Congressional Research Service Report Examines Earned Income Tax Credit
RL31768
- AuthorsScott, Christine
- Institutional AuthorsCongressional Research Service
- Subject Area/Tax Topics
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 2003-7292 (33 original pages)
- Tax Analysts Electronic Citation2003 TNT 55-14
Report for Congress
Received through the CRS Web
The Earned Income Tax Credit (EITC):
An Overview
Updated March 19, 2003
Christine Scott
Specialist in Tax Economics
Domestic Social Policy Division
The Earned Income Tax Credit (EITC): An Overview
Summary
[1] The Earned Income Credit (EITC or EIC) began in 1975 as a temporary program to return a portion of the social security taxes paid by lower income taxpayers, and was made permanent in 1978. In the 1990s, the program became a major component of federal efforts to reduce poverty, and is now the largest anti-poverty entitlement program. In tax year 2000, the EITC totaled $31.8 billion for 19.2 million recipients, an average tax credit of $1,658. Most of the EITC (85.8%) was received as a refund to low income workers with little or no income tax liability. While childless adults in 2000 received an average EITC of $206, families with one child received an average EITC of $1,571 and families with two or more children received an average EITC of $2,385.
[2] A low income worker must file an annual income tax return to receive the EITC and meet certain requirements for income and age. A tax filer cannot be a dependent of another tax filer and must be a resident of the United States unless overseas because of military duty. The EITC is based upon income and whether or not the tax filer has a qualifying child.
[3] The EITC interacts with several nonrefundable federal tax credits to the extent lower income workers can utilize the credits to reduce tax liability before the EITC. Income from the credit is not used to determine eligibility or benefits for means tested programs. However, 16 states and the District of Columbia now offer an EITC for state taxes, and most of them are based on the federal EITC. Any change in the federal EITC would flow down to impact the state EITC.
[4] Policy issues for the EITC, which reflect either the structure, impact, or administration of the credit include: the work incentive effects of the credit; the marriage penalty for couples filing joint tax returns; the anti-poverty effectiveness of the credit (primarily a family size issue); potential abuse, i.e., compliance with credit law and regulations; and the use of paid tax preparers.
[5] The National Taxpayer Advocate heads an independent program within the Internal Revenue Service (IRS) to handle taxpayer problems not resolved through normal channels, and to identify issues that create problems for taxpayers. As part of identifying problems for taxpayers, the National Taxpayer Advocate prepares a report each year to Congress summarizing at least 20 of the most serious problems faced by taxpayers with recommendations to resolve the problems. In the National Taxpayer Advocate's Annual Report to Congress of December 31, 2002, six of the "most serious problems" are EITC related problems. This report will be updated annually.
Contents
Eligibility
Families with children
Childless Adults
Credit Amount
Calculation of EITC Amount
Indexing
Marginal Tax Rates
Participation
Characteristics of Tax Year 2000 EITC Tax Returns
Number of Children
Filing Status
Geographic Distribution
Interaction With Other Tax Provisions
Other Federal Tax Credits
Means Tested Programs
State EITC Provisions
Issues
Work Incentives
Marriage Penalty
Anti-Poverty Effectiveness (Family Size)
Compliance
Paid Tax Preparers
National Taxpayer Advocate's "Most Serious Problems"
Appendix 1. Legislative History of the EITC
Work Bonus Plan (1972-1974 Proposals)
Enactment of EITC in 1975
Extensions of EITC (1975-1977 Laws)
Permanent Status for EITC and Rise in Maximum Credit (1978 Law)
Rise in Maximum Credit (1984 Law)
Indexation of EITC and Rise in Maximum Credit (1986 Law)
Rise in Maximum Credit and Establishment of Family-Size
Adjustment and Supplemental Credits (1990 Law)
Basic EITC
Supplemental Young Child Credit
Supplemental Health Insurance Credit
Expansion of Credits, Coverage of Childless Adults, and Repeal
of Supplemental Credits (1993 Law)
Credit for Families
Extension of EITC to Childless Households
Coverage of Overseas Military Personnel (1994 Law)
Eligibility Limit Based on Investment Income (1995 Law)
Revisions of EITC in the Welfare Reform Bill (1996 Law)
Deny EITC to Undocumented Workers
Disqualified Income
Broaden Income Used in EITC Phase-out
