Information about Earned Income Tax Credit
The United States federal Earned Income Tax Credit (EITC) is a refundable tax credit that reduces or eliminates the taxes that low-income married working people pay (such as payroll taxes) and also frequently operates as a wage subsidy for low-income workers. Enacted in 1975, the then very small EITC was expanded in 1986, 1990, 1993, and 2001 with each major tax bill, regardless of whether the tax bill in general raised taxes (1990), lowered taxes (2001), or eliminated other deductions and credits (1986). Today, the EITC is one of the largest anti-poverty tools in the United States (despite the fact that income measures, including the poverty rate, generally do not account for the credit), and enjoys broad bipartisan support.
Other countries with EITCs include Great Britain (see: working tax credit), Canada, Ireland, New Zealand, Finland, Belgium, France, the Netherlands and Denmark. In some cases, these are small (the maximum EITC in Finland is 290 Euros), but others are even larger than the US EITC (the UK EITC is worth up to 6150 Euros).
In addition, not everyone whose income is in the range described below is eligible for the credit. For instance, if your earned income is in one of the qualifying ranges described below but your investment income is large enough ($2,800 for tax year 2006), then you cannot claim the credit.[1]
The credit is also characterized by a unique three-stage structure that consists of a phase-in range in which the credit increases as earnings increase, a plateau range in which the maximum credit has been reached and further earnings do not affect it, and a phase-out range in which the credit decreases as earnings increase.
In tabular form, the credit is as follows:
The same data, in words: Currently for tax year 2006, for a family with two dependent children, the credit is equal to 40 percent of the first $11,340 earned, plateaus at a maximum credit of $4,536, begins to phase-out when earnings increase beyond $14,810, and reaches zero when earnings pass $36,348. For filers using the Married Filing Jointly status, the phase-out thresholds are increased by $2000. For a family with one dependent child, the structure is similar but has a phase-in rate of 34 percent and a maximum credit of $2,747. The structure of the credit in this case can be illustrated as follows:
For those filing without dependents, there is a small credit of 7.65 percent of earnings with a maximum of $412, which covers the employee's portion of the social security and medicare payroll taxes.[2] Workers without dependents must satisfy all of three additional rules in order to qualify for the credit: (1) be at least age 25 but under 65 at the end of the year, (2) live in the United States for more than half the year, and (3) not qualify as a dependent of another person.[1]
All dollar amounts are now indexed to inflation.
In addition to the federal EITC, as of 2006, 20 states (including D.C.) have their own EITCs. These state plans primarily mimic the federal EITC’s structure on a smaller scale, as individuals receive a state credit equal to a fixed percentage – between 15 and 30 percent depending on the state – of what they received from the IRS. Furthermore, small local EITC’s have been enacted in New York City, Montgomery County in Maryland, and San Francisco.
The EITC is the largest poverty reduction program in the United States. Almost 21 million American families received more than $36 billion in refunds through the EITC in 2004. These EITC dollars had a significant impact on the lives and communities of the nation’s lowest paid working people, lifting more than 5 million of these families above the federal poverty line.
Further, economists suggest that every increased dollar received by low and moderate-income families has a multiplier effect of between 1.5 to 2 times the original amount, in terms of its impact on the local economy and how much money is spent in and around the communities where these families live. Using the conservative estimate that for every $1 in EITC funds received, $1.50 ends up being spent locally, would mean that low income neighborhoods are effectively gaining as much as $18.4 billion.
Due to its structure, the EITC is effective at targeting assistance to low-income families. By contrast, only 30% of minimum wage workers live in families near or below the federal poverty line, as most are teenagers, young adults, students, or spouses supplementing their studies or family income.[3][4] Opponents of the minimum wage argue that it is a less efficient means to help the poor than adjusting the EITC. Proponents argue that the EITC is more open to abuse through fraudulent tax credit claims.
Research shows that the EITC has also boosted labor force participation, particularly by low-educated single mothers. However, there is also some evidence that this increase in labor supply has led to a fall in hourly wages among those eligible for the credit. In particular, studies have shown that a 10% increase in the generosity of the EITC causes a 4% decrease in wages for high school drop outs and a 2% decrease in wages for high school graduates.
