The Earned Income Tax Credit as an Incentive to Report: Engaging the Informal Economy through Tax Policy

Abstract

The Earned Income Tax Credit (EITC) provides financial assistance to low-income workers through a refundable tax credit. The EITC, which has received strong bipartisan support since its introduction in 1975, now represents the nation's largest anti-poverty program for non-elderly individuals. In this Note, I contend that the EITC's historical development failed to account for (and prior scholarly analysis of its impact on labor supply decisions have ignored) the important role of informal employment in the lives of the working poor. This Note presents the first analysis of the financial impact of government transfer and tax programs on the decision to report informal income¿income that, were it reported, would be otherwise legal. As the Note's analysis reveals, while drastic changes in both tax and transfer programs may be necessary to provide financial incentives for many households with children to report informal income, more targeted changes to the EITC could provide strong incentives for childless informal workers to report. The Note argues that the benefits to both individuals and society, financial and otherwise, of tax reporting by low-income individuals engaged in informal work merits reconsideration of the EITC's overall structure and administration. Administrative and policy innovations, described in the Note, are also necessary to maximize reporting compliance.

Keywords: EITC, informal economy, tax policy, law and economics, poverty law

JEL Classification: K34, 017, I38