How does the EITC affect poor families?
In 2015, the earned income tax credit (EITC) will provide credits of up to $3,359 for workers with one child. Larger credits are available to workers with more children, and a small credit is available to workers without children. The Census Bureau has developed a supplemental measure of poverty that includes tax credits—according to one analysis, in 2013 the EITC lifted 6.2 million people out of poverty, including 3.2 million children. This figure may underestimate the full effect by half.
Poverty and the EITC
Official estimates of poverty compare the before-tax cash income of families of various sizes and compositions with a set of thresholds. Many social transfer programs use the poverty thresholds to determine program eligibility. The official poverty measure excludes the effect of federal tax and noncash transfer programs on resources available to the family. Thus, although the EITC adds income to poor households, it does not change the official number of those living in poverty.
To understand how the social safety net changes resources, the US Census Bureau has developed a supplemental estimator that better measures the relative well-being of various households (Short 2013). To determine how well off a family is, the estimator compares the resources available to them to the resources they need, taking into account regional differences.
Resources needed include not only basic items such as food and housing, but also expenses such as those associated with work and health. Resources available include government transfers, including noncash transfers, and tax credits such as the EITC. Official Census publications show that together, the child tax credit (CTC) and the EITC lifted 9.4 million people out of poverty in 2013 (Short 2013). The Center on Budget and Policy Priorities separates the effects of the EITC and the CTC and calculates that the EITC was responsible for lifting 6.2 million people out of poverty (DaSilva 2014). This makes the EITC the single most effective program targeted at reducing poverty for working-age households.
The credit ranges from $506 for workers with no children to $6,269 for workers with at least three children (figure 1).
Reducing poverty by encouraging work
A lot of research confirms that the EITC encourages single people and primary earners in married couples to work (Dickert, Houser, and Sholz 1995; Eissa and Liebman 1996; Meyer and Rosenbaum 2000, 2001). The credit, however, appears to have little effect on the number of hours people work once they are employed. Although the EITC phaseout could cause people to reduce their work hours (because credits are lost for each additional dollar of earnings, effectively a surtax on earnings in the phaseout range), there is little evidence that this actually happens. (Meyer 2002).
The most recent relevant study found that a $1,000 increase in the EITC led to a 7.3 percentage point increase in employment and a 9.4 percentage point reduction in the share of families with aftertax and transfer income in poverty (Hoynes and Patel 2015). If this employment effect were included in census estimates of poverty reduction (rather than just the dollars transferred through the credit), the number of people lifted out of poverty would be much greater.
Bipartisan Policy Center. 2013. “Bipartisan Policy Center (BPC) Tax Reform Quick Summary.” Washington, DC: Bipartisan Policy Center.
DaSilva, Bryann. 2014. “New Poverty Figures Show Impact of Working-Family Tax Credits.” Off the Charts (blog). October 17.
Dickert, Stacy, Scott Hauser, and John Karl Scholz. 1995. “The Earned Income Tax Credit and Transfer Programs: A Study of Labor Market and Program Participation.” Tax Policy and the Economy (9) edited by James M. Poterba. Cambridge, MA: National Bureau of Economic Research.
Eissa, Nada, and Jeffrey B. Liebman. 1996. “Labor Supply Response to the Earned Income Tax Credit.” The Quarterly Journal of Economics May: 605–37.
Executive Office of the President and Department of the Treasury. 2014. “The President’s Proposal to Expand the Earned Income Tax Credit.” Washington, DC: Executive Office of the President and Department of the Treasury.
Hatcher Group. “Tax Credits for Working Families.”
Hoynes, Hilary, and Ankur J. Patel. 2015. “Effective Policy for Reducing Inequality? The Earned Income Tax Credit and the Distribution of Income.” NBER Working Paper 21340. Cambridge, MA: National Bureau of Economic Research.
Internal Revenue Service. 2014. “Compliance Estimates for the Earned Income Tax Credit Claimed on 2006–2008 Returns." Washington, DC: Internal Revenue Service.
Maag, Elaine. 2015a. “Earned Income Tax Credit in the United States.” Journal of Social Security Law 22(1).
———. 2015b. “Investing in Work by Reforming the Earned Income Tax Credit.” Washington, DC: Urban-Brookings Tax Policy Center.
Meyer, Bruce D. 2002. “Labor Supply at the Extensive and Intensive Margins: The EITC, Welfare, and Hours Worked." American Economic Review, 92(2): 373–79.
Meyer, Bruce D., and Dan T. Rosenbaum. 2000. “Making Single Mothers Work: Recent Taxand Welfare Policy and Its Effects.” National Tax Journal (53): 1027–62.
———. 2001. “Welfare, the Earned Income Tax Credit, and the Labor Supply of Single Mothers.” The Quarterly Journal of Economics August: 1063–1114.
Pergamit, Mike, Elaine Maag, Devlin Hanson, Caroline Ratcliff, Sara Edelstein, and Sarah Minton. 2014. “Pilot Project to Assess Validation of EITC Eligibility with State Data.” Washington, DC: Urban Institute.
President’s Advisory Panel on Federal Tax Reform. 2005. Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System. Washington, DC: President’s Advisory Panel on Federal Tax Reform.
Short, Kathleen. 2013. “The Research Supplemental Poverty Measure: 2012.” Current Population Reports P60-247. Washington, DC: US Census Bureau.