Abstract:

In this paper I simulate the entrance to the labor market in the presence of cultural barriers that constraint labor market participation of low-income workers. In this case, an optimal EITC depends on social planner’s relative preferences for persistently unemployed and working poor. I check EITC optimality in the short run under different types of social planners - from mild inequality averse to Rawlsian; and different kinds of policy makers – conservative, who favors the Working Poor, and liberal, who tolerates cultural barriers and favors the unemployed. Using simulations, I find that the imposition of an EITC is optimal in all cases, except for a Rawlsian and liberal policy-maker under the unusual case of full compliance to minimum wage. By calibrating the model for Israel, a country with well-documented cultural barriers for labor market participation, I find that the proposed framework will remain relevant in the foreseeable future. In light of these results and of EITC documented advantages, its scare use in developed economies remains an open question that merits further research.