Allow State Welfare Programs to Count EITC
Denying Credit Based on Prior Claims (1997 Laws)
Reduction of Marriage Penalty and Simplification of the EITC
(2001 Law)
Appendix 2. History of the EITC Parameters
List of Figures
Figure 1. EITC Levels by Income, Single Parent Family with One Child,
Tax Year 2002
Figure 2. Statutory and Marginal Tax Rates, Single Parent Family with
One Child, Tax Year 2002
List of Tables
Table 1. EITC Parameters for Tax Years 2001-2003
Table 2. EITC and Recipients 1975-2000
Table 3. Percent Distribution of Returns and Total EITC by Number of
Children, Tax Year 2000
Table 4. EITC by Number of children, Tax Year 2000
Table 5. Percent Distribution of Returns and Total EITC by Tax Filing
Status, Tax Year 2000
Table 6. Federal EITC Recipients and EITC Amount By State, Tax Year
2000
Table 7. Impact of Savings Credit on EITC for A Single Parent Family
with One Child, Tax Year 2002
Table 8. State EITC Programs
Table 9. Impact of Family Size on Net Income after Taxes Relative to
Poverty Level, 2001
Table 10. EITC Parameters, 1975-2003
[6] The earned income tax credit (EITC) program began in 1975 as a temporary and small (6.2 million recipients) program to reduce the tax burden on working low income families. The program has grown into the largest federal anti-poverty program with 19.2 million tax filers receiving $31.8 billion in tax credits for tax year 2000.
Appendix 1 outlines the history of the EITC and Appendix 2 shows how the parameters for calculating the EITC have changed since the original enactment in 1975.
Eligibility
[7] The EITC is a refundable tax credit available to eligible workers earning relatively low wages. Under current law there are two categories of EITC recipients: childless adults and families with children. Because the credit is refundable, an EITC recipient need not owe taxes to receive the benefits. An EITC eligible family may also receive a portion of the credit in the form of advanced payments. Eligibility for, and the size of, the EITC is based on income, age, residence, and the presence of qualifying children.
[8] Families with children. For a family to receive the EITC, the family must have adjusted gross income (AGI) and earned income below the amount which reduces the EITC to $0, and have investment income no greater than $2,200 (indexed for inflation). Investment income includes interest income (including tax-exempt interest), dividends, net rent and royalties that are from sources other than the filer's ordinary business activity, net capital gains, and net passive income.
[9] Earned income includes wages, tips, and other compensation included in gross income and self-employment income after the deduction for self-employment taxes. Earned income does not include: pension or annuity income; income for nonresident aliens not from a U.S. business; income earned while incarcerated (for work in prison); and to the extent subsidized, earnings from a mandatory state work program.
[10] The family must reside in the United States unless in another country because of U.S. military duty. The child (or children) must meet the three requirements for a qualifying child:
relationship -- the child must be: a son, daughter or descendant of such (grandchild); a brother, sister, or descendent of such (niece or nephew) cared for by the taxpayer; or foster child;
residence -- the child must live with the taxpayer for more than half the year; and
age -- the child must be under age 19 (or age 24, if a full- time student) or be permanently and totally disabled.
[11] If a child qualifies for more than one tax filer, the natural parent claims the child. If the natural parent is not one of the tax filers, the tax filer with the highest AGI claims the child for the EITC. If both tax filers are natural parents, the parent the child resided the longest with during the tax year claims the child. If the child resided with each parent for the same period of time, the filer with the larger AGI must claim the child.1
[12] Childless Adults. Childless adults must reside in the United States unless in another country because of U.S. military duty. A childless adult must be at least 25 years of age, but not more than 64 years of age to be eligible for the EITC, and cannot be claimed as a dependent on another person's tax return. Childless adults may include married couples if both persons meet eligibility requirements. Eligibility is restricted to those with both earnings and AGI below the income amount which reduces the EITC to $0, and investment income (as defined above) not in excess of $2,200 (indexed for inflation).
