samlet årgang - Økonomisk Institut - Københavns Universitet

LABOR SUPPLY BEHAVIOR AND THE DESIGN OF TAX AND TRANSFER POLICY 339
Fixed
work
cost
Disposable income
Phase-in Flat Phase-out Beyond
Figure 5. Impact of an Earned Income Tax Credit.
Ernings
The credit is first phased in at low earnings, then stays constant, and is finally phased
out at higher earnings. 13 The consequence for the relationship between disposable
income and earnings is shown in Figure 5. The total tax burden on labor income is
reduced in all three intervals of the EITC. The impact on the marginal tax rate depends
on the initial earnings level of the person. In the phase-in interval, the marginal tax
rate is reduced, in the plateau range it is unchanged, while in the phase-out range it is
increased.
The labor supply responses along the intensive margin, illustrated by the small arrows
in Figure 5, depends on substitution and income effects. In the phase-out range
both of these effects reduce labor supply. In the flat range only the income effect is
present which leads to a reduction in labor supply. Finally, in the phase-in range the
substitution effect and income effect have opposite signs, so that hours increase as
long as the substitution effect is stronger than the income effect. This is equivalent to
the so-called uncompensated hours-of-work elasticity being positive in this range.
The sign of the intensive margin welfare effect depends on the direction of the
13. Notice that the EITC recently introduced in Denmark is different. The Danish EITC is given to everyone
participating in the labor market, while the EITC in the United States is phased-out at high earnings. In
addition, the size of the EITC in the US is related to the number of dependent children and, if married, on
the income of the spouse.