The Congressional Research Service (CRS) recently released a report on the Earned Income Tax Credit (EITC). The EITC is a tax credit that is aimed at helping low-income taxpayers while increasing labor force participation. As a refundable credit, it not only reduces an individual’s taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. bill by the amount of the credit, but can also reduce a taxpayer’s tax bill below zero, yielding a refund.
The CRS report outlined four important aspects about the credit that people should know:
- The EITC alters the decisions to work.
The EITC is designed in a way that both increases the size of the labor force and the amount people work, both positively and negatively. The EITC’s benefits “phase-in” for workers. This means that as a worker earns more, the size of their EITC increases. All else equal, an individual is more likely to work and will work more hours. According to the CRS “one study found that 34 percent of the increase in employment among single mothers between 1993 and 1999 was due to the expansion of the EITC.”
The EITC has a phase-out of benefits as well. The phase-out creates what is called an implicit marginal tax rate. All else equal, this reduces an individual’s hours of work when they earn enough to be in the phase-out range.
- Reduces poverty among low-income taxpayers with children
Since the EITC both increases the size of the workforce, especially among single mothers with children, and provides a wage subsidy, it has an impact on poverty. According to the CRS report “the EITC reduces unmarried and married childless workers’ poverty rates by 0.14 percent and 1.39 percent, respectively” and the impact on individuals with children is even larger.
- Increases unfairness in the tax code
The EITC is more generous to taxpayers with children than it is to taxpayers without children. In 2015, a taxpayer with one child can receive a maximum credit of $3,359. A taxpayer without a child receives a tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. of $503. This major difference in benefit level was a conscious choice from lawmakers according to the CRS, “For workers with children who work full-time at a minimum wage job, the EITC was intended to ensure that the family would not be in poverty. In contrast, the smaller childless EITC was designed to help childless workers offset a gas tax increase.” The CRS states that this is creates an unfairness in the EITC.
- Complexity has led to significant payment error
A major drawback to the EITC is that it has a high level of payment error. According to the CRS report, between 22 and 26 percent of all EITC claims were made in error. This has resulted in $14 to 19.3 billion in overpayments per year. The CRS points to two issues. The first is that the EITC’s rules are complex compared to many other individual income tax provisions. Taxpayers understandably make errors preparing their taxes. Additionally, there is outright fraud in the program. Some taxpayers and tax preparers purposefully misrepresent their personal details in order to increase their EITC payment.
The EITC enjoys bipartisan support among lawmakers. This is due to the fact it both reduces poverty among families with children and has a positive impact on the labor force for certain individuals. Yet, the EITC is not without its flaws. It’s benefit phase-out has a negative impact on the labor force and it suffers from high error rate and overpayment.
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