Credit Amount
[13] Calculation of EITC Amount. Claimants receive an EITC in one of four ways:
as a reduction in income tax liability;
as a year-end cash payment from the Treasury if the family has no income tax liability;
as a combination of reduced taxes and direct payments; or
as advance payments by adjusting withholding.2
[14] To receive an EITC, a person must file an income tax return at the end of the tax year, together with a separate schedule (Schedule EIC) if claiming a qualifying child. An eligibility certificate (Form W-5) must be filed with the employer to receive advance credits through the employer's payroll.
[15] If the family (or childless adult) is eligible for the credit, the credit is based on the credit rate, which varies with the number of children, and the earned income. Up to the maximum earned income amount, the credit equals the earned income times the credit rate. During this phase-in period for the credit, for each additional $1 of earned income the recipient receives an additional credit equal to the credit rate. For example, in tax year 2003 for a family with one child, for each additional $1 of earnings (up to a total earned income of $7,500) the family receives an additional 34 cents in EITC.
[16] For earned income between the maximum earned income amount and the phaseout income level, the EITC is constant at the maximum credit. Above the phase-out income level, for each additional $1 of income the recipient loses credit at the phaseout rate. In tax year 2003, for a family with one child, for each $1 of income above the phase-out level of income ($14,750 for married couples, $13,750 for others), the recipient loses 15.98 cents of EITC. Graphically, the phase-in period for the credit is steeper than the phase-out period because the credit is increased faster during the phase-in than the credit is reduced during the phase-out.
[17] In general, the EITC amount increases with earnings up to a point (the maximum earned income eligible for the credit), then remains unchanged for a certain bracket of income (the plateau), and then (beginning at the phase-out income level) gradually decreases to zero as earnings continue to increase. Figure 1 provides a graphic representation of EITC levels, by income level for a single parent family with one child.
[18] The parameters for calculating the EITC (credit rates, phase-out rates, maximum earned income amount, maximum credit amount, phase-out income level, and disqualifying investment income level) for tax years 2001, 2002 and 2003 are shown in Table 1.
[19] The EITC is taken against total tax liability (regular, alternative minimum, and self-employment taxes) after several nonrefundable tax credits. Because the EITC is a refundable credit, on the tax return the line for the EITC can be found in the payment section after the lines for withholding and estimated tax payments. The individual income tax return booklet presents the EITC amounts in tables by income brackets (in $50 increments). This allows a tax filer to look up the correct amount of the EITC based on income, filing status, and number of children.
Figure 1. EITC Levels
by Income, Single Parent Family with One Child,
Tax Year 2002
[Figure 1 omitted]
Table 1. EITC Parameters for Tax Years 2001-2003
2001 2002 2003 Credit Phase-out
rate rate
No Children 7.65% 7.65%
Maximum earned income
amount $4,800 $4,950 $5,000
Maximum credit $364 $376 $382
Phase-out income level
Joint returns $5,950 $7,150 $7,250
Other returns $5,950 $6,150 $6,250
Income where EITC =$0
Joint returns $10,750 $12,100 $12,250
Other returns $10,750 $11,100 $11,250
One child 34% 15.98%
Maximum earned
income amount $7,100 $7,400 $7,500
Maximum credit $2,428 $2,506 $2,547
Phase-out income level
Joint returns $13,100 $14,550 $14,750
Other returns $13,100 $13,550 $13,750
Income where EITC =$0
Joint returns $28,300 $30,250 $30,700
Other returns $28,300 $29,250 $29,700
Two or more children 40% 21.06%
Maximum earned
income amount $10,050 $10,400 $10,550
Maximum credit $4,008 $ 4,140 $ 4,204
Phase-out income level
Joint returns $13,100 $14,550 $14,750
Other returns $13,100 $13,550 $13,750
Income where EITC =$0
Joint returns $32,121 $34,178 $34,692
Other returns $32,121 $33,178 $33,692
Disqualifying
investment income
level $2,450 $2,550 $2,600
Source: Table prepared by the Congressional Research Service.
