Tax credits ; Personal Responsibility and Work Opportunity Reconciliation Act of 1996 ; Poverty

Rubén Hernández-Murillo

English

Research Papers in Economics

NationalEconomicTrends
April 2001
The Earned Income 
Tax Credit at Work
The Personal Responsibility and Work Opportunity
Reconciliation Act of 1996 has been praised for achiev-
ing record reductions in poverty rates and for increasing
the labor force participation of women, especially sin-
gle women with children.  This reform replaced the Aid
to Families with Dependent Children (AFDC) program,
which had unambiguous work disincentives, with the
Temporary Assistance for Needy Families (TANF) pro-
gram.  TANF has eligibility criteria similar to AFDC,
such as income thresholds and the presence of related
children, but imposes a lifetime limit on the receipt of
welfare benefits and includes work requirements to
provide employment incentives.
In addition to TANF, the Earned Income Tax Credit
(EITC) has played an important role in raising employ-
ment among low-income individuals and alleviating
poverty through wage subsidies to low-income individ-
uals and families.  During the 1990s, the EITC was
expanded significantly on several occasions, and today
it provides as much in payments—about $31 billion in
1999—as TANF and the Food Stamp program com-
bined.  Since more than half of the EITC payments go
to families with wage incomes below the poverty line,
the program has also become an important instrument
for reducing poverty, lifting 4.1 million people out of
poverty in 1999 according to the Economic Report 
of the President, January 2001.
Less-educated individuals are predominant among
low-income workers.  The accompanying chart com-
pares the employment-to-population ratio, or employ-
ment rate, of individuals 25 years and older with less
than a high school education with the fraction of indi-
viduals of working age (18 to 64 years) with incomes
below the poverty line, as compiled in the Current
Population Survey.  A decline in the poverty rate since
1993—when the EITC was expanded—has coincided
with a rise in the employment rate, and both trends
have accelerated since welfare reform was enacted in
1996.  In contrast, the employment rate among individ-
uals who completed a high school education has
remained fairly constant at 62 percent during the same
time period.  Thus, while the TANF time limits may
have pushed welfare recipients to work, the strong
economy and the EITC may have done more to pull
them into jobs and lift them out of poverty.
This conclusion is consistent with existing evidence
on employment and poverty rates for single mothers—
who have been the focus of analysis by economists,
because the size of the wage subsidy adjusts for the
number of children in a family.  In a recent study, for
example, Meyer and Rosenbaum provide evidence
showing that, among several alternative explanations,
the EITC has been crucial in raising the employment
rate for single mothers, while its effectiveness with
other low-income groups, such as single women with-
out children, has been moderate at best.
1 This contrast
in results suggests that the EITC has benefited families,
in particular, at the bottom of the income ladder.
—Rubén Hernández-Murillo
1 Meyer, Bruce D., and Dan T. Rosenbaum. “Making Single Mothers Work:
Recent Tax and Welfare Policy and Its Effects.” National Tax Journal. Part 2,
December 2000, 53(4), pp. 1027-61.
Views expressed do not necessarily reflect official positions of the Federal Reserve System
Poverty and Employment Rates
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1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
R
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8
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R
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Employment Rate (left scale)
Poverty Rate (right scale)
Source:  Bureau of the Census.  Poverty Rate: people 18 to 64 years
Source:  Bureau of Labor Statistics.  Employment Rate: people 25+ years with less than  a high school diploma 
              (annual averages of monthly data)

The earned income tax credit at work

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The earned income tax credit at work

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