Tax Reforms and Labor Force Participation of Married Women

Economics Students Association seminar

The presentation is based on “To Work or Not to Work: Did Tax Reforms Affect Labor Force Participation of Secondary Earners?” by:

Michael Bar and Oksana Leukhina

2

The Tax Panic

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1960 1965 1970 1975 1980 1985 1990 1995 20000

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Year

Fra

ctio

nLabor Force Participation of Married Couples

% 1F

% 1M

% 2E

Labor Force Participation in U.S.

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Questions

• How did taxes reforms affect the households’ decisions to participate in the labor market?

• Is the U.S. tax system progressive?

• What are the effects of various tax laws on household’s behavior?

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Plan

1. Visualizing tax laws (using TAXSIM)

2. Case study: Earned Income Tax Credit

3. New methodology for studying the effects of taxes

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Federal Income Taxes in 2006

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Example (singles)

• Suppose that your taxable income in 2006 was $70,000. How much federal income tax should you pay?

058,14$sum

)650,30000,70%(25

)550,7650,30%(15

)550,7%(10

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Major Tax Reforms in the Federal Income Tax Code

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Major Tax Reforms in the Federal Income Tax Code

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Taxes Are More Complicated Than That

• Federal Income Tax

• FICA (Federal Insurance Contributions Act tax):O Social Security: 6.2% up to a limit of $94,200O Medicare 1.45%

• State Taxes

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Visualizing FICA Taxes

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Visualizing the Federal Income Tax

• Much more complicated than FICA

• All sorts of deductions that depend on age, number of children, mortgage, etc.)

• Need to look at actual returns to see how much people paid – TAXSIM (Tax Simulator).

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TAXSIM http://www.nber.org/~taxsim/

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Computing Tax Returns With TAXSIM

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Using TAXSIM to Visualize the Federal Income Taxes

Effects of Earned Income

Tax Credit

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Earned Income Tax Credit

• Wage subsidy for low-income workers.

• EITC is the largest poverty reduction program in the United States

• EITC enjoys broad bipartisan support.

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Earned Income Tax Credit

REAL FEDERAL SPENDING ON THE EITC, CHILD CREDIT, AND WELFARE (AFDC/TANF), FY 1976-2010

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

In B

illio

ns

of R

ea

l 20

05

Do

llars

EITC Child Credit AFDC/TANF

Notes: "AFDC" = Aid to Families with Dependent Children; "TANF" = Temporary Assistance to Needy Families. EITC and CTC aggregate amounts include both outlays and receipts. Sources: FY 2000-2006 U.S. Budgets and IRS Statistics on Income data.

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EITC Parameters

Earned Income Tax Credit for 2007(Married filing jointly)

0500

100015002000250030003500400045005000

0 10000 20000 30000 40000

Adjusted Gross Income

EIT

C

2 child.

1 child.Phase in

Plateau

Phase out

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EITC Incentives for Married Couples

Husband’s Income

Wife’s Income

Total Federal Tax Liability (2007)

Average Tax Rate on Wife’s Income

$20,000 0 - 4,027.34 ------

$20,000 $20,000 1,572.5 28%

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Comparison to a Single Earner

Single Earner’s incomeTotal Federal Tax Liability (2007)

$100,000$19,660.75

(Or 19.66% of income)

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New Methodology: Combining TAXSIM With an Economic Model• Write down an economic model with many married

couples, that earn income and make joint participation decisions.

• File taxes for all the couples in the model, and let the couples choose who goes to work (husband, wife, both).

• Change the tax laws (the year of the tax code) and see how the couples in the model respond to changes in taxes.

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Filing tax Returns for Many Couples

0.5 1 1.5 2 2.5 3

x 104

0.5

1

1.5

2

2.5

3

x 104

wm

wf

Using TaxSim with our model

1F2E

1M

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Effects of Taxes on Participation of Married Couples

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5

x 104

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5x 10

4 Decision Rule Thresholds, Labor Income < $50,000

Husband's Labor Income (1999 $)

Wife

's L

ab

or

Inco

me

(1

99

9 $

)

60L60U69L69U79L79U89L89U99L99U

2E

1F

1M

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Effect of EITC Reforms on Participation

0 0.5 1 1.5 2 2.5 3

x 104

0

0.5

1

1.5

2

2.5

3x 10

4 EITC Reforms, Labor Income < $30,000

Husband's Labor Income (1999 $)

Wife

's L

ab

or

Inco

me

(1

99

9 $

)

69L69U79L79U89L89U99L99U

2E

1F

1M

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Summary

• It is possible to combine the realistic tax laws with economic models (using TAXSIM).

• Taxes in the U.S. changed a lot, but these changes had little effect on the total Labor Force Participation of married couples.

• Our results suggest that the EITC might have decreased the labor force participation of wives married to low-earning husbands.