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INCREASE IN EARNED INCOME TAX CREDIT

Key Points

 

·        This proposal would increase the earned income tax credit (EITC) for families with three or more children from 40 to 45 percent of qualifying earnings. It would also increase the income range over which the EITC phases out for married couples to $5,000 more than that for single people, up from the 2009 level of $3,120.

·        Increases to the EITC focus resources on relatively low-income families, who are most likely to spend the money.

·        Marriage-penalty relief furthers efforts started with EGTRRA to keep low-income families from losing their EITC because of marriage.

·        JCT estimates that the proposal would cost $4.7 billion over 10 years.

 

Current Law

 

The earned income tax credit (EITC) subsidizes earnings for low-income working families. The credit equals a fixed percentage of earnings until the credit reaches a maximum; both the percentage and the maximum credit depend on the number of children in the family. Maximum credits in 2009 are $457 for workers with no children, $3,043 for families with one child, and $5,028 for those with two or more children. Larger families get no additional credit. The credit stays at that maximum as income rises up to the phase-out threshold, above which the credit falls with each additional dollar of income until it disappears entirely. The phaseout 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.

The table below summarizes the EITC parameters in 2009.

 

 

Number of children

 

Credit rate (percent)

Income level for maximum credit

 

 

Maximum credit

 

Phase-out rate (percent)

 

Phase-out range*

Beginning income

Ending income

None

    7.65

  5,970

  457

  7.65

  7,470

13,440

One

  34

  8,950

3,043

15.98

16,420

35,643

Two or more

  40

12,570

5,028

21.06

16,420

40,295

*The phase-out range for married couples begins and ends $3,120 higher than the values listed in this table. 

All dollar levels are adjusted annually for inflation.

Stimulus Proposal

The proposal would increase the earned income tax credit rate for working families with three or more children to 45 percent in 2009 and 2010. The maximum credit for families with three or more children would increase from $5,028 to $5,657. It would also increase the phase-out income levels for all married couples filing a joint tax return (regardless of the number of children) to $5,000 above the thresholds for single filers in 2009 and 2010. 


 

Discussion

The EITC helps low-income families, but its structure ignores the greater needs of larger families. The credit goes to families with relatively low income—no more than $43,415—for whom having an additional child could impose significant demands on scarce resources.

Under the proposal, all families with three or more children who currently qualify for the EITC would receive a larger credit, and more families would become eligible for the credit because the phase-out range would extend over about $2,000 more income than the current credit for affected families.

The EITC may impose substantial marriage penalties on low-income families. When two low-income individuals marry, they may get a smaller or no EITC because of their higher combined earnings. The 2001 tax act increased the income level at which the credit begins to phase out for married couples to $3,120 above that for single people in 2009. The stimulus bill would further mitigate the marriage penalty by raising that higher phase-out start for couples to $5,000 above that for single people and thus make the credit available to more married tax filers.

The proposal is highly targeted, providing benefits to poor families, who are most likely to spend the additional income. Research based on credit card data showed that low-income households spent about 75 percent of their rebates from the 2001 tax stimulus (Johnson, Parker, and Souleles 2006). Shapiro and Slemrod (2003), however, found that low-income families spent much less than three-fourths of their 2001 rebates and not much more than higher-income families.

The larger EITC would increase the benefits of working and could thus induce some very low income people to look for jobs. In an ordinary time, that would help boost the economy. Given the currently high unemployment rate, however, new job seekers are unlikely to find work so the economy would get little stimulus through this mechanism.

There is likely to be substantial pressure to extend the credit beyond two years. That would increase long-term revenue losses, but it would also improve fairness for large families by recognizing their relatively greater needs and would mitigate some marriage penalties.

Grade: B

This provision is targeted on low-income households that are likely to spend additional income. The proposal would receive a higher grade if money could be distributed to affected families quickly—for example, through rebates based on 2008 income levels. More than 98 percent of recipients get the EITC as a refund at filing time, so the higher credit would not affect most recipients until they file their tax returns in 2010.

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