The Impact of the Earned Income Tax Credit on Household Finances

Abstract

Expansions to the federal and state Earned Income Tax Credit (EITC) over the last two decades have made the EITC one of the largest cash transfer programs in the United States. Using a simulated instrument strategy, we analyze how policy-induced changes to the generosity of the EITC have impacted household savings and unsecured debt holdings. Using data from the Survey of Income and Program Participation (SIPP) wealth topical modules, we explore two potential mechanisms accounting for the relationship between EITC generosity and household finances: changes in the household budget set associated with expansions to the EITC and changes in labor supply due to the incentives in the benefit structure. Results suggest that a $1,000 policy-induced increase in the average household EITC leads to a 4 percentage point increase in the likelihood of holding credit card debt and a 6 percentage point increase in the likelihood of having any savings. Results are concentrated among single mothers on the phase-in portion of the EITC schedule, and are correlated with increases in labor force participation, suggesting that one of the mechanisms through which the EITC increases savings and credit card debt is through its positive impact on labor force participation and income.