Suppose a country wants to introduce an earned income tax credit (EITC) for single mothers with children. It plans to implement it in the following way:

- For earnings below $5; 000; a tax credit of 20 percent can be claimed;

- For earnings between $5; 000 and $10; 000, a tax credit of 40 percent can be claimed;

- For earnings above $10; 000 the tax credit is phased out at a 10 percent tax rate

(a) Show graphically how the budget constraint changes after the introduction of the earned income tax and explain your reasoning. Clearly mark all the important points in your graph.

(b) Using the basic static model of individual labour supply, predict what will happen after the introduction of the earned income tax to

(i) labour force participation of single mothers with children;

(ii) labour supply of single mothers with children that earn below $5; 000 without the EITC (but are working);

(iii) labour supply of single mothers with children that earn between $5; 000 and $10; 000 without the EITC;

(iv) labour supply of single mothers with children that earn above $10; 000 without the EITC. Explain your answer in each case.

Answer rating: 100% (QA)

a The graph below shows the budget constraint of a single mother with children before and after the introduction of the earned income tax credit E IT ... View the full answer