Note:All income amounts rounded up to the nearest $50 to reconcile with the IRS published tables.
[20] A formula presentation of the EITC calculation follows (where category reflects EITC factors based on the number of children and filing status as in Table 1, and adjusted gross income (AGI) is equal to gross income from all taxable sources such as earned income, dividends, taxable interest, alimony, capital gains, taxable pensions, etc. less statutory adjustments).
EITC =
Lesser of: earned income or maximum earnings amount/category
times
credit rate/category
minus
Greater of 0 or [earned income (or AGI whichever is larger) minus
phase-out
income level/category times phase-out rate/category]
[21] The following three examples for a married couple with 2 children in tax year 2002, illustrate how the EITC is calculated. The parameter values in the examples are close to, but not the same as in Table 1, because in the table the values are rounded to reflect the use of $50 brackets in the tax return booklet.
[22] Example 1. For a family receiving less than the maximum allowable credit, with earned income and AGI of $9,500 (which is less than the maximum earned income amount):
EITC = $9,500 times 40% = $3,800
Example 2. For a family receiving the maximum allowable with earned income and AGI of $12,500 (which is greater than the maximum earned income amount but less than the phase-out income level):
EITC= $10,350
(the maximum earned income amount) times 40%
= $4,140 (the maximum credit)
Example 3. For a family subject to the phase-out of EITC with earned income and AGI of $20,500 (which is greater than the maximum earned income amount and the phase-out income level):
EITC = $10,350 (the maximum earned income amount) times 40%
or $4,140 (the maximum credit)
minus
($5,950 (the amount by which income exceeds the phase-out
income level[$14,550] times 21.06%)
or $1,253
= $2,887
[23] Indexing. With everything else held constant, when inflation increases income, taxes increase. In periods of high inflation, this may result in increases in taxes which many view as a windfall to the government. To reduce the impact of inflation on taxes certain tax provisions, such as the personal exemption amount, are increased each year by the rate of inflation. The Tax Reform Act of 1986 (P.L. 99-514) began indexing of the maximum earned income and the phase-out income levels for the EITC. The structure of the EITC combined with indexing results in the largest annual percentage increases in EITC going to higher income EITC eligible taxpayers. 3 The effect of indexing on the EITC between year 1 and year 2 can be defined for four groups of taxpayers:
Tax filers below the year 1 maximum earned income level will have no increase in the EITC between year 1 and year 2.
Tax filers above the year 1 maximum earned income amounts and below the year 1 phase-out income level will have an increase in EITC equal to the change in the maximum credit amount (the credit rate times the change in the maximum earned income).
Tax filers above the year 1 phase-out income amount but below the year 2 phase-out income amount, will have an increase in EITC equal to the change in the maximum credit plus the year 1 phase-out reduction in the EITC (the amount by which their year 1 income exceeded the year 1 phase-out income times the phase-out rate).
Tax filers above the year 2 phase-out income level, will have a change in the EITC that is fixed at every income level until the end of the phase-out range. The change is calculated as:
Change in Maximum Credit
plus
Change in Phase-out Income Level x Phase-out Rate
[24] Marginal Tax Rates. Marginal tax rates reflect the additional tax paid for each additional $1 of income earned (or subject to tax). Economic theory suggests that the higher the marginal tax rate, the lower the incentive to work to increase income. The structure of the EITC (phase-in, plateau, and phase-out ) creates a wide range of marginal tax rates for EITC recipients based on income. The marginal tax rate for an EITC recipient, excluding interactions with other credits, can be broken down into four ranges that correspond to the structure of the EITC:
During the phase-in, when income is below the maximum earned income, the marginal tax rate is negative and equal to the credit rate because for each additional dollar of income the EITC recipient pays no income tax and receives an increase in the EITC equal to the credit rate times the additional income.
