Earned income tax credit (EITC) Lecture 20

1. Earned income tax credit (EITC)Lecture 20

2. Reading Assignment and Sources • Reading Assignment: • Greenstein, “The Earned Income Tax Credit: Boosting Employment, Aiding the Working Poor,”http://www.cbpp.org/7-19-05eic.htm • DeParle, Ch. 17: Money: Milwaukee, Summer 1999 • 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/part-3/part3-3.htm

3. Today’s 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

4. 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 family’s income tax bill, the family receive a refund check. • Usually claimed when the income tax return is filed. Can opt for equal monthly payments.

5. Parameters are adjusted for inflation each year.

6. Source: 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

7. Example 1 • A single parent with one child, working full time throughout the year at a wage of $10 per hour, earns $20,800 per year. This worker owes $710 in 2005 federal income taxes which are with held from the paycheck during the year. The family also qualifies for an EITC of $1,635. The EITC allow the family to get back the $710 it paid in income taxes and to receive an additional refund of $925. The EITC refund serve to offset some of the worker’s $1,591 in payroll taxes that also were paid during the year. Source: Nagle and Johnson, 2006

8. Example 2 • A single parent with two children working nearly full-time--50 weeks per hear at 38 hours per week--at the minimum wage of $5.15 per hour has an annual income of about $9,800. After subtracting payroll tax and adding the $3,920 federal EITC for which the family qualifies, the family’s cash income totals $12,970, or abo9ut $2,461 below the 2005 poverty line for a family of three. • Source: Nagle and Johnson, 2006.

9. 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

11. Who Receives the EITC? Source: Holt, 2006

12. Who Receives the EITC? Source: Holt, 2006

13. Who Receives the EITC?

14. Who Receives the EITC? Source: Holt, 2006

15. How large are the credits? Source: Nagle and Johnson, 2006

16. 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.

17. Source: Nagle and Johnson, 2006

18. Source: Nagle and Johnson, 2006

19. 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

20. 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

23. Child Credit • Children who are under 17 as of the end of the tax year, you can get a $1,000 tax credit per child on your tax return. • 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

24. 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).

25. 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% !

26. Will this popularity last?-- problems with the EITC, cont. • Subsidy to low-wage employers • They would have to raise their offers in the absence of the EITC wages S S’ w weitc D workers

27. Will this popularity last?-- problems with the EITC, cont. • The EITC is an entitlement!

28. 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