We have discovered that the welfare system discourages recipients from working because the more income they earn, the less welfare benefits they receive. How does the earned income tax credit attempt to loosen the poverty trap?

The welfare system of an economy allows the society (especially the low-income group) to have some advantages from the government in the form of unemployment assistance, direct payments, etc. When government is engaged in transferring direct financial assistance to the low-income groups and when this assistance falls as they earn more on their own, the incentive of workers to work falls. This leads to the existence of a poverty trap in the economy. The earned income tax credit is a kind of welfare system that attempts to loosen the poverty trap.

The Earned Income Tax Credit (EITC) is a kind of welfare system that provides benefits to the working poor in an attempt of loosening the poverty trap so that the incentive to work for workers does not get loosened. It was first passed in 1975 with the aim of assisting the low-income group via the tax system. The assistance comes to the poor or low-income groups in the form of a tax credit of a certain amount up to a certain income level, followed by an increase in the tax break with an increase in the income earned up to a certain point. Such a welfare program incentivizes people to work more since the welfare received from the program increases with an increase in income. It has been so a popular welfare system for society. In order to minimize the poverty trap, this system does not reduce the benefits received for a range of income (in 2013, from $13,430 to $17,530) and after that, the tax credit falls by 21.06 cents for every extra unit dollar earned and finally phases out at an earning level of $46,227..