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The Earned Income Tax Credit

The Earned Income Tax Credit. Overview. The EITC is a refundable tax credit for low-and-moderate-income working people, primarily those with qualifying children. It is designed to encourage and reward work as well as offset federal payroll and income taxes.

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The Earned Income Tax Credit

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  1. The Earned Income Tax Credit

  2. Overview • The EITC is a refundable tax credit for low-and-moderate-income working people, primarily those with qualifying children. • It is designed to encourage and reward work as well as offset federal payroll and income taxes. • The federal EITC is refundable, which means that if the worker qualifies for a credit that exceeds her/his income tax liability, the IRS will refund the balance. • Twenty-four states, and DC, have established their own EITCs to supplement the federal credit.

  3. Has Been a Popular Program • In the last 15 years, the EITC has expanded into the most important government cash program for low income families, especially those with children. • The EITC has enjoyed relatively wide ranging political support because it transfers resources to low income families while promoting work. • Only those who work can receive benefits. Recipients must be citizens or legal residents. • It also subsides businesses that pay their employees low wages (Walmart, Target, McDonalds, etc.).

  4. Who Is Eligible:2013?

  5. How are Benefits Calculated? • Workers receive the credit beginning with their first dollar of earned income. • The amount of the credit rises with earned income until it reaches a designated level and then begins to phase out at higher income levels. • During the 2011 tax year, the average EITC was $2,240. This was $2,805 for families with children and $262 for individuals or couples with no children. • Research indicates that families mostly use the EITC to pay for necessities, repair homes, maintain vehicles that are needed to commute to work, and in some cases, obtain additional education or training.

  6. Costs and Recipients • In 2012 about 27 million families received the EITC • Total gross cost of the EITC was estimated to be $61 billion in 2012. • The net cost is estimated to have been about $45 billion. • TANF cost at the federal level was $18 billion. • SNAP was about $75 billion. • The EITC is then the largest cash program for low income families in the US.

  7. EITC Eligibility and Payments • EITC Eligibility: • Positive earned income, but below designated levels • Credit amount depends on family earnings and number of children: • Phase-in: credit is flat percentage of earned income • Flat range: receive maximum credit • Phase-out: credit is phased out at a flat rate • Until 2001, EITC parameters were identical for single and married filers. • now $3100 higher for couples.

  8. An Example: A Single Parent or Guardian with Two Children

  9. Stage One: The Phase-in: A Base ($13, 430) with a Subsidy Rate of 40% • Imagine a single parent or guardian with two children that earns less than the established base for their family size: • In 2013 the base for this family is $13,430. • For earnings below the base, the family receives a refundable credit equal to 40 percent of earnings.

  10. Phase-In • For example, if this worker earns $6,000, she/he will receive a credit worth $2,400 (40% of $6,000 = $2,400). • If the family owes no federal taxes (which would almost always be the case at the lowest income levels), the subsidy will be $2,400 in the form of a check from the federal government.

  11. Phase-In • This would raise this family's total income from $6,000 to $8,400. • The EITC credit check can be in a lump sum at the end of the tax year, or it can be prorated and paid out in monthly payments. • Very few families take the latter option.

  12. Stage Two: Flat Rate Range : $13,431-17,530 Subsidy: $5372 • Another worker with two children might earn above the base, but within the flat rate. • In 2013 the base for this family is $13,431 with a phase-out range beginning at incomes above $17,530. • Earning that fall within this range receive a standard subsidy of $5,372.

  13. Flat Rate • Thus, a worker with two children earning $12,600 in 2013 will have had a total income of $17,972 ($12,600 + $5,372). • This is a major increase in this family’s income.

  14. Stage Three. Phase-Out Range: $17,531 to $43,038 • Another worker with two children might have earnings within the phase-out range. • In 2013 this range starts at $17,531 and ends at $43,038. • The maximum tax credit of $5,372 is reduced by 21.06 cents for every dollar earned above $17,531. • If earnings reached or exceeded $43,038, the family would not be eligible for a subsidy.

  15. Phase-Out Range To see how the formula works, imagine that a worker with two children earns $30,000. They would have $12,469 in income above the beginning of the phase-out range. These dollars would be taxed at the 21.06 rate (21.06% of $12,469 = $2625). The maximum credit of $5,372 would be reduced by $2625, leaving an EITC of $2747.

  16. Phase-Out Range • With this credit the family will have a total income of $32,747 ($30,000 plus $2747). • This represents a rather modest but not insignificant increase in the family’s income. • A very large percentage of all families and individuals receiving EITC benefits receive a rather modest amount of money. • As noted earlier, during the 2011 tax year, the average EITC was $2240.

