Earned income tax credit (EITC)

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Earned income tax credit (EITC)
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Reading Assignment

• Greenstein, The Earned Income Tax Credit
  Boosting Employment, Aiding the Working Poor,
  http//www.cbpp.org/7-19-05eic.htm
• Jason A. Levitis and Nicholas Johnson, Together,
  State Minimum Wages and State Earned Income Tax
  Credits Make Work Pay, http//www.cbpp.org/7-12-0
  6sfp.pdf
• DeParle, Ch. 17 Money Milwaukee, Summer 1999

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Additional Sources

• A. Nagle and N. Johnson, A Hand Up How State
  Income Tax Credits Help Working Families Escape
  Poverty In 2006, Center for Budget and Policy
  Priorities, www.cbpp.org
• S. Holt, The Earned Income Tax Credit at Age 30
  What We Know, The Brookings Institution,
  February, 2006 http//www.brookings.edu/metro/pubs
  /20060209_Holt.pdf
• Citizens for Tax Justice, The Hidden
  Entitlements, 1996 http//www.ctj.org/hid_ent/par
  t-3/part3-3.htm
• Ifie Okwuje and Nicholas Johnson, A RISING
  NUMBER OF STATE EARNED INCOME TAX CREDITS ARE
  HELPING WORKING FAMILIES ESCAPE POVERTY, Center
  for Budget and Policy Priorities, October 20,
  2006 http//www.cbpp.org/10-12-06sfp.pdf

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Todays Questions

• What is the EITC and how does it work?
• Who receives the EITC?
• How large are the credits?
• Which States supplement the credit?
• Why is the EITC politically popular?
• Will this popularity last?-- problems with the
  EITC

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What is the EITC and how does it work?

• A tax reduction and wage supplement for low- and
  moderate-income families
• Available to both single parent, two parent
  families, and childless low-income workers
• Must work to be eligible
• A refundable credit, which means that if the
  credit amount is larger than a familys income
  tax bill, the family receives a refund check
  equal to the difference.
• Usually claimed when the income tax return is
  filed. Can opt for equal monthly payments.

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Source Tax Policy Center, Joint effort of the
Urban Institute and Brookings Institution
http//www.taxpolicycenter.org/TaxFacts/TFDB/Conte
nt/PDF/eitc_parameters.pdf
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• Source Together,State Minimum Wages and State
  Earned Income Tax Credits Make Work Pay Center
  for Budget and Policy Priorities,
  http//www.cbpp.org/7-12-06sfp.pdf

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Inflation Adjustments
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Example

• A single parent with two children working nearly
  full-time--52 weeks per year at 38 hours per
  week--at the minimum wage of 5.15 per hour has
  an annual income of about 10,712. After
  subtracting 819 in federal payroll taxes and
  adding the 4,536 federal EITC for which the
  family qualifies, the familys cash income totals
  14,429, or 1,813 below the 2006 poverty line
  for a family of three (16,242).
• Source Nagle and Johnson, 2006.

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Who Receives the EITC?

• 5.4 million poor families with at able-bodied
  parents
• 3.3 million or 66 percent had at least one parent
  in the labor force
• Among poor families with children in which one or
  both parents worked anytime during the year, the
  parents worked at combined 44 weeks.
• About 75 percent of the families on welfare
  (TANF, SSI, or GA) had a parent working in 2004

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Who Receives the EITC?
Source Holt, 2006
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Who Receives the EITC?
Source Holt, 2006
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Who Receives the EITC?
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Who Receives the EITC?
Source Holt, 2006
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How large are the credits?
Source Nagle and Johnson, 2006
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Source Levitis and Johnson, 2006
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Source Levitis and Johnson, 2006
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Which States supplement the credit?

• Nineteen States (counting the District of
  Columbia as a State) supplement with Federal
  EITC.
• A campaign is being waged to convince the
  remaining States to do likewise.

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Source Okwuje and Johnson, 2006
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Notes for previous table
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Source Nagle and Johnson, 2006
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Why is the EITC Politically Popular?

• Encourages work
• More people enter the labor force
• Workers work more hours
• Reduces welfare costs
• Grogger concluded that the EITC may be the
  single most important policy for explaining
  recent increases in work and earnings and
  declines in receipt of cash welfare assistance
  among female-headed families.
• Source Greenstein, 2005

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Why is the EITC Politically Popular?, Cont.

• Reduces poverty
• By 4.4 million in 2003
• The poverty rate among children would be 1/4
  higher without EITC
• Lifts more children out of poverty than any other
  program

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Child Credit

• a 1,000 tax credit per child on your tax return
  for children who are under 17 as of the end of
  the tax year
• Phased out for taxpayers with modified adjusted
  gross income
• reduced (but not below zero) by 50 for each
  1,000 (or fraction thereof) by which the
  taxpayer's modified adjusted gross income exceeds
  the threshold amount.
• Threshold amounts
• 110,000 in the case of a joint return
• 75,000 in the case of an unmarried individual
• 55,000 in the case of a married individual
  filing a separate return

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Will this popularity last?-- problems with the
EITC

• Fraud
• Overpayments to eligibles
• Fraudulent claims from ineligibles
• Nonparticipation
• Marriage penalty encourages cohabitation
• A two earner, two-child couple making 35,000
  (with a 60/40 earnings split) can save 3,923 a
  year in federal income taxes by avoiding marriage
  (EITC 4,400 vs. 476).

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Will this popularity last?-- problems with the
EITC, cont.

• High cumulative marginal tax rates
• When earnings are in the phase-out range, the
  combined marginal tax rates for the may create a
  substantial work disincentive
• Federal income taxes 15
• Payroll tax 7
• EITC phase-out 21
• Add a State income tax (3 to 6) to this 43
  marginal tax rate if relevant.
• Add 24 phase-out rate for Food Stamps.
• Cumulatively the marginal tax rate face by
  low-income Americans is in the range of 43- 73 !

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Will this popularity last?-- problems with the
EITC, cont.

• Subsidy to low-wage employers
• w0, L0 initial equilibrium
• w1, L0 equilibrium with EITC
• EITC w0 - w1
• Final equilbrium is at w2, L2

wages
S
S
w0
w2
w1
D
L0
L2
workers
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Will this popularity last?-- problems with the
EITC, cont.

• The EITC is an entitlement!

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Proposed Improvements

• Increase tax credit for low-income workers
  without children
• Increase tax credit for families with three or
  more children
• Eliminate the marriage penalty
• Simplify filing procedures

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EITC Marriage Penalty
Source Iris J. Lav, Extending Marriage-Penalty
Relief to Working Poor and Near Poor Families,
http//www.cbpp.org/6-10-99tax.htm