Abstract:

In this paper we ask the following question: Is the optimal Earned Income Tax Credit (EITC) schedule a trapezoid, as widely used by policy-makers, or is it a triangle? We show that a trapezoid is optimal only when the wage distribution among the working poor is even with a discrete jump for higher wage groups. Since this pattern is not in line with the observed wage distributions of countries, we conclude that the optimal schedule is a triangle. Our simulations show that the use of a trapezoid implies a substantial loss in terms of Social Welfare.