Tackling Vulnerable Households through a Working Tax Credit Scheme: A Feasible Alternative to Cash Transfers

Abstract

Conditional Cash Transfer Programs (CCTs) have been extremely popular strategies to fight poverty in developing countries for the last three decades. Although these programs can be effective to improve the welfare of the poor in the short run and even to guarantee basic health care and education services, they can also discourage employment and reduce formality rates. Furthermore, they can create welfare dependence and prevent the generation of autonomous income. Many developed countries have been using the income tax system not only to redistribute income but also to implement social policies. A good example is the Earned Income Tax Credit (EITC) in the United States, which offers a reimbursable credit conditioned on working to low-income individuals. This paper uses Chilean data to empirically analyze the effect that a system such as the EITC would have on poverty and inequality in a developing country. Our polity targets single 18-60 years old women, without a partner, with and without eligible children. The results show that a tax credit could increase employment while reducing poverty and inequality. Additionally, we show that an EITC design might be more cost-effective to increase the income of individuals below the poverty line and to reduce inequality. Given that a program like the EITC mostly benefits those who have a higher chance of seeking and obtaining employment in the formal sector, such policy should be implemented as a complementary tool to other social policy programs aimed at helping individuals out of the informal sector.