An Earned Income Tax Credit Proposal for Chile

Abstract

In recent decades, we have seen in Latin America an increase in the use of conditional cash transfer programs to fight poverty. Although these programs can be effective to improve the welfare of the poor in the short term and to guarantee a certain basic health care and education, they can also discourage employment, thus creating a poverty trap and a dependence on the social welfare system. In other regions of the world, the tax system has been used not only to redistribute income, but also to implement social policies. A good example is the Earned Income Tax Credit (EITC) in the United States, which offers to lower-income individuals a reimbursable credit conditioned on working. This policy has simultaneously increased employment, reduced inequality and reduced poverty particularly among single mothers. This paper estimates, through simulation, the effect that a system like the EITC would have in Chile. The results show that a tax credit could increase employment and at the same time reduce poverty and inequality. Additionally, a comparison of the results to a simulation of the Ethical Family Income Program allows concluding that the EITC is more effective in increasing the income of individuals below the poverty line and it has a lower transfer cost per family.