At the same time, however, this cost may be at least partially offset by several factors: 1) any new taxes (such as payroll taxes paid by employers) generated by new workers drawn by the EITC into the labor force, 2) any reductions in entitlement spending that result from individuals being lifted out of poverty by the EITC (the poverty line is sometimes a watermark for eligibility for state and federal benefits), and 3) taxes generated on additional spending done by families receiving earned income tax credit. 4) Not to mention a potential reduction in crime and other more indirect factors.
The average EITC amount received per family in 2002 was $1,766. Using this figure and a 15% unclaimed rate would mean that low-wage workers and their families lost out on more than $6.5 billion, or more than $12 billion if the unclaimed rate is 25%.
Many nonprofit organizations around the United States, sometimes in partnership with government and with some public financing, have begun programs designed to increase EITC utilization by raising awareness of the credit and assisting with the filing of the relevant tax forms.
In addition, the EITC is a major driver for the walk-in, storefront tax industry, which includes such well-known companies as H&R Block, Jackson Hewitt, and Liberty Tax. These companies frequently offer loan products such as Refund Anticipation Loans ("RALs"). Such loans have been criticized for being over-promoted and for such practices as "cross-collection." [1] [2] (The loans are sometimes not as easy to be approved for as the advertising implies. Customers denied the next-day loans are then required to accept the two-week loan products, in which they still end up paying the bulk of the fees. "Cross-collection" occurs when the loan-issuing bank, such as Santa Barbara Bank & Trust or HSBC in recent years, engages in debt collection for other companies, notably credit card companies. This practice is often not adequately disclosed.)
Furthermore, military members who are deployed to certain areas of the world receive all of their pay (regardless of type) tax free for the time that they are deployed. For a member who is deployed for one full tax year, this means that their taxable income is reduced to zero. As this could alter their eligibility for the EITC, they are permitted to choose to incude their tax free money (that otherwise would be taxable) into their income calculation for this credit. They must elect to choose all or none, they cannot include a portion of it.
There are also others, who are deployed for less than a full tax year, but have a taxable income low enough to make them eligible for this credit. For example, an E-8 for example, who is deployed from January to October will have a taxable income for just two months (November and December), and could then become eligible for this credit, because, while a total of perhaps $50,000 was made, less than $10,000 is taxable.
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Other countries with EITCs include Great Britain (see: working tax credit), Canada, Ireland, New Zealand, Finland, Belgium, France, the Netherlands and Denmark. In some cases, these are small (the maximum EITC in Finland is 290 Euros), but others are even larger than the US EITC (the UK EITC is worth up to 6150 Euros).
Structure
The size of the earned income credit, as its name suggests, is a function of how much earned income the filer has accumulated, where "earned income" is a technical term defined by the Internal Revenue Service under guidance of the tax code. The following three are the main sources of income that count:[1]- Wages, salaries, tips, and other taxable employee pay
- Net earnings from self-employment
- Gross income received as a statutory employee
In addition, not everyone whose income is in the range described below is eligible for the credit. For instance, if your earned income is in one of the qualifying ranges described below but your investment income is large enough ($2,800 for tax year 2006), then you cannot claim the credit.[1]
The credit is also characterized by a unique three-stage structure that consists of a phase-in range in which the credit increases as earnings increase, a plateau range in which the maximum credit has been reached and further earnings do not affect it, and a phase-out range in which the credit decreases as earnings increase.
