Question

1. Explain why, if you measure poverty according to the Supplemental Poverty Measure, the Earned Income Tax Credit (EITC) reduces poverty the most of any program except for Social Security, but if you measure poverty according to the Poverty Gap, the EITC is less effective at reducing poverty. (15 points)

2. In the paper “The EITC and the Extensive Margin: A Reappraisal,” Kleven says that the increases in the EITC in the mid-1990s did not increase the employment rates of mothers as much as had previously been thought. Give at least one of the pieces of empirical evidence Kleven relies on for that claim. (5 points)

Answer 1

​​​​​​Official estimates of poverty compare the before-tax cash income of families of various sizes and compositions with a set of thresholds. The official poverty measure excludes the effect of federal tax and noncash transfer programs on resources available to the family. Thus, although the EITC adds income to poor households, it does not change the official number of those living in poverty.

Reducing poverty by encouraging work

Substantial research confirms that the EITC encourages single people and primary earners in married couples to work . The credit, however, appears to have little effect on the number of hours people work once they are employed. Although the EITC phaseout could cause people to reduce their work hours there is little evidence that this actually happens.

The most recent relevant study found that a $1,000 increase in the EITC led to a 7.3 percentage point increase in employment and a 9.4 percentage point reduction in the share of families with after tax and transfer income in poverty . If this employment effect were included in census estimates of poverty reduction , the number of people lifted out of poverty would be much greater.

The earned income tax credit (EITC) will provide maximum credits ranging from $538 for workers with no children to $6,660 for workers .