Incentive Overlaps: Examining the Influence of the EITC on Labor Supply Responses to Wage Shocks

• In Event: Gender, Taxation, and Labor Markets

Abstract

This study examines how the Earned Income Tax Credit (EITC) affects individuals’ labor supply responses to wage shocks. A theoretical framework is developed to investigate how EITC-eligible individuals adjust their labor supply to optimize benefits in response to both positive and negative wage shocks. The analysis reveals that the EITC amplifies labor supply sensitivity among low-income earners, intensifying the effects of wage fluctuations, while dampening sensitivity for higher-income earners. Empirical evidence, leveraging the 1993 EITC expansion as a policy variation and case studies including local economic booms, the China trade shock, and minimum wage increases, supports these predictions. The findings, particularly among single women, highlight the EITC’s dual role in shaping labor market dynamics—heightening vulnerability to wage shocks at lower income levels while stabilizing labor supply for higher earners. This research offers valuable insights for designing income support policies to safeguard vulnerable populations during economic fluctuations.

Author

• Qilu Pan, Purdue University