A Tax Credit Encourages Work. But What Is That Worth?

(Bloomberg Opinion) -- Here’s an Econ 101 lesson: If you want less of something, tax it. If you want more of something, subsidize it.

Today many, including me, are concerned about the low rates at which people participate in the U.S. labor force. Basic economics suggests addressing that concern by subsidizing employment.

The federal government and many state governments already do this through a program called the earned-income tax credit, or EITC. It is well designed. It supplements earnings from employment, so EITC payments go only to working households. Unlike the minimum wage — which applies to most workers, not just low-income workers — the EITC is based on household income rather than the earnings of any individual household member. This ensures that its benefits are targeted at lower-income households. Over the lowest range of earnings, the more you work, the more generous the credit. This increases the financial reward from working, and encourages people to enter the labor force.

The EITC is intended to encourage employment among low-income households. Does it work?

Yes. Research shows that previous expansions of the EITC have significantly increased employment rates. And earnings from paid employment, along with the credit itself, lift millions of people, including several million children, out of poverty each year.

Among economists, this is not in dispute. Economists share a strong and striking consensus that EITC expansions have led to significant increases in employment rates among targeted populations. But surprisingly, outside of economists, I am confronted with some regularity by policy experts who question this consensus and who doubt the claim that an expansion focused on men without dependent children in the home — a group with troublingly low employment rates — would increase their participation in the workforce.

MDRC, a research organization that runs large-scale demonstrations to evaluate policies, worked with New York City and Atlanta to test exactly this. Would a bonus of up to $2,000, given at tax time to low-income working adults without dependent children, reduce poverty and pull more of these individuals into the workforce?

The test, called Paycheck Plus, is designed to mimic an expansion of the EITC for this group, which is currently eligible for a maximum federal credit of only about $500. (The maximum federal credit for households with three or more children is around $6,400.) Paycheck Plus also offers a bonus for workers without kids who earn up to about $30,000 per year. In contrast, if you earn more than around $15,000, you are ineligible for the federal EITC.

MDRC recently released findings for three years of Paycheck Plus in New York. The bonus reduced severe poverty among participants and increased child support payments from them. The effects on employment were more modest than I would expect. But an actual EITC expansion would most likely have a stronger effect on employment than would a demonstration project.

And employment did increase. In Paycheck Plus’s final year in New York — by which time participants were more likely to understand the program and view the bonus as legitimate — the average annual employment rate among participants increased by 2.1 percentage points. That’s a solid boost.

Women increased their employment in response to the bonus. Overall, male participants did not. Given low employment rates among men without dependent children, this is discouraging. But among the subgroup of men who had been incarcerated or who were noncustodial parents ordered to pay child support, Paycheck Plus increased employment rates by a whopping 10 percent in the final year of the program.

These men face significant barriers to work, and Paycheck Plus suggests an expanded EITC might serve as a ladder of opportunity into employment for them.

Such ladders are likely to be increasingly necessary. As technology marches forward, workers with more skills — who can use technology to be more productive — will see their wages continue to increase, and lower-skilled workers will see their relative wages stagnate or fall. Low wages keep lesser-skilled individuals out of the labor market. The trends of the past several decades could continue, and even accelerate.

Americans will be under stronger pressure to decide on principle whether employment in itself is a good thing – and if so, how vigorously public policy should encourage it. Are we comfortable with the federal government providing, say, half of the financial rewards from working? Or more? What if that is what’s necessary to attract a large share of people without a college degree into the workforce?

The EITC uses social resources to encourage work and to help keep working households out of poverty. Paycheck Plus suggests that the EITC can help people who face particularly strong barriers to employment to find jobs and earn their own success. If wage growth does not accelerate for all income groups over the coming years, a growing battle line in public policy may be just how important work is, and how many resources should be committed to supporting it.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”

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