Income-maintenance policy: wage subsidies and tax credits The U.S. Earned Income Tax Credit (EITC) has been described

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Income-maintenance policy: wage subsidies and tax credits The U.S. Earned Income Tax Credit (EITC) has been described as one of the most successful elements of U.S. antipoverty public policy, especially as it directs benefits towards the poor. Low-wage workers receive additional income (through a tax credit) from the federal government, depending on how much they earn each year.

Consider these program features that define an individual worker’s eligibility: i) There is no tax credit if no labour market income is earned. ii) Phase-in range: the tax credit equals $0.35 per dollar earned, and peaks at $3000, when the worker earns $9000. iii) Flat range: the tax credit remains at $3000 until the worker earns around $16,500. iv) Phase-out range: the tax credit is phased out gradually, by $0.15 per dollar earned, until eliminated completely if the worker earns $35,500 or more per year.

Part (a). Assuming the worker does not receive any non-labour market income, graph the budget constraint associated with the EITC for a typical worker earning W per hour.

Hints. Do not put too much emphasis on drawing a constraint line that precisely reflects this numerical data. Focus instead on producing the correct shape and labeling the key values along the two axes as well as the budget constraint (in terms of total income earned and number of hours worked). There are kinks involved in this budget constraint.

Part (b). Analyze how the imposition of the EITC affects hours of labour supplied. Assuming that substitution effects are larger than income effects for the typical low- wage worker, does the credit necessarily increase hours of work for all those who are eligible? Why or why not? Assume non-labour market income is very low (close to zero).

Part (c). Analyze the impact of the EITC on an individual’s labour force participation decision, assuming that the individual was not working in the absence of the EITC. Assume non-labour market income is very low (close to zero).

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