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Earned income tax credit (EITC). Reading Assignment. Greenstein, “The Earned Income Tax Credit: Boosting Employment, Aiding the Working Poor,” http://www.cbpp.org/7-19-05eic.htm DeParle, Ch. 17: Money: Milwaukee, Summer 1999. Additional EITC Links.

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Reading Assignment

  • Greenstein, “The Earned Income Tax Credit: Boosting Employment, Aiding the Working Poor,” http://www.cbpp.org/7-19-05eic.htm

  • DeParle, Ch. 17: Money: Milwaukee, Summer 1999


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Additional EITC Links

  • IRS EITC information: http://www.irs.gov/individuals/article/0,,id=96406,00.html

  • Thresholds and maximum credits: http://www.irs.gov/individuals/article/0,,id=150513,00.html

  • Q & As: http://www.irs.gov/individuals/article/0,,id=96466,00.html

  • EITC’s reach: http://www.taxpolicycenter.org/publications/url.cfm?ID=1000467


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Today’s Questions

  • What is the EITC and how does it work?

  • Who receives the EITC?

  • How large are the credits?

  • Which States supplement the credit?

  • Why is the EITC politically popular?

  • Will this popularity last?-- problems with the EITC


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What is the EITC and how does it work?

  • A tax reduction and wage supplement for low- and moderate-income families

  • Available to both single parent, two parent families, and childless low-income workers

  • Must work to be eligible

  • A refundable credit, which means that if the credit amount is larger than a family’s income tax bill, the family receives a refund check equal to the difference.

  • Usually claimed when the income tax return is filed. Can opt for equal monthly payments.



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ARRA and the Earned Income Tax Credit

  • The American Recovery and Reinvestment Act (ARRA) provides a temporary increase in the earned income tax credit (EITC) for taxpayers with three or more qualifying children. The maximum EITC for this new category is $5,657. ARRA also increases the beginning point of the phaseout range for the credit for all married couples filing a joint return, regardless of the number of children. These changes apply to 2009 and 2010 tax returns.

  • Source: irs.gov


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Example

  • A single parent with two children working nearly full-time--52 weeks per year at 38 hours per week--at the minimum wage of $7.25 per hour has an annual income of about $14,326. After subtracting $1,095 in federal payroll taxes and adding the $4,842 federal EITC for which the family qualifies, the family’s cash income totals $18,054, or $708 above the 2008 poverty line for a family of three ($17,346).


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Who Receives the EITC?

  • 5.4 million poor families with at able-bodied parents

    • 3.3 million or 66 percent had at least one parent in the labor force

    • Among poor families with children in which one or both parents worked anytime during the year, the parents worked at combined 44 weeks.

  • About 75 percent of the families on welfare (TANF, SSI, or GA) had a parent working in 2004


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Who Receives the EITC?

Source: Holt, 2006


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Who Receives the EITC?

Source: Holt, 2006



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Who Receives the EITC?

Source: Holt, 2006


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How large are the credits?

Source: Nagle and Johnson, 2006




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Which States supplement the credit?

  • 24 States (counting the District of Columbia as a State) supplement with Federal EITC.

  • See http://www.cbpp.org/cms/index.cfm?fa=view&id=462 for details.


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Why is the EITC Politically Popular?

  • Encourages work

    • More people enter the labor force

    • Workers work more hours

  • Reduces welfare costs

    • Grogger concluded that the EITC “may be the single most important policy for explaining recent increases in work and earnings and declines in receipt of cash welfare assistance among female-headed families.”

      Source: Greenstein, 2005


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Why is the EITC Politically Popular?, Cont.

  • Reduces poverty

    • By 4.4 million in 2003

    • The poverty rate among children would be 1/4 higher without EITC

    • Lifts more children out of poverty than any other program


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Child Credit

  • a $1,000 tax credit per child on your tax return for children who are under 17 as of the end of the tax year

    • Phased out for taxpayers with modified adjusted gross income

    • reduced (but not below zero) by $50 for each $1,000 (or fraction thereof) by which the taxpayer's modified adjusted gross income exceeds the threshold amount.

    • Threshold amounts:

      • $110,000 in the case of a joint return

      • $75,000 in the case of an unmarried individual

      • $55,000 in the case of a married individual filing a separate return


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Will this popularity last?-- problems with the EITC

  • Fraud

    • Overpayments to eligibles

    • Fraudulent claims from ineligibles

  • Nonparticipation

  • Marriage penalty encourages cohabitation

    • A two earner, two-child couple making $35,000 (with a 60/40% earnings split) can save $3,923 a year in federal income taxes by avoiding marriage (EITC: $4,400 vs. $476).


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Will this popularity last?-- problems with the EITC, cont.

  • High cumulative marginal tax rates

    • When earnings are in the phase-out range, the combined marginal tax rates for the may create a substantial work disincentive

      • Federal income taxes 15%

      • Payroll tax 7%

      • EITC phase-out 21%

    • Add a State income tax (3 to 6%) to this 43% marginal tax rate if relevant.

    • Add 24% phase-out rate for Food Stamps.

    • Cumulatively the marginal tax rate face by low-income Americans is in the range of 43- 73% !


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Will this popularity last?-- problems with the EITC, cont.

  • Subsidy to low-wage employers

    • w0, L0 initial equilibrium

    • w1, L0 equilibrium with EITC

    • EITC = w0 - w1

    • Final equilbrium is at w2, L2

wages

S

S’

w0

w2

w1

D

L0

L2

workers



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Proposed Improvements

  • Increase tax credit for low-income workers without children

  • Increase tax credit for families with three or more children 

  • Eliminate the marriage penalty

  • Simplify filing procedures


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EITC Marriage Penalty

Source: Iris J. Lav, Extending Marriage-Penalty Relief to Working Poor and Near Poor Families, http://www.cbpp.org/6-10-99tax.htm


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EB = G/t + D


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labor force participation for individuals, cont.Budget Constraints

Y

  • Budget constraint ADE

    The individual has higher nonwage income (Z2 = AD) and the same market wage rate

E

F

  • Budget constraint ADF

    The individual has higher nonwage income (Z2 = BD) but a lower market wage (DF is less steep).

C

D

Z2

Z1

B

A

O

leisure hours

hours of work


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labor force participation for individuals, cont.Individual Chooses To Work

U3

Income (Y)

U2

Utility is maximized at D where MRCS = w

U1

C

D

Y1

B

A

L1

0 Leisure hours

(maximum work hours)

0 Work Hours

(maximum leisure hours)

Leisure hours (l)

Work hours (L)


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labor force participation for individuals, cont.Individual ChoosesNotTo Work when nonwage income increases

Income (Y)

Utility is maximized at F where:

MRCS = w = reservation wage

F is a corner solution

Work hours fall from L1 to 0

(pure income effect: Yl)

Un

U2

U1

C

F

D

Y1

B

A

0 Leisure hours

(maximum work hours)

L1

0 Work Hours

(maximum leisure hours)

Leisure hours (l)

Work hours (L)


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labor force participation for individuals, cont.Individual Chooses To Work Less as Wage rate falls

U3

  • Utility is maximized at E

  • Hours worked falls from L1 to L2

Income (Y)

U2

U1

C

  • income effect: L1 -LY

  • Substitution effect L2 - LY

D

Y1

Y2

E

B

A

LY

L1

L2

0 Work Hours

(maximum leisure hours)

0 Leisure hours

(maximum work hours)

Leisure hours (l)

Work hours (L)