Policy Studies Economic Mobility

Local labor markets and the federal Earned Income Tax Credit

The attached policy study was co-authored by Zackary Hawley.

The Earned Income Tax Credit (EITC), which offers relief from federal income-tax payments for a targeted group of taxpayers, is based on national income limits and the presence of dependent children. Benefits determinations are made with a flat national maximum level of assistance. The EITC is extended to nearly 29 million families and costs the U.S. Treasury about $64 billion annually.

While the EITC uses national parameters to determine eligibility and benefits, the U.S. labor force is dispersed among a series of disparate labor markets in metropolitan areas. Each market within each geography has unique characteristics, with vastly different wage distributions and costs of living. The unique characteristics of local labor markets make the unyielding nature of a national EITC far less effective to induce labor-force changes in high-cost areas, and much more effective in low-cost areas.

In this paper, we demonstrate that, while 20 percent of U.S. residents claim the EITC, the rate of claims differs vastly by metro area. EITC claim rates range from 5.5 percent in Los Alamos, New Mexico, to more than 50 percent in Rio Grande City, Texas. A primary contributor to these differentials is the difference in the credit’s real value across areas with different costs of living. The real value of the maximum EITC for a single taxpayer with one child ranges from $4,131 in Harlingen, Texas, to $1,531 in New York City.

The EITC’s national income limits for eligibility and its phase-out range induce varying labor-market incentives across markets with different wage distributions. The national parameters treat similar workers differently when they live in different areas. Consider a typical single parent working as a dishwasher in San Francisco; she will be subject to the phase-out of benefits after working 1,688 hours, while that same dishwasher in Brownsville, Texas won’t face this tax until working 2,190 hours.

Adjusting the value of the EITC for local labor-market and cost-of-living conditions would provide a way to target credit expansion to the most needy and induce a larger labor-market response. Changing the EITC to adjust for real purchasing-power differences could be set to maximize the policy’s employment impact across labor markets by reducing implicit marginal tax rates. Our simulations show that, to induce a 6-percentage-point increase in the labor-forceparticipation rate of eligible taxpayers, the maximum EITC for single parents in New York City would need to be $9,905, while a credit of $5,897 would induce the same response in Memphis, Tennessee.

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