In tabular form, the credit is as follows:
| Earned income (x) | Stage | Credit (2+ children) |
|---|---|---|
| $0-$11,340 | phase in | 40% * x |
| $11,340-$14,810 | plateau | $4,536 |
| $14,810-$36, 348 | phase out | $4,536 - 21.06% * (x - $14,810) |
| >= $36, 348 | no credit | $0 |
| Earned income (x) | Stage | Credit (1 child) |
| $0-$8,080 | phase in | 34% * x |
| $8,080-$14,810 | plateau | $2,747 |
| $14,810-$32,001 | phase out | $2,747 - 15.98% * (x - $14,810) |
| >= $32,001 | no credit | $0 |
| Earned income (x) | Stage | Credit (no children) |
| $0-$5,380 | phase in | 7.65% * x |
| $5,380-$6,740 | plateau | $412 |
| $6,740-$12,120 | phase out | $412 - 7.65% * (x - $6,740) |
| >= $12,121 | no credit | $0 |
The same data, in words: Currently for tax year 2006, for a family with two dependent children, the credit is equal to 40 percent of the first $11,340 earned, plateaus at a maximum credit of $4,536, begins to phase-out when earnings increase beyond $14,810, and reaches zero when earnings pass $36,348. For filers using the Married Filing Jointly status, the phase-out thresholds are increased by $2000. For a family with one dependent child, the structure is similar but has a phase-in rate of 34 percent and a maximum credit of $2,747. The structure of the credit in this case can be illustrated as follows:
For those filing without dependents, there is a small credit of 7.65 percent of earnings with a maximum of $412, which covers the employee's portion of the social security and medicare payroll taxes.[2] Workers without dependents must satisfy all of three additional rules in order to qualify for the credit: (1) be at least age 25 but under 65 at the end of the year, (2) live in the United States for more than half the year, and (3) not qualify as a dependent of another person.[1]
All dollar amounts are now indexed to inflation.
In addition to the federal EITC, as of 2006, 20 states (including D.C.) have their own EITCs. These state plans primarily mimic the federal EITC’s structure on a smaller scale, as individuals receive a state credit equal to a fixed percentage – between 15 and 30 percent depending on the state – of what they received from the IRS. Furthermore, small local EITC’s have been enacted in New York City, Montgomery County in Maryland, and San Francisco.
Impact
The EITC is the largest poverty reduction program in the United States. Almost 21 million American families received more than $36 billion in refunds through the EITC in 2004. These EITC dollars had a significant impact on the lives and communities of the nation’s lowest paid working people, lifting more than 5 million of these families above the federal poverty line.
Further, economists suggest that every increased dollar received by low and moderate-income families has a multiplier effect of between 1.5 to 2 times the original amount, in terms of its impact on the local economy and how much money is spent in and around the communities where these families live. Using the conservative estimate that for every $1 in EITC funds received, $1.50 ends up being spent locally, would mean that low income neighborhoods are effectively gaining as much as $18.4 billion.
Due to its structure, the EITC is effective at targeting assistance to low-income families. By contrast, only 30% of minimum wage workers live in families near or below the federal poverty line, as most are teenagers, young adults, students, or spouses supplementing their studies or family income.[3][4] Opponents of the minimum wage argue that it is a less efficient means to help the poor than adjusting the EITC. Proponents argue that the EITC is more open to abuse through fraudulent tax credit claims.
Research shows that the EITC has also boosted labor force participation, particularly by low-educated single mothers. However, there is also some evidence that this increase in labor supply has led to a fall in hourly wages among those eligible for the credit. In particular, studies have shown that a 10% increase in the generosity of the EITC causes a 4% decrease in wages for high school drop outs and a 2% decrease in wages for high school graduates.
Cost
It is difficult to measure the cost of the EITC to the Federal Government. At the most basic level, federal revenues are decreased by the lower, and often negative, tax burden on the working poor for which the EITC is responsible. In this basic sense, the cost of the EITC to the Federal Government was more than $36 billion in 2004.At the same time, however, this cost may be at least partially offset by several factors: 1) any new taxes (such as payroll taxes paid by employers) generated by new workers drawn by the EITC into the labor force, 2) any reductions in entitlement spending that result from individuals being lifted out of poverty by the EITC (the poverty line is sometimes a watermark for eligibility for state and federal benefits), and 3) taxes generated on additional spending done by families receiving earned income tax credit. 4) Not to mention a potential reduction in crime and other more indirect factors.
Uncollected tax credits
Millions of American families who are eligible for the EITC do not receive it, leaving billions of additional tax credit dollars unclaimed. Research by the Government Accountability Office (GAO) and Internal Revenue Service indicates that between 15% and 25% of households who are entitled to the EITC do not claim their credit, or between 3.5 million and 7 million households.The average EITC amount received per family in 2002 was $1,766. Using this figure and a 15% unclaimed rate would mean that low-wage workers and their families lost out on more than $6.5 billion, or more than $12 billion if the unclaimed rate is 25%.
