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Tax-Transfer Policy and Labor Market Outcomes

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Document date: October 07, 2005
Released online: October 07, 2005

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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Public policy towards low-income families with children in the United States has changed dramatically in the last two decades. The Aid to Families with Dependent Children (AFDC) program, in existence since 1935, was replaced with Temporary Assistance to Needy Families (TANF) as part of the 1996 Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA). PRWORA eliminated the entitlement feature of cash assistance to poor families. Alongside this dismantling of the traditional welfare system has been the increasing reliance on the tax system as a means of providing cash support for needy families. A series of tax acts starting with the 1986 Tax Reform Act have increased assistance to the working poor through expansions of the Earned Income Tax Credit (EITC). In 2003, more than 21 million families are estimated to have benefited from the tax credit, at a total cost to the federal government of more than 37 billion dollars (U.S. Treasury 2004).1

It is widely accepted that the Earned Income Tax Credit (EITC) raised the employment of eligible women with children. Empirical evidence consistent with economic theory suggests that the EITC has been especially successful at promoting employment among eligible unmarried women with children (Eissa and Liebman 1996, Meyer and Rosenbaum 2000). In fact, the labor force participation rate of single mothers increased by an astounding 14 percentage points between 1989 and 2002, a period of substantial expansions in the size of the EITC. It is also generally accepted that the credit has been successful in reducing poverty (see Hotz and Scholz 2003). Census data indicate that the EITC removed almost five million people (over half of whom were children) from poverty in 2002, more than any other government program (Llobrera and Zahradnik 2004). These estimates reflect the intent of the 1994 EITC expansion to lift full-time workers earning the minimum wage out of poverty.

This paper reviews the effects of expansions in the EITC on labor market outcomes across demographic groups, and argues that the employment effects raise the question of the incidence of the EITC on wages.

Notes from this section of the report

1. By comparison, federal spending on Temporary Assistance to Needy Families (TANF) stands at about 18.6 billion dollars (Hotz and Scholz 2003).

Note: This report is available in its entirety in the Portable Document Format (PDF).



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