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Impact of the Tax Reform Act of 1986 (TRA86)

• The study examines the impact of the Tax Reform Act of 1986 (TRA86) on single women with children's labor force participation and hours of work.
• TRA86 included an expansion of the Earned Income Tax Credit (EITC).
• The impact of TRA86 is identified by comparing the change in labor supply of single women with children to the change for those without children.
• Single women with children increased their relative labor force participation by up to 2.8 percentage points between 1984-1986 and 1988-1990.
• There was no change in the relative hours worked by single women with children already in the labor force.

Historical Context and the EITC

• Historically, the United States provided a safety net for families with children, starting with Aid to Families with Dependent Children (AFDC) in 1935.
• AFDC supplied cash welfare payments to needy single-parent families.
• Families on AFDC may also receive food stamps, Medicaid, and housing assistance.
• Static labor supply theory predicts that the welfare system discourages labor force participation and hours of work for single parents.
• Empirical evidence mostly confirms these theoretical predictions.
• The EITC emerged as a popular alternative for transferring income to needy families with children, with major expansions beginning in 1987.
• The EITC is a refundable credit, meaning any excess over tax liability is refunded to the taxpayer.
• In 1996, the maximum credit was scheduled to reach $2206 for a taxpayer with one child and $3644 for a taxpayer with two or more children.
• Advocates argue that the EITC transfers income to the working poor with less distortion of labor supply compared to other welfare elements and encourages labor force participation.

EITC's Complex Labor Supply Incentives

• The EITC creates a complicated and ambiguous set of labor supply incentives.
• Standard labor supply theory predicts that the EITC will generally encourage labor force participation.
• Theory also predicts that the credit reduces the number of hours worked by most eligible taxpayers already in the labor force.
• The credit initially increases with income, producing offsetting income and substitution effects on hours worked.
• Over 70% of recipients have incomes in regions in which the credit is constant, producing only a negative income effect on labor supply.
• Phase-out regions produce negative income and substitution effects.
• The phaseout of the credit produces a nonconvexity in the budget constraint, leading some taxpayers beyond the phaseout region to reduce work hours.
• Cumulative marginal tax rates can be quite high in the phaseout region; in 1996, some taxpayers with two children and income between $11,610 to $28,495 faced a net marginal tax rate of 53%.

Analysis of TRA86 and EITC

• The study examines the impact of the Tax Reform Act of 1986 (TRA86), which included an expansion of the EITC, on labor force participation and hours of work.
• The expansion of the credit affects single women with children, but has no predicted effect on single women without children.
• Other features of TRA86, such as the increase in the value of dependent exemptions and the increase in the standard deduction for head of household filers, reinforced the impact of the EITC.

EITC Structure

• The earned income tax credit began in 1975 to offset the social security payroll tax for low-income families with children.
• After major expansions in 1986, 1990, and 1993, the EITC became a central part of the federal government's antipoverty strategy.
• Federal spending on the EITC (including tax expenditures and outlays) is projected to be 1.7 times larger than federal spending on AFDC by 1996.
• To be eligible for the EITC, a taxpayer must have positive earned income.
• The taxpayer’s adjusted gross income and earned income must both be below a specified amount ($28,495 in 1996 for taxpayers with two or more children).
• A taxpayer must have a qualifying child (child, grandchild, stepchild, or foster child under 19, or under 24 if a full-time student, or permanently disabled) who lives with the taxpayer for more than half the tax year.
• The credit is refundable, so a taxpayer with no federal tax liability would receive a tax refund from the government.
• Taxpayers may also receive the credit throughout the year with their paychecks.
• Less than 0.5% of all EITC recipients availed themselves of this early payment option in 1992.
• The amount of the credit depends on the taxpayer's earned income, adjusted gross income, and the number of EITC-eligible children in the household.
• In 1996, the credit for a family with two or more children is phased in at a 40% rate over the first $8890 of earned income, resulting in a maximum credit of $3556.
• As income rises from $8890 to $11,610, the credit remains at $3556.
• The credit is phased out at a 21.06% rate on income starting from $11,610 (the maximum of AGI and earned income governs the phaseout), so that by $28,495 the taxpayer is no longer eligible for the credit.

Impact of Introducing the EITC

• The introduction of an EITC shifts the budget constraint of an otherwise untaxed individual.
• Every choice of work hours produces at least as much after-tax earnings (and utility) as it did before the earned income tax credit.
• A taxpayer who does not work has no change in well-being because no earned income tax credit is available with zero earnings.
• Any taxpayer who preferred working before will still prefer working, and some may find it worth entering the labor force.
• The impact of the EITC on the labor force participation of unmarried taxpayers is unambiguously positive.
• The impact of introducing the EITC on the hours of work of an already participating taxpayer depends on which region of the EITC the taxpayer was in before the credit.
• For a worker in the phase-in region, the effect on labor supply is theoretically ambiguous, as there are offsetting income and substitution effects.
• For workers in the constant region, there is only an income effect, reducing hours.
• In the phase-out region the EITC unambiguously reduces labor supply due to substitution and income effects.
• Beyond the credit region, taxpayers may reduce work hours to receive the credit.