Many nonprofit organizations around the United States, sometimes in partnership with government and with some public financing, have begun programs designed to increase EITC utilization by raising awareness of the credit and assisting with the filing of the relevant tax forms.
In addition, the EITC is a major driver for the walk-in, storefront tax industry, which includes such well-known companies as H&R Block, Jackson Hewitt, and Liberty Tax. These companies frequently offer loan products such as Refund Anticipation Loans ("RALs"). Such loans have been criticized for being over-promoted and for such practices as "cross-collection." [1] [2] (The loans are sometimes not as easy to be approved for as the advertising implies. Customers denied the next-day loans are then required to accept the two-week loan products, in which they still end up paying the bulk of the fees. "Cross-collection" occurs when the loan-issuing bank, such as Santa Barbara Bank & Trust or HSBC in recent years, engages in debt collection for other companies, notably credit card companies. This practice is often not adequately disclosed.)
EITC and United States Military Service Members
A member of the armed forces of the United States may receive multiple types of military monetary compensation, to include their regular pay as well as tax free allowances for housing, clothing and food. Up until tax year 2005, the nontaxable portions were included with the regular basic pay, and other taxable pay to determine their eligibility for the EITC. Being that this is no longer the case, there are many more service members eligible for this credit, even though they may live well above the poverty line, and well above the other members of the labor force who receive this credit. A similar change was enacted in 2001 which also made many service members eligible for WIC.Furthermore, military members who are deployed to certain areas of the world receive all of their pay (regardless of type) tax free for the time that they are deployed. For a member who is deployed for one full tax year, this means that their taxable income is reduced to zero. As this could alter their eligibility for the EITC, they are permitted to choose to incude their tax free money (that otherwise would be taxable) into their income calculation for this credit. They must elect to choose all or none, they cannot include a portion of it.
There are also others, who are deployed for less than a full tax year, but have a taxable income low enough to make them eligible for this credit. For example, an E-8 for example, who is deployed from January to October will have a taxable income for just two months (November and December), and could then become eligible for this credit, because, while a total of perhaps $50,000 was made, less than $10,000 is taxable.
See also
External links
Background:- Section 13 ("Tax Provisions Related to Retirement, Health, Poverty, Employment, Disability, and Other Social Issues") of the House Ways and Means Committee's Green Book provides historical information, including previous EITC parameters. (The version linked to here is the 2004 edition. Note: it's not published anuually.)
- Congressional Budget Office report for Senate Finance Committee, on "the Effects of Increasing the Federal Minimum Wage Versus Expanding the Earned Income Tax Credit" (January 9, 2007)
- New Research Findings on the Effects of the Earned Income Tax Credit, Center on Budget and Policy Priorities, March 11, 1998
- The Earned Income Tax Credit (EITC): Percentage of Total Tax Returns and Credit Amount by State a Congressional Research Service (CRS) Report
- The Earned Income Tax Credit at Age 30: What We Know, Steve Holt, the Brookings Institution
- National Community Tax Coalition, an organization that supports the EITC and tries to help make sure people claim it
- Boston EITC Campaign
- The IRS EITC Assistant, which can help determine if you qualify for EITC
- IRS Publication 596 - Earned Income Credit, a document aimed at people who will potentially be seeking the credit
References
1. ^ IRS Publication 596 (See link under "External links" heading.)
2. ^ Figures cited are from EITC Parameters 2002-2007, at the Tax Policy Center (Accessed January 26, 2007)
3. ^ Turner, Mark (2007-1-17). The Low-Wage Labor Market.
4. ^ Characteristics of Minimum Wage Workers: 2005. Bureau of Labor Statistics, US Department of Labor (2007-1-17).
2. ^ Figures cited are from EITC Parameters 2002-2007, at the Tax Policy Center (Accessed January 26, 2007)
3. ^ Turner, Mark (2007-1-17). The Low-Wage Labor Market.
4. ^ Characteristics of Minimum Wage Workers: 2005. Bureau of Labor Statistics, US Department of Labor (2007-1-17).
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