Once the income reaches the plateau level, the marginal rate is zero while there is no tax liability and no change in the EITC amount (which is at the maximum).
Just before the end of the plateau, the EITC recipient will begin to have a regular tax liability at the statutory rate with no decrease in the EITC, creating a marginal tax rate equal to the statutory rate.
During the phase-out of the EITC, for each additional dollar of income the EITC recipient will pay taxes at the marginal tax rate and have a reduction in the EITC at the phase-out rate creating a marginal tax rate equal to the sum of the two changes. This results in a marginal tax rate that is significantly higher than the statutory tax rate.
Figure 2 shows the ststutory and marginal tax rates, in tax year 2002, as income increases for a single parent family with one child.
Figure 2. Statutory and Marginal Tax Rates,
Single Parent Family with One Child, Tax Year 2002
[Figure 2 omitted]
Participation
[25] The EITC program has grown significantly since its inception in 1975. In 1975 there were 6.2 million recipients for a total of $1.2 billion in EITC, with 72.0% of the EITC received as a refund, and an average EITC of $201. For tax year 2000, a total of 19.2 million tax filers received an EITC, for a total of $31.8 billion. In 2000, the average EITC was $1,658, and 85.8% of the EITC was received as a refund. Estimates of the percentage of EITC eligible families participating in the EITC program (i.e., receiving an EITC ) ranged from 80-86% in a 1993 study4 using 1990 data to 93-96% for families with children in a recent study5 by the General Accounting Office using 1999 data.
[26] Table 2 provides the total EITC, refunded portion, number of recipients (tax filers), and average credit for 1975 through 2000.
Table 2. EITC and Recipients 1975-2000
Refunded Number of Average
Total EITC portion of EITC Receipients EITC
Tax year ($ millions) ($ millions) (thousands) ($)
1975 $1,250 $900 6,215 $201
1976 1,295 890 6,473 200
1977 1,127 880 5,627 200
1978 1,048 801 5,192 202
1979 2,052 1,395 7,135 288
1980 1,986 1,370 6,954 286
1981 1,912 1,278 6,717 285
1982 1,775 1,222 6,395 278
1983 1,795 1,289 7,368 224
1984 1,638 1,162 6,376 257
1985 2,088 1,499 7,432 281
1986 2,009 1,479 7,156 281
1987 3,391 2,930 8,738 450
1988 5,896 4,257 11,148 529
1989 6,595 4,636 11,696 564
1990 7,542 5,266 12,542 601
1991 11,105 8,183 13,665 813
1992 13,028 9,959 14,097 924
1993 15,537 12,028 15,117 1,028
1994 21,105 16,598 19,017 1,110
1995 25,956 20,829 19,334 1,342
1996 28,825 23,157 19,464 1,481
Refunded Number of Average
Total EITC Portion of EITC recipients EITC
Tax year ($ millions) ($ millions) (thousands) ($)
1997 30,389 24,396 19,391 1,567
1998 30,812 26,333 19,442 1,585
1999 31,479 27,132 19,207 1,639
2000 31,773 27,268 19,166 1,658
Source: U.S. Congress, House Committee on Ways and Means. 2000 Green Book. Background Material and Data on Programs Within the Jurisdiction of the Committee on Ways and Means, 106th Congress, 2nd Sess., WMCP 106-14, October 6, 2000, p. 813. Internal Revenue Service. Total File, All States, Individual Income and Tax Data, by State and Size of Adjusted Gross Income, Tax Year 1998, 1999, and 2000. Expanded unpublished version.
Note: The number of recipients is the number of tax filers.
Characteristics of Tax Year 2000 EITC Tax Returns
[27] Number of Children. In tax year 2000, the majority of the EITC (60.4%) went to families with two or more children, which represented 42.4% of the returns. The percent distribution of returns and total EITC by number of children is shown in Table 3. Table 4 shows the number of recipients, amount of EITC, and average EITC by number of children for tax year 2000.