  17. The EITC targets families with children A small amount of the tax cost is for childless filers; but they represent a fraction of total recipients.

  18. What Does the EITC do for a Minimum Wage Earner? • The federal minimum wage for 2013 is $7.25. • Some states set a higher minimum wage, but most states enforce the federal standard. • $7.25 x 40 = $290.00. • $290.00 x 52 = $15,080.

  19. Minimum Wage Earner • A minimum income earner benefits quite significantly from the EITC. • In 2013 a minimum wage worker employed 40 hours a week for 52 weeks would earn a yearly income of $15,080. • If this worker was married with two children, her/his earnings would be in the Flat Range. • The EITC would provide a flat subsidy of $5,372, yielding a total yearly income of $20,452.

  20. Minimum Wage • With the EITC subsidy, the worker's $7.25 an hour job is turned into a job that paid $9.83 an hour (40*52 = 2080 hours of work per year), a considerable improvement. • EITC research clearly shows that the EITC promotes work.

  21. Impact on Child Poverty • Over a five year period, about half of all families with children receive benefits from the EITC. • This is about 27 million families. • In 2012 it is estimated that about 4.2 million children were lifted above the poverty line by the EITC. • The EITC saves more children from poverty than any other American program. • The evidence is clear that early intervention into the lives of poor children is extremely important.

  22. Impact on Children • Research has demonstrated that lifting income in early childhood not only tends to improve a child’s immediate educational outcomes, but also is associated with more schooling, more hours worked as an adult, and higher earnings in adulthood. • One major study found a link between an increase in the EITC for families with children and an increase in achievement in middle childhood. • And, there is less violence, divorce and separation in homes lifted above the poverty level.

  23. Impact of EITC on American Poverty • In 2012 a total of 7.4 million people were lifted above the poverty level by the EITC (including some 4.2 million children). • Combined with the Child Tax Credit, some 9.2 million people (including 4.9 million children), were lifted above poverty in 2012. • Social Security prevented another 13 to 16 million families from living in poverty. • The Social Security program and the EITC are America’s most effective antipoverty programs.

  24. Supplemental Slides

  25. Real EITC Benefits Increasing over Time (2+ children)Tax laws expanded EITC in 1986, 1990, 1993

  26. Married couple extensions and credit for childless

  27. Tax cost of EITC, 1975-2004 The tax expenditure is modest compared to the direct outlay.

  28. EITC Recipients, 1975-2004 55% increase in number of recipients between 1990 and 1996.

  29. Relatively Broad Support (2) Why is there (relatively) broad support for the EITC?

  30. The EITC targets working families (no earnings= no EITC)

  31. The EITC targets low income families Poverty line, mom, one-kid Poverty line, mom, two-kids

  32. Distribution of EITC tax benefits and recipients by Family Income Decile 38

  33. The EITC encourages work • Earnings contingent benefit, high subsidy rate (34%/40%) means higher employment rates • Research shows overwhelming evidence that EITC expansions have increased labor force participation by single mothers with children.

  34. But that is not quite the whole story Phase-out of the EITC creates an increase in the marginal tax rates for those already in the labor force  Hours worked expected to decrease for working single parents Little empirical evidence for this. Explanation may be due to the way EITC is received (lump sum, refund) or lack of knowledge about precise tax schedule (Chetty and Saez 2008). In two parent families, secondary earners are expected to reduce employment and hours Empirical evidence supports modest reduction in work among two parent families. 40

  35. Salience of concerns about possible negative effects for workers Majority of recipients in flat/phase-out where EITC discourages work

  36. The EITC reduces poverty Reduction in poverty through: • Increases in earnings • EITC pushes income over limit

  37. Census estimates of poverty reduction due to EITC, 2003

  38. (3) Possible changes to EITC 44

  39. Expand EITC for childless taxpayers • Credit for childless taxpayers is quite small • Many proposals consider expanding this • Effects: increase incomes of low earning childless; encourage work

  40. Expand eligibility for married couples • Expand income eligibility range further for married couples • Effects: reduce marriage penalty (likely small impacts), reduce secondary earner work incentives

  41. Make work pay credit • Part of candidate-Obama’s tax plan and stimulus package passed by House • 6.2% subsidy for those earnings $8,100 or less. • Each (nondependent) worker is eligible • Phased out slowly (2% rate) starting at $75,000 ($150,000) for single (married) filers • Modeled on success of EITC • Transfer resources to needy while encouraging work • Importance of low phase out rate in minimizing hours worked distortion

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