Identification Strategy

• The study examines the labor supply response of single women with children to the 1987 expansion of the earned income tax credit, part of the Tax Reform Act of 1986.
• Single women with children are the largest group of taxpayers eligible for the EITC, making up 48% of the eligible population in March 1992.
• This group is most relevant for studying whether the EITC reduces welfare dependency.
• The single parent situation helps makes the assumption that joint labor supply decisions of other family members can be ignored.
• The 1987 expansion of the credit was the largest EITC expansion that was not phased in over several years
• The incentives created by the 1987 EITC expansion were reinforced other tax changes of TRA86.
• The 1987 expansion of the EITC increased the subsidy rate for the phase-in of the credit from 11% to 14% and increased the maximum income to which the subsidy rate was applied from $5000 to $6080.
• The maximum credit increased from $550 to $851 ($788 in 1986 dollars).
• The phaseout rate was reduced from 12.22% to 10%.
• The higher maximum credit and the lower phaseout rate expanded the phaseout region.
• Taxpayers with incomes between $11,000 and $15,432 became newly eligible for the credit and faced its phaseout marginal tax rate in 1987.
• The constant region was lengthened in 1988, further extending the phaseout region to $18,576.
• The EITC amount after the expansion was at least as large as before at every earnings level.
• Theory predicts that labor force participation of eligible taxpayers will increase in response to the expansion.
• The positive impact of the EITC expansion was reinforced by elements of the Tax Reform Act of 1986: increased standard deduction for head of household filers from $2480 in 1986 to $4400 in 1988 and for single taxpayers from $2480 to $3000
• TRA86 reduced the tax liability of taxpayers with children by increasing the deduction per dependent exemption from $1086 in 1986 to $1950 in 1988
• Tax schedule changes were beneficial to to head of household filers, who did not jump from the 15% tax bracket to the 28% tax bracket until their AGI exceeded $33,565 in 1988, singles began paying 28 percent on AGI over $22,800
• The predicted impact of the EITC expansion is to increase labor force participation but decrease working house. Single women with children who are already in workforce may decrease hours for most eligible taxpayers.
• The estimation strategy compares the labor force participation and hours worked of single women with children before and after TRA86.
• Most single women with children are eligible for the EITC (if they have appropriate incomes), and if they file tax returns, they usually file as household heads.
• The "treatment" in this natural experiment is not a specific change in tax liability, but the entire shift in the budget constraint.

Control Groups for EITC Studies

• Control groups are used since there may be underlying trends in participation or hours of work, as well as other policy or economic shocks that affect labor market outcomes.
• A good control group is similar in characteristics to the treatment group, responding similarly to underlying trends or contemporaneous shocks, but not receiving the treatment.
• Eligibility for the EITC depends on the presence of a child in the tax unit and on income being above zero and below complete phase-out.
• Increased EITC may affect taxpayers with incomes beyond the level at which credit phases out, as they reduce hours (and incomes) and take advantage of the increased credit.
• All single women with children are used as the primary treatment group, and all single women without children are the control group.
• The change in labor force participation difference between single women with children and single women without children is the estimate of TRA86 on particiaption.
• This is the difference-in-differences approach, controlling for any contemporaneous shocks to the labor force participation of single women with children through the change in participation for the control group.
• Identifying assumptions: 1) no contemporaneous shocks (other than the tax changes) to treatment/control group labor market outcomes over the reform period; 2) no difference in participton or work hours in the two groups.

Further Refinements of the Data and Findings

• The study includes taxpayers (those with high incomes) unlikely to be affected by the EITC, also increasing the importance of non-EITC aspects of TRA86, as said effects were larger incomes beyond the phaseout
• Focus on low-income families also requires focusing on the credit impact: alternative treatment groups include single women with children and low levels of education/predicted would have earned incomes making them eligible for the EITC.
• Each treatment group has two control groups: single women without children and with low levels of education (predicted income in the EITC range) and single women with children and more than high school education
• The advantages of control groups are that if similar results are found, estimation of effects is more acurate.
• Data is from March Current Population Surveys from 1985 to 1987 and 1989 to 1991; since March CPS includes labor market/income data from the previous year, data has is for tax years 1984 to 1986 and 1988 to 1990.
• 1987 excluded to allow taxpayers time to adjust their behavior to TRA86
• CPS contains information on households, families and individuals.
• Tax-filing unit is unit of analysis.
• The sample has unmarried females (widowed, divorced, never married) who are between 16 and 44 years old; any female separated from her spouse, who was ill/disabled, or in school full time in the year prior are excluded
• Also excluded are women with negative earned income/unearned income, or with positive earned income but zero hours of work.
• Overall sample size is 67,097 observations.
• Table I has summary statistics of the charateristics of the treatment and control groups.
• There are differnences between the groups: those with children tend to be older, are less educated, and less likely to hav been in workforce.
• Average earnings are less for women with children than those without, but similar conditional on working.
• Differences can reflect non-tax shocks that affect people with some characteristics differently from others.

