Suppose the government introduces an earned income tax credit (EITC) such that for the first $6,000 in earnings, the government adds $0.50 to the credit for each $1 of earned wages. For the next $3,000 of earnings, the size of the credit is held constant at its cap of $5,000. After that point, the size of the credit is reduced by $0.25 for each $1 of earned wages. When the credit reaches zero, there is no additional EITC.
Draw the budget constraint that reflects this EITC structure for a worker who can work up to 2,000 hours per year at a wage of $25 per hour. Be sure to note the leisure hours and income levels associated with the kinks in the budget constraint.
Discuss whether the labor supply effects of the EITC are positive, negative, or ambiguous, relative to the "no-EITC" status quo, for individuals (a) not working at all, (b) in the "phase-in" range of the EITC, (c) in the "constant" range, and (d) in the "phase-out" range. Hint: consider the directions of the income and substitution effects for each type of worker.