The Earned Income Tax Credit and Reported Self-Employment Income

The Earned Income Tax Credit subsidizes earnings from both the wage sector and the self-employment sector. This paper uses tax return data to investigate how the EITC affects the reporting of self-employment income to the IRS. A difference-in-difference strategy is used, considering three expansions in the EITC and comparing changes across filers with and without children. The expansions are predicted to increase the reporting of self-employment income for those in the phase-in region of the EITC and to reduce the reporting of self-employment income for those in the phase-out region. Among the lowestincome filers, the 1994 EITC expansion is associated with a significant increase in the probability of reporting positive self-employment income, equal to 3.2 percentage points for unmarried filers and 4.1 percentage points for married filers. The Earned Income Tax Credit (EITC) is widely recognized to have increased employment, particularly among single mothers with low levels of education. For purposes of calculating the credit, the tax code treats income earned through self-employment in nearly the same way as income earned through wage sector employment. This paper uses tax return data to investigate the effects of the EITC on the reporting of self-employment income to the IRS. There are two reasons why the impact of the EITC on self-employment is of interest independent of its impact on wage sector employment. First, while overall self-employment rates have been declining in the long run, sociologists including Edin and Lein (1997) and Venkatesh (2006) have documented widespread informal self-employment among the poor. Edin and Lein interview 379 low-income single mothers, finding that 39% of welfare-reliant mothers and 28% ∗Department of Economics, Williams College, Williamstown MA 01267. Many thanks to Joel Slemrod, Jim Hines, Charlie Brown, Mary Corcoran, Therese McGuire, Samara Gunter and participants at the November 2006 National Tax Association meeting and February 2007 CSWEP workshop. All errors are my own.