymakers may wish to address 
this issue.   
Kartik B. Athreya is a senior economist and research 
advisor and Aaron Steelman is director of publica-
tions at the Federal Reserve Bank of Richmond.
Page 3
Endnotes
1   Nada Eissa and Hilary Hoynes, “Taxes and the Labor Market Par-
ticipation of Married Couples: The Earned Income Tax Credit,” 
Journal of Public Economics, August 2004, vol. 88, iss. 9-10, pp. 
1,931-1,958. 
2   Jeffrey Grogger, “Welfare Transitions in the 1990s: The Economy, 
Welfare Policy, and the EITC,” Journal of Policy Analysis and Man-
agement, Autumn 2004, vol. 23, no. 4, pp. 671-695.
3   Jason Levitis and Jeremy Koulish, “State Earned Income Tax 
Credits: 2008 Legislative Update,” Center on Budget and Policy 
Priorities, October 8, 2008.
4   Kartik B. Athreya, Devin Reilly, and Nicole B. Simpson, “Earned 
Income Tax Recipients: Income, Marginal Tax Rates, Wealth, 
and Credit Constraints,” Federal Reserve Bank of Richmond Eco-
nomic Quarterly, Third Quarter 2010, vol. 96, no. 3, pp. 229-258.
5   Bruce D. Meyer, “Taxes, Welfare, and Work by Single Mothers,” 
National Bureau of Economic Research Reporter OnLine, Fall 
2001.
6   V. Joseph Hotz and John Karl Scholz, “Not Perfect but Still Pretty 
Good: The EITC and Other Policies to Support the U.S. Low-
Wage Labour Market,” OECD Economic Studies, April 2000, no. 
31/II, pp. 25-42.
7   See, for example, Michael Keane and Robert Moffitt, “A Struc-
tural Model of Multiple Welfare Program Participation and 
Labor Supply,” International Economic Review, August 1998, vol. 
39, no. 3, pp. 553-589; and Jon Gruber and Emmanuel Saez, 
“The Elasticity of Taxable Income: Evidence and Implications,” 
Journal of Public Economics, April 2002, vol. 84, no. 1, pp. 1-32.
8   Jennifer L. Romich, “Difficult Calculations: Low-Income Workers 
and Marginal Tax Rates,” Social Service Review, March 2006, vol. 
80, no. 1, pp. 27-66.
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Federal Reserve Bank of Richmond, and include the 
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Bank of Richmond or the Federal Reserve System.

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