Abstract
Nowadays Earned Income Tax Credit (EITC) has become one of the most expensive and fastest growing social welfare programs in America. As a result of the success of the EITC in America, this program has also been successfully instituted in many other countries. This paper evaluates the potential effect of an EITC on labor supply in Taiwan. The traditional econometric methods estimating reduced form labor supply by a Tobit or OLS will lead to serious endogeneity problems, when labor faces a kink-point-piecewise-linear budget. We apply the Two Error Model (TEM) in Triest (1990) to overcome this issue. Our finding reveals first that wives' labor hours tend to cluster more at the kink point than husbands do, and the elasticity of substitution for wives is larger than that for husbands. Secondly, the simulation of an EITC shows that when the largest tax credit rises, workers' labor hours are likely to be in the largest tax credit region. When the largest tax credit is 48,000, phase-in and phase-out rates are 40% and 20% respectively. An EITC program could cause a husband and wife on average to reduce their labor hours 6.9% and 8.4% respectively. Finally, no matter what the largest tax credit is, on average, the EITC program will encourage about 59% of non-working family to work.