Implementing the Earned Income Tax Credit: shall governments design an employee or an employer-based system?

Abstract

Abstract In this paper I use a labor market equilibrium model and a social welfare analysis for comparing between an employee-based EITC and an employer-based system. Since the labor supply of the low-wage workers is relatively rigid, firms enjoy market power that might be used in detriment of the policy-maker's goals when implementing an EITC system. While the employee-based system avoids coordination among firms, and thus reduces their market power, an employer-based system allows for automatic take-up at the initial stage of the program's implementation, which constitutes an advantage. These pros and cons in both systems shall be weighted one against the other; for that purpose, I run simulations using empirically plausible parameters taken from data of countries that implemented an EITC. The simulations show that in terms of social welfare the employee-based EITC tends to dominate the employer-based system. JEL Numbers– H21, H24 and I38.