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Taxes and the Poor: How do refundable and nonrefundable credits differ?

Taxpayers may claim the full value of most tax credits only if their tax liability before applying the credit exceeds the value of the credit. Stated another way, most tax credits cannot reduce a person’s tax bill below zero. Three tax credits-the earned income tax credit (EITC), the child tax credit (CTC), and the small Health Coverage Tax Credit (HCTC)-do not face that limitation; they are termed refundable because they can generate cash refunds that exceed the taxpayer’s tax liability. The EITC and the HCTC are fully refundable: taxpayers may receive their full value regardless of their other tax liability. In contrast, the CTC is only partially refundable because it can result in negative tax bills only in specified circumstances.

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  • The federal budget distinguishes between the portion of a tax credit that offsets positive tax liability and the portion that is refundable. Most of the EITC-an estimated $39.4 billion of the 2008 total of $46.5 billion-is refundable. Much less of the CTC is refundable: $16.3 billion out of $44.8 billion in 2008.
  • Proponents of refundable credits argue that only by making credits refundable can the tax code effectively carry out desired social policy. Particularly in the cases of the EITC and the CTC, precisely those low-income households most in need of assistance would be denied the benefit of the credits if they were not refundable. Furthermore, allowing credits only against income tax liability ignores the fact that most low-income families also incur payroll taxes.
  • Opponents of refundable credits raise four objections: that the tax code should not redistribute income; that the government should not use the tax code to carry out social policies; that everyone should pay some tax as a responsibility of citizenship; and that refundable credits increase administrative and compliance costs and encourage fraud and abuse.
  • Like the federal government, states have few refundable tax credits. However, fourteen states-Colorado, Illinois, Indiana, Kansas, Massachusetts, Minnesota, Nebraska, New Jersey, New York, Oklahoma, Oregon, Rhode Island, Vermont, and Wisconsin-and the District of Columbia do provide a refundable EITC. Part of Maryland’s EITC is refundable and part is not. Four states-Delaware, Iowa, Maine, and Virginia-have a nonrefundable EITC.
 
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   Entry 2 of 4