The Congressional Research Service (CRS) recently released a report on the Earned Income 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. Credit (EITC). The EITC is 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. that is aimed at helping low-income taxpayers while increasing labor force participation. As a refundable credit, it not only reduces an individual’s tax 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 rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. . 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 credit 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 taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline. 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 taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. 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.Share