Summary of Project Results

The objective of this research project is to assess the welfare effects of targeted transfers, such as tax credits.

In particular, this project has three main objectives. First, to analyse the implications of tax credits on equilibrium wages. The literature has so far developed frameworks that allow accounting for the direct effect of targeted transfers, which dampens wage inequality, however, it is unclear whether in equilibrium the increased selection into working (induced by such tax credit schemes) exerts a downward pressure on wages, which overturns the direct effect. Second, this project will take into perspective the increased reliance of policy makers on targeted transfers over the past 2 decades and assess through the lens of a structural model the implications of such fiscal policies on the distribution of income, and in particular, to what extent such programs dampened or contributed to the increased wage inequality.

In the first subsection, we describe the empirical project, and in the second subsection, its theoretical counterpart. The outcomes of this research project will contrast existing literature on tax credits, which unilaterally disregards general equilibrium effects. In terms of policy guidance, this research project offers a strong test for the acclaimed success of tax credit programs, in particular in the US.

Research Output

This paper highlights the macroeconomic and distributional effects of tax credit policies using the Earned Income Tax Credit program as a case study.

In particular, we analyse the labour supply and saving responses to changes in tax credit generosity at the individual and aggregate level. Also we study the distributional and welfare consequences of this policy. Our results show that the EITC raises labour force participation, provides insurance to working poor households but also disincentivises private savings for many. Whilst reducing post-tax earnings inequality, the EITC contributes to a higher skill premium and wealth inequality. Also our analysis features transitional dynamics of the tax credit reform and robustness checks with respect to the financing of the reform, as well as several decompositions to analyse the relative importance of the savings margin, and the participation margin. We find the participation margin to be particularly important for the poorest low income households, whereas the savings margin becomes more important for low to high income households. In terms of welfare, our results suggest that EITC expansions are welfare improving for the majority of the population, both ex ante and when accounting for transitional dynamics.

This paper has been presented at various stages in the following external workshops, seminars, and conferences:

• 2014: EIEF 13th Workshop on Macroeconomic Dynamics: Theory and Applications (Rome)

• 2015: Society for Economic Dynamics Annual Meeting (Warsaw), Verein fuer Socialpolitik (Muenster)

• 2016: York University (Seminar), EEA-ESEM meetings Geneva.

The first version was listed in the Cambridge-INET working paper series as working paper wp1615 in 2016. This paper is currently revised and resubmitted at the Canadian Journal of Economics.