Optimal Design of Earned Income Tax Credits: Evidence from a British Natural Experiment

Abstract

With many countries considering the adoption of a system of earned income tax credits, it is useful to analyze how different types of credits affect labor supply and earnings. This paper focuses on a 1999 reform to the UK tax credit system, which increased the value of the credit and reduced the phase-out rate. Using panel data, with individual fixed effects, I compare eligibles and ineligibles within five groups: all individuals; those whose demographic characteristics predict that they will have low earnings; single women; women in couples; and men in couples. The short-term effect of boosting the credit was to raise the labor participation rates, hours, and earnings of those who were eligible for the credit. The reform also reduced the fraction of people who said that they had a serious health problem, or that a health problem prevented them from working.

Keywords: Working Families' Tax Credit, Earned Income Tax Credit, wage subsidies, labor supply, earnings, self-reported health status

JEL Classification: C23, H21, H31, I18, I38, J22