The Earned Income Tax Credit (EITC)

The Earned Income Tax Credit (EITC) was enacted by President Gerald Ford’s administration in 1975.   The Tax Policy Center explains that it is a federal tax credit that “equals a fixed percentage of earnings from the first dollar of earnings until the credit reaches its maximum.  The maximum credit is paid until earnings reach a specified level, after which it declines with each additional dollar of income until no credit is available.”   The federal EITC is fully refundable.  This means that if the credit exceeds the family’s tax liability, the family still receives the full credit in the form of a tax refund.  The EITC is only awarded if you have an income.  What’s more is that the EITC’s credit grows with each additional dollar of income, this creates an incentive for people to increase their income either by increasing their hours, leaving welfare and looking for work, and looking for higher paying jobs.  The Center on Budget and Policy Priorities (CBPP) explain the eligibility requirements.  For filing taxes for the 2015 calendar year, “working families with children that have annual incomes below about $39,000 to $53,300 (depending on marital status and the number of dependent children) may be eligible for the federal EITC.”  To be eligible for the EITC if you do not have children, you have to be in the ages of 25-64 and also have an income below about $14,800 ($20,300 for a married couple). You can receive a small EITC.  In 2013, over 27 million working families and individuals received the EITC.  97% of benefits from the EITC go to families with children.  According to the Tax Policy Center, almost all benefits of this tax credit go to families in the bottom three quintiles of income distribution.  The U.S. Census Bureau found that the EITC lifted 6.2 million people out of poverty in 2013.  This included 3.2 million children.

How does it work?  The phase in rate is the money where you earn a portion of your income to increase the value of the EITC.  So let’s say the phase-in rate for a married couple with one child is 34%, for every dollar that is earned by the couple, the EITC is increased by 34 cents until you reach the income threshold where the phase-in ends and the EITC holds steady. It includes every dollar that you earn.  The phase-in for a married couple with one child ends at $9,880 so at that point, your EITC would be $3,359.  If you make between $9,880 and $23,630, your EITC would be $3,359.  Then you slowly lose that money from your EITC depending on how much you earn until it is reduced by zero.  The phaseout rate is 15.98% for a married couple with one child.  All of these numbers were based in 2015.   If your EITC is larger than your tax liability, you receive it back from the federal government in a refund.  In 2013, the average EITC was $3074 for a family with children compared to $281 for a family without children.  That $3074 is equivalent to boosting wages by $256/month.

More benefits of the EITC

The EITC and relative expansions of it have had tremendous effects on unemployment and reducing welfare and other cash assistance programs.  Because the EITC essentially requires you to work to be able to claim the credit, it encourages people to transition from welfare to work.   In Examining the Effect of the Earned Income Tax Credit on the Labor Market Participation of Families on Welfare, the authors V. Joseph Hotz, Charles H. Mullin, and John Karl Scholz found that the EITC had a “substantial, positive effect on the employment of families who have uses or will use welfare.”  In a paper by Jeffrey Grogger, titled Welfare Transitions in the 1990s: The Economy, Welfare Policy, and the EITC, he finds that the EITC had the most signficant effects in reducing welfare caseloads during the 1990s.  He writes the EITC expansions “reduced welfare participation by 6.5%,relative to its 1993 peak.  Thus they accounted for over 10% of the 1993-1999 decline.”  Hotz, Mullin, and Scholz write that “for those out of the labor market, the EITC provides an unambiguous, positive incentive to work.”  Similarly, they found EITC expansion “accounted for 11.8% of the average increase in employment” over 1991 – 2000.

By far, the biggest recipients of the EITC are single mothers.  They are the ones most likely to qualify because of their low income earnings and qualifying children.  From March of 1990 and March of 2000, Hotz, Mullin, and Scholz wrote that employment rates of single mothers rose to 73.9% from 55.2%.  Not all of this can be attributed to the expansions of the EITC but as we’ve seen the increase encourages people to work.  The CBPP analysis shows

Economic studies controlling for other policy and economic changes during this period also found that the most significant gains in employment attributable to the EITC occurred among mothers with young children and mothers with low education…

Other research has found that EITC expansions between 1984 and 1996 accounted for more than half of the large increase in employment among single mothers during that period…

The EITC expansions of the 1990s “appear to be the most important single factor in explaining why female family heads increased their employment over 1993-1999,” University of Chicago economist Jeffrey Grogger has concluded.

The recession in recent years has hurt a number of workers and decreased wages.  The National Employment Law Project found in their analysis that “mid-wage jobs made up  60% of the jobs lost during the recession, they made up only 22% of the job gained during the recovery…lower-wage jobs, in contrast, represented 21% of the jobs lost during the recession but 58% of jobs gained during the recovery.”  The money refunded through the EITC help low-wage workers meet temporary needs, able to afford college, or pay other bills.  When I received my portion of the EITC, I used a majority of my money to afford daycare for my daughter for a substantial part of the year. The majority of those who receive the EITC only do so for a year or two at a time.  61% of those who received the EITC between 1989 and 2006 did so for only a year or two at a time.

Childless workers, the minimum wage, and strengthening the EITC

In order to help reduce income inequality, we need to strengthen the EITC.  Conservative economists including economic adviser to Donald Trump, Stephen Moore support raising the earned income tax credit.  Beyond that, conservative think tanks the American Enterprise Institute and American Action Forum also support strengthening the EITC.  The difference is that they support strengthening the EITC in a vacuum instead of tying it to strengthening the minimum wage, as well.  The CBPP argues that both the minimum wage and the EITC should be strengthened because “they function best when both are strong because each helps fill gaps that the other can’t fully address on its own, and neither is sufficient by itself.”

The current phase in for the maximum amount for the EITC for a single filer is $6,580 with a the phase out beginning at $8,240.  With the current federal minimum wage at $7.25/hour that is roughly the equivalent of 17-21 hours per week to earn the maximum amount of the EITC.  The maximum amount from the federal EITC is $503.  The EITC return begins to decline at that point.  A single filer who works full-time in a minimum wage position would earn $15,080/year and would not qualify for the EITC.  The maximum amount of hours to qualify for any portion of the EITC is $14,819 which would be just over 39 hours per week.  The credit’s value would be $1.  That hourly estimate is based off the federal minimum wage instead of any increases in the minimum wage at the state level.

This may not seem like a giant deal, although, we do have data on who earns the minimum wage or close to it so to see how many people this might affect.  The Congressional Budget Office (CBO) found that only 26.1% of low-wage earners are parents.  The Department of Labor found that 50.6% of those who are earning $7.25/hour or less are aged 16-24.  The Economic Policy Institute (EPI) found that 36.5% of workers earning $11.10 per hour or less were aged 20-29 while 73.7% of all those earning $11.10 per hour or less were aged 20-54.  The guidelines for childless single adults are that you have to be 25 or older and you have to work essentially 17-21 hours per week at $7.25/hour.  EPI found that 14.2% of workers who earn $11.50 or less work fewer than 20 hours/week.  Also, according to them, 54% work full time, meaning 35 or more hours per week.  A minimum wage increase without an accompanying increase in the EITC would harm workers and reduce their potential income.

While we are at the point where we should be strengthening the EITC.  The easiest solution is to adjust the ages that people are eligible to receive the EITC if they are childless. The typical response has been to expand the age requirements to 21 instead of 25 and expand it from 65 to 67.  My fear with expanding it that much is just that there is still a gap of those who are covered.  I would rather have it expanded to those at 18 (which we have generally decided is the age to become an adult) all the way up to 70.  But we must also go further, increasing phase in ending income threshold and increasing when the phase out income threshold begins would also wonders to help reducing poverty.