Table 3. Percent Distribution of Returns and Total EITC by
Number of Children, Tax Year 2000
Percent of Percent of
total returns/*/ total EITC
No children 17.7 1.8
One child 39.9 37.4
Two or more children 42.4 60.4
Total 100.0 100.0
Source: Table prepared by the Congressional Research Service (CRS) from data provided by the Joint Committee on Taxation.
FOOTNOTE TO TABLE
/*/Total returns is all returns claiming an EITC.
END OF FOOTNOTE TO TABLE
Table 4. EITC by Number of children, Tax Year 2000
Number
Number Number of Percent
of recipients Total EITC Average of EITC
children (Tax filers) ($ thousands) EITC refunded
None 3,410,000 704,000 $206 69.9
One 7,691,000 12,081,000 1,571 82.2
Two or More 8,179,000 19,510,000 2,385 89.1
Source: Table prepared by the Congressional Research Service (CRS) from data provided by the Joint Committee on Taxation.
Filing Status. Heads of Household represented 57.4% of the EITC returns and 69.2% of the total EITC on returns in 2000, while single filers represented 21% of the returns and only 8.6% of the EITC. Table 5 shows the percent distribution of returns and total EITC by filing status.
Table 5. Percent Distribution of Returns and Total EITC by
Tax Filing Status, Tax Year 2000
Percent of Percent of
Filing status total Returns/*/ total EITC
Single 21.0 8.6
Married joint 21.6 22.2
Head of household 57.4 69.2
Total 100.0 100.0
Source: Table prepared by the Congressional Research Service (CRS) from data provided by the Joint Committee on Taxation.
FOOTNOTE TO TABLE
/*/Total returns is all returns claiming an EITC.
END OF FOOTNOTE TO TABLE
Geographic Distribution. The distribution of EITC by state is a function of the relative populations and income levels of the states. In general states with larger populations and/or a large number of lower income workers will have more EITC recipients. The number of federal EITC returns, the total EITC, average EITC, and percent of the credit refunded by state for tax year 2000 are shown in Table 6.
Table 6. Federal EITC Recipients and EITC Amount By State,
Tax Year 2000
Number of Total EITC Average % of EITC
State returns ($ thousands) EITC refunded
Alabama 442,954 818,625 1,848 88.9
Alaska 30,200 39,756 1,316 81.4
Arizona 335,315 562,941 1,679 87.4
Arkansas 248,838 439,734 1,767 87.5
California 2,265,569 3,777,915 1,668 84.7
Colorado 222,907 329,852 1,480 83.5
Connecticut 143,136 213,841 1,494 85.1
Delaware 48,151 78,760 1,626 87.7
District of
Columbia 51,439 4,094 1,635 88.5
Florida 1,316,856 2,181,077 1,656 84.8
Georgia 717,138 1,270,584 1,772 87.7
Hawaii 67,500 94,456 1,399 85.1
Idaho 81,278 129,632 1,595 83.8
Illinois 755,305 1,228,331 1,626 86.7
Indiana 361,359 569,808 1,577 86.5
Iowa 143,624 212,600 1,480 83.4
Kansas 144,236 223,642 1,551 85.2
Kentucky 299,343 477,580 1,595 85.9
Louisiana 481,637 921,578 1,913 90.0
Maine 75,192 112,197 1,492 80.8
Maryland 310,997 493,076 1,585 85.6
Massachusetts 263,809 384,770 1,459 83.4
Michigan 549,864 879,957 1,600 86.6
Minnesota 209,999 305,302 1,454 82.5
Mississippi 345,172 663,519 1,992 89.8
Missouri 378,195 609,816 1,612 86.4
Montana 64,610 100,341 1,553 83.8
Nebraska 90,518 139,824 1,545 84.2
Nevada 128,750 197,677 1,535 86.7
New Hampshire 51,234 73,183 1,426 79.8
New Jersey 440,175 701,394 1,593 85.0
New Mexico 174,027 291,188 1,673 88.3
New York 1,326,071 2,202,718 1,661 81.8
North Carolina 642,264 1,078,432 1,679 87.2
North Dakota 35,122 52,156 1,485 82.8
Ohio 676,466 1,074,043 1,588 86.3
Oklahoma 273,434 458,218 1,676 86.2
Oregon 193,296 297350 1,538 84.6
Pennsylvania 674,406 1,040,973 1,544 86.2
Rhode Island 58,084 88,737 1,528 86.1
