Working Paper: NBER ID: w18232
Authors: Raj Chetty; John N. Friedman; Emmanuel Saez
Abstract: We develop a new method of estimating the impacts of tax policies that uses areas with little knowledge about the policy's marginal incentives as counterfactuals for behavior in the absence of the policy. We apply this method to characterize the impacts of the Earned Income Tax Credit (EITC) on earnings using administrative tax records covering all EITC-eligible filers from 1996-2009. We begin by developing a proxy for local knowledge about the EITC schedule -the degree of "sharp bunching"at the exact income level that maximizes EITC refunds by individuals who report self-employment income. The degree of self-employed sharp bunching varies significantly across geographical areas in a manner consistent with differences in knowledge. For instance, individuals who move to higher-bunching areas start to report incomes closer to the refund-maximizing level themselves, while those who move to lower-bunching areas do not. Using this proxy for knowledge, we compare W-2 wage earnings distributions across neighborhoods to uncover the impact of the EITC on real earnings. Areas with high self-employed sharp bunching (i.e., high knowledge) exhibit more mass in their W-2 wage earnings distributions around the EITC plateau. Using a quasi-experimental design that accounts for unobservable differences across neighborhoods, we find that changes in EITC incentives triggered by the birth of a child lead to larger wage earnings responses in higher bunching neighborhoods. The increase in EITC refunds comes primarily from intensive-margin increases in earnings in the phase-in region rather than reductions in earnings in the phase-out region. The increase in EITC refunds is commensurate to a phase-in earnings elasticity of 0.21 on average across the U.S. and 0.58 in high-knowledge neighborhoods.
Keywords: EITC; Tax Policy; Neighborhood Effects; Earnings; Income Distribution
JEL Codes: H26; H31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Neighborhood knowledge about EITC (R23) | Wage earnings (J31) |
| Higher self-employed sharp bunching (L84) | More mass in W-2 wage earnings distributions (J31) |
| Moving to higher-bunching areas (R23) | Report incomes closer to refund-maximizing level (H31) |
| Moving to lower-bunching areas (R23) | Do not report incomes closer to refund-maximizing level (H26) |
| Increase in EITC refunds (H26) | Intensive margin increases in earnings in the phase-in region (J31) |
| EITC (H26) | Raised net incomes significantly at the low end of the income distribution (D31) |
| EITC eligibility (H31) | Decrease in the fraction of EITC-eligible wage earners below the poverty line (H31) |
| Increase in knowledge about EITC schedule (H26) | Fall in poverty rate (I32) |
| Changes in EITC incentives triggered by the birth of a child (H31) | Larger wage earnings responses in higher bunching neighborhoods (J31) |