Empirical Results for Labor Force Participation

• Table II presents labor force participation rates for the treatment groups/control in years before/after the Tax Reform Act of 1986
• Labor force particiaption involves working a posititive number of hours during the year
• The predicted impact of the EITC is unambiguous.
• A: The participation rate of the treatment group increased by a statistically 2.4 percentage points.
• There was no change in labor force participation the control group.
• Absence is important because it suggests there is not much of an aggregate effect
• To further examine whether the EITC caused participation rate of female household heads to ruse, the subset of females with children who were most likely to, those with low education levels, were examined.
• B presents participation rates for for women with children/less than high school education, compared with women with that level of education, no children, and more educated women with children
• The participation rate before TRA86 = 47.9% for women with children/less than high school education compared with 78.4% for women less than children and 91.1% for women more than children.
• After TRA86, there was an increase in participation rate of 1.8 pp for the ''less than high school" group, there also was a 2.3 pp dorp for the control group.
• Figures suggest participation repsosne of 4.1 percentage points.
• Panel C reports for those with 12 uears and the number of estimates.
• Results suggest the l labor force participation of unmarried heads of households increased following the Reform Act of 1986.

Regression Results: Overview

• The observed differences in participation outcomes may reflect underlying differences between groups rather than a treatment effect, as treatment and control groups differ demographic characteristics.
• Reducing residual variance and producing more efficient estimates requires controlling for said characteristics within the difference-in-differences approach.
• Interacting characteristics with a time dummy will give reduced chance that affects will produce a false treatment effect
• We estimate the PROVIT equation with
• P(lfpit = 1) = Φ(α + βZit + Yotreatment; + Y₁post86, + y2(treatment × post86)it)
• lfp is a dummy =1 if women reported working for the last hour; Zit is a factor of unearned income variables, treatment has controllaed differecnes variable.
• To evaluate the EITC impact, women w/children increased participation after their group relative to others.
• Results replace treatment in equation 1 =kids-sample/unmarried women. The first column excludes demographics/2nd includes.
• The result is changes by dramatically once demographic characteristics included.
• Some results were only suggestive that having a child reduces labor force participation even controllaing for observale deomgrpahoc variabiles / unovsebrvalr diffs adorss grpups.

More In-depth Analysis of Regression Results

• The porbit is a non-linear model: effects cannot be directly used.
• Effects are calculated through both interaction variables: one set to one/zero Effect is the average over the sample of post women.
• C: Basis is both pacticpaiton/regresseions is that labor force participation of single W/children consistent with TRA86 positive impact on labor force.
• The long run trends are for all unmarried females ages 16-44 between 1981-1992 in terms of partiapction.

Discussion of the Alternative Explanations For Data:

• Increased labor force particiaption should be a result between 1960-1970.
• Macroecmonic factors contribute with unemplyment and decrease with EITC impact.
• Some non-white women may induced labor force that we may not capture from impacts from TRA 86.
• Unemployment rate correlated with state unemploymrnt and time.
• Interactions for rate show women are less sensitive to the buienss cycles.

Overall Summary

• Three peices of evidence increase likely hood of observation:
• increase is response for first child, as its not additonal benefits for more.
• Timing of post increase = consistent due EITC- most increase comes late.
• The EITC has most affect among people likely eligible for the credits.

Further Analysis on EITC

• There needs to be more insight and better design.
• Important overall- EITC had to be the effect among with had it.
• In depth - hours overall decrease the affect that EITC women could and should recieve.

Impact of the EITC on Hours Worked: Baselines

• Results earlier indicated the increase with related to the EITC- expansion has reduced worked already int he work source.
• 2. Annual Hoursit= α + βZit + Yokids; + Y₁post86, + y2(kids × post86) it + &it- (Demographic variable is to the specifications.)
• Distribution will cause impacts and alter distribution.
• Cannot provide with the shifts and attempts as they can depend on specifications by other and new ones within this context.

EITC Impact

• Table V (1) the coefficients for interaction and hours are the most impact . (Less than high school) almost no charge to single woman with children.