Taxation and the Family: What is the Earned Income Tax Credit?
The earned income tax credit (EITC) provides a subsidy for low-income working families. The credit equals a fixed percentage of earnings from the first dollar of earnings until the credit reaches a maximum; both the percentage and the maximum credit depend on the number of children in the family. The credit then stays flat at that maximum as earnings continue to rise, but eventually earnings reach a phase-out range. From that point the credit falls with each additional dollar of income until it disappears entirely (figures 1 and 2). The phase-out begins at a higher income for married couples than for single parents. The credit is fully refundable: any excess beyond a family’s income tax liability is paid as a tax refund.
- Families with three or more children may receive a credit of up to $5,666 in 2010. The maximum credit is $5,036 for families with two children, $3,050 for families with one child, and just $457 for those without children.
- In addition, twenty-three states and the District of Columbia had their own EITCs in 2008, typically set equal to a percentage of the federal credit.
- The EITC is the largest cash assistance program targeted at low-income families. In 2006, 22 million households received a total of $41.2 billion in reduced taxes and refunds (figure 3). The credit lifts roughly 4 million people out of poverty each year. More than 80 percent of families with children eligible for the EITC in 1999 claimed the credit, a much higher take-up rate than for Temporary Assistance to Needy Families (52 percent in 1999) or for food stamps (67 percent in 1999).
- The EITC has been successful at encouraging people, particularly single mothers, to take jobs. Its effectiveness at increasing hours worked is more ambiguous.
- Critics complain that the EITC is too complex, forcing potential recipients to seek help filing their federal tax return: two-thirds of low-income parents get such assistance, typically from paid tax preparers.
- The credit’s complexity may also contribute to relatively high error rates. The IRS estimates that nearly a third of EITCs were claimed erroneously in 1999, because of tax filer confusion or fraud.
- The EITC imposes significant marriage penalties on some families. If a single parent receiving the EITC marries, the addition of the spouse’s income may reduce or eliminate the credit. To address this issue, the Economic Growth and Tax Relief Reconciliation Act of 2001 raised the income level at which the EITC begins to phase out for couples to $3,000 above that for single filers. The American Recovery and Reinvestment Act of 2009 (ARRA) increased that amount to $5,000 for 2009 and indexed that threshold to inflation. The differential is scheduled to expire completely in 2011, but the 2011 budget proposes to make the change permanent.
- Several reforms to the EITC have been proposed. One would increase the credit for childless workers to an amount closer to that for families with children; this would provide much-needed assistance for many additional poor workers.
- Another reform would extend the higher phase-out threshold for married couples beyond its scheduled expiration in 2011, as proposed in the 2011 budget.
- The EITC could also be consolidated with other tax provisions benefiting families with children into a single family credit, with lower phase-out rates and a uniform definition of who counts as a child. This could simplify tax filing and increase the assistance provided to working families with children.
- Separating the EITC into two parts—one directed at providing an incentive to work, and the other at costs associated with raising children—could both increase work effort and provide more assistance for needy families with children.
- The American Recovery and Reinvestment Act of 2009 increased the EITC rate for families with three or more children to 45 percent in 2009 and 2010. The 2011 budget proposes to make this increase permanent.
