Earned income tax credit
(EITC)
Lecture 20
Reading Assignment and
Sources
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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
– 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
Today’s Questions
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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
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.
Parameters are adjusted for inflation each year.
•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
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
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.
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
Who Receives the EITC?
Source: Holt, 2006
Who Receives the EITC?
Source: Holt, 2006
Who Receives the EITC?
Who Receives the EITC?
Source: Holt, 2006
How large are the credits?
Source: Nagle and Johnson, 2006
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.
Source: Nagle and Johnson, 2006
Source: Nagle and Johnson, 2006
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 femaleheaded families.”
Source: Greenstein, 2005
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
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
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).
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
• Payroll tax
• EITC phase-out
15%
7%
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 lowincome Americans is in the range of 43- 73% !
Will this popularity last?-problems with the EITC, cont.
• Subsidy to low-wagewages
employers
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– They would have to
raise their offers in
the absence of the
w
EITC
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workers
Will this popularity last?-problems with the EITC, cont.
• The EITC is an entitlement!
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