Single Mothers and the Earned Income Tax Credit: Insurance without Disincentives?

This paper provides the first quantitative statement about the insurance provided by Earned Income Tax Credit (EITC), which is the U.S. Federal Government's largest cash-assistance program for low-income families. It evaluates EITC's role as an insurance mechanism against risks faced by its primary target population, unskilled single mothers. The paper studies a dynamic model of consumption, savings, and labor supply in which households face wage and demographic risk, but have only limited self-insurance capacity. Key findings include:

• EITC is playing an important role in insuring the lives of its targeted population. It buffers households both against uncertainty in productivity (wages) and against risk with respect to demographics (dependent child care);
• EITC has large positive effects on labor force participation and much smaller, but negative, effects on hours worked among young, unskilled single mothers;
• Presence of risk and relative proximity of single mothers to borrowing constraints gives them strong incentives to work hard irrespective of their productivity in order to build up precautionary balances;
• Highly productive unskilled households experience the phase-out of the EITC, which generates very high marginal income tax rates for relevant income ranges;
• Insurance provided by EITC reduces the need to work in order to accumulate precautionary savings.