TAX CREDITS & LABOUR SUPPLY

QUESTION: What are the theoretical and empirical

effects of the Working Family Tax Credit on hours worked and labour force participation?

What problems have researchers encountered when estimating labour supply responses? How have they solved them?

OUTLINE Working Family Tax Credit (WFTC)

Introduction Theoretical & Empirical Impact: Increased LFPR

3 methods of evaluation – problems and solutions SSP, Canada: Natural Experiment (Card & Robbins,

1996) EITC, US: Diff-in-diff (Eissa & Liebman, 1996) WFTC, UK: Modelling and computer simulation

(Blundell, 2001; Brewer et al, 2006)

WORKING FAMILY TAX CREDIT

In-work means-tested benefit for families with children One adult working min 16 hours Threshold: £90 per week Benefit reduction rate: 55% Inclusion of childcare credit: 70% of childcare costs

Similar to EITC in the US Difference: eligibility criteria, phase-in rate

Introduced in 1999, replaced Family Credit (1980) Increased generosity: ↑ threshold, ↓ benefit reduction

rate, childcare costs

THEORETICAL IMPACTMOVING FROM FC TO WTFC

Group Theoretical

Non-working households

LFPR↑ (SE)

Single parents on benefit

Ambiguous effect on hours worked (↓ due to IE; ↑ due to SE)

Newly eligible single parents

Hours worked ↓ (SE, IE)

Second earners of couples on benefit

Ambiguous effect on hours worked (↓ due to IE; ↑ due to SE)Could lead to LFPR↓

Second earners of newly eligible couple

Hours worked ↓ (SE, IE)Could lead to LFPR↓

EMPIRICAL IMPACT

Hours worked for married women (partner working): – 0.18 hours

Brewer et al (2006): + 5.5% for single parents +0.06% and +2.1% for married women and men

(partner not working)

#1 EXPERIMENT, CARD & ROBBINS (1996) - SELF SUFFICIENCY PROGRAM (CANADA) Population: ~6000 single parents who have

received welfare for at least 12 months Treatment Group: half of the population

selected to take part in the SSP, which lasted for 3 yrs

Participation conditional on working full-time (>30 hours) and not receiving income assistance within a year of being offered the SSP

Compare outcomes for T and C groups to isolate labour supply responses due to SSP

EFFECT OF SSP ON FULL TIME EMPLOYMENT(CARD & ROBBINS, 1996)

SELF SUFFICIENCY PROGRAM (CANADA)IS THE EVALUATION SOUND?

YES

• Random Assignment – C and T are not systematically different

NO (Problems)

• Non-compliance of treated (only 30% participated) – introduce new selection bias? • Solution: Control for demographic characteristics

• Differential rates of response for T and C group, and rates vary by treatment status and employment status • Solution: Assign different types of individuals

different weights to get a more representative sample

#2 DIFF-IN-DIFF, EISSA & LIEBMAN (1996) - EARNED INCOME TAX CREDIT (US)

YES

• T1: Single mothers, C1: Single women. LS responses are due solely to EITC if parallel trends assumption holds

NO (Problems)

• Parallel trends assumption doesn’t hold• Solution: Use 2 alternative treatment groups: • T2: Low education single mothers, T3: Single mothers

who are likely to be eligible for EITC. • C2: Low ed single women, C3: single mothers with

more than high school ed• Control for demographic characteristics (age, income

etc.)

• Switching from C to T – single women incentivized to have children to be eligible for EITC

#3 MODELLING & SIMULATING, BLUNDELL (2001), BREWER ET AL (2006) - WFTC

Discrete choice structural approachCareful modelling of each individual’s budget constraint

Simulate budget constraint for each individual Accounts for taxes, benefits, childcare costs and other fixed costs

Careful modelling of preferences for different groups – single parents and couplesData: Family Resources Survey from 1995-2003

WORKING FAMILY TAX CREDIT (UK)IS THE EVALUATION SOUND?

YES

• Able to isolate impact of WFTC from all other changes in tax and benefits

NO (Problems)

• Wages of non-workers not observed • Solution: infer wages from set of similar workers or

use wages of similar new entrants • Other functional form assumptions

CONCLUSION

On the whole, there is consensus amongst researchers that WFTC and other tax credit schemes increase work incentives among low-income

However, determining the exact magnitude of the impact is tricky due to selection bias, presence of confounders and other research problems

Compare estimates with other studies to strengthen one’s case