Let’s fix the Earned Income Tax Credit

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Progressives and conservatives can agree that self-sufficiency is a worthy goal of social policy. That’s why policy wonks of all stripes support the Earned Income Tax Credit.

How does the EITC work?

The concept is simple. People who work but earn less than a threshold receive an income supplement that depends on income. Single parents with one child qualified in 2018 if their income was below $40,320. 

The EITC is available only to individuals with earned income. For a single parent with one child, the credit grows as annual income rises to $10,150, equivalent to 923 hours worked at the 2019 Upstate New York minimum wage of $11.10 an hour. The combined federal and state EITC ($4,500) is equivalent to an increase in pay of $4.87 an hour.

The credit stays constant until income hits $15,200, then gradually declines to zero when income reaches $46,000. Read the typically-complicated IRS bulletin here.

Progressives like the EITC because it puts earning power in the pockets of people in need and promotes self-reliance. Conservatives like it because the credit rewards work and encourages engagement with the mainstream economy.

Economists like the EITC because it avoids the labor market distortions of a minimum wage increase—low-skill workers can receive a higher wage than employers might be willing to pay. When markets work reasonably well, low-wage work can improve an individual’s skills and make better jobs more likely.

What’s not to like?

The EITC may appear to be a salve for low-wage work, but there’s a rather big fly still fluttering in the ointment. Unlike a higher hourly wage that appears in every paycheck, the EITC is a tax credit. Workers who qualify receive the money only after filing their tax return. If you owe $6,000 in tax, you get to deduct the EITC from what you owe. As it is a “refundable” tax credit, you get a check if the credit is more than you owe.

Thus, while we can pretend it is equivalent to a pay increase, that’s only mathematically true. The once-per-year lump sum payout is certainly a benefit to recipients, but doesn’t help with the rent in October or the car repair in August. 

The EITC doesn’t appear to encourage work

The wonkish promise of the EITC is that it will encourage more people to enter the labor force. A recent study by Princeton University’s Henrik Kleven (brought to my attention by the Children’s Agenda’s Peter Nabozny) argues that the impact of the EITC on labor force participation has been exaggerated in previous studies. 

These studies connected a late 90s increase in labor force participation with the 1993 EITC reform. “Not supported,” says Kleven. Instead, he finds strong evidence that EITC participants were pushed into the labor market by the 1996 welfare reform and pulled in by a strong job market. The EITC incentive played only a bit part. Passed with the support of the Clinton Administration, the 1996 policy changes added significant work requirements and limited the duration of public assistance payments. A summary of Kleven’s paper and its conclusions is available from the Institute for Family Studies.

What should change?

Fans of the EITC (me included) have long speculated that the incentive value of the credit is blunted by the annual nature of the payout. With SNAP benefits and cash assistance having made the transition to forms of electronic funds transfer, surely we can devise a system for distributing a large share of worker’s anticipated EITC throughout the year. 

That would make the EITC even more complicated than it is already, of course. Even the IRS’s online “EITC Assistant” requires some work to disentangle. Fortunately, many community organizations offer technical assistance, particularly on the annual EITC Awareness Day (coming January 31). 

The Earned Income Tax Credit is an important part of our national safety net. Let’s make some common sense changes that will improve its power to pull potential workers into the labor market.

Kent Gardner is Rochester Beacon opinion editor.

2 thoughts on “Let’s fix the Earned Income Tax Credit

  1. I agree that the EITC is far preferable to hiking the minimum wage, since it 1) targets those who most need the help, 2) doesn’t price low-skilled workers out of the market, and 3) puts the burden on the government/taxpayers for a government program, rather than burdening a third party (the employer). One problem is that it can act as a marriage disincentive, because combining two low incomes can push a couple over the limit for maximum credit (the federal EITC starts reducing at $18,700 for a head of household, $24,400 for a married couple). A higher maximum for married couples would be healthy, I think.

    EITC recipients used to be able to get advance payments during the year from their employer. However, the Obama administration discontinued that in 2010; it was little used, and I believe there were fraud problems. (While I support the EITC, and I saw how significant it was for people when I volunteered at VITA preparing tax returns for low-income people, fraud and misuse have been a significant issue for many years.)

    An important issue for providing it early is making sure that the payments don’t exceed what people qualify for. If people are scamming the system, it’s going to be difficult to get the money back, and if they make an honest mistake, they’re going to find themselves in a serious hole, because they’re likely to spend the money pretty much as soon as they have it. Having advance payments administered by employers had the advantage that they knew how much the person was working, and the payment would automatically be cut off if someone quit work. (Job tenure is much shorter than average at the low end of the pay scale.) But most employers probably aren’t eager for one more responsibility, though perhaps with the tightening job market, it could be an incentive for a potential employee (and for retaining employees).

    In any case, I would suggest that not more than 75% of the expected EITC should be available during the year, both to reduce the potential for overpayment and to provide a lump sum, which is often very helpful. My VITA clients typically declined my suggestion to reduce their withholdings when they were getting a $2-3K refund; they wanted to have a sizable lump sum refund, because it made it easier for them to get bigger ticket items that they otherwise found hard to save for. In essence, Uncle Sam operated their Christmas Club account.

  2. I agree, agree , agree . EITC is supported by conservatives because it encourages work of all kinds . Progressives like it because it is based on need for workers and working families .
    It is a good idea that can be improved .

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