South Carolina 376,046 647,690 1,722 88.4
South Dakota 47,039 71,825 1,527 84.2
Tennessee 479,050 793,889 1,657 85.9
Texas 1,856,111 3,362,353 1,811 86.3
Utah 107,538 170,421 1,585 85.2
Vermont 32,581 46,268 1,420 79.4
Virginia 426,677 686,593 1,609 86.6
Washington 300,031 456,344 1,521 84.9
West Virginia 133,149 209,068 1,570 87.6
Wisconsin 243,219 367,619 1,511 84.3
Wyoming 30,551 46,391 1,518 85.1
Other Areas 15,201 15,081 992 93.1
United
States 19,166,053 31,773,221 1,658 85.8
Source: Internal Revenue Service, Total File, All States, Individual Income and Tax Data, by State and Size of Adjusted Gross Income, Tax Year 2000, Expanded unpublished version.
Interaction With Other Tax Provisions
Other Federal Tax Credits. On the tax return, the EITC is calculated after total tax liability and several nonrefundable credits. The nonrefundable tax credits which are taken against (reduce) tax liability, include credits for education, dependent care, savings, and the child credit. To the extent an EITC eligible family has a tax liability and can utilize one or more of these credits, the refundable portion of the family's EITC is higher. This is because using one or more of the tax credits reduces tax liability before the EITC, but does not affect the calculation of the EITC.
For tax filers in the plateau or phase-out period of the EITC, pre-tax contributions to savings for retirement, education or medical purposes can increase the amount of the EITC by reducing the amount of "earned income" used to calculate the EITC, in addition to reducing tax liability before the EITC if the contributions also qualify for a nonrefundable credit. This is because the earned income for the EITC, like the income subject to tax, does not include these pre-tax contributions as income.
Table 7 shows for a single parent family with one child, the interaction between the EITC and the savings credit if the parent chooses to put aside $2,000 in a retirement savings plan, such as a 401(k), from pre-tax income that reduces taxable income and qualifies for the savings credit of 50% (on savings up to $2,000).
Table 7. Impact of Savings Credit on
EITC for A Single Parent Family with One Child, Tax Year
2002
Before savings Post savings
Gross income $25,000 $23,000
Federal tax before credits $1,315 $1,015
Savings credit $0 $1,000
Child credit $600 $600
Net tax after credits $715 $0 /*/
EITC $671 $991
Total net taxes $44 $991 /**/
Source: Table Prepared by the Congressional Research Service.
FOOTNOTES TO TABLE
/*/Only $15 of the $600 child credit, or $385 of the savings credit may be taken against tax to a total of $1,015. Although the family may be eligible for the refundable portion of the Child Credit, this example does not include the refundable Child Credit in order to show the impact of the savings credit on only the EITC.
/**/ This is the refundable EITC.
END OF FOOTNOTES TO TABLE
The refundable portion of the child credit for families interacts with the EITC for a small number of families with three or more children. This interaction however impacts only the child credit and not the EITC. This is because the calculation of the refundable portion of the child credit for families with three or more children is the greater of 10% of the income above $10,000 or the excess of social security taxes over the EITC benefits received by the family.
Means Tested Programs. By law, the EITC cannot be taken into account for purposes of determining eligibility or benefits for food stamps, low-income housing, and Medicaid and Social Security Income (SSI). Under Temporary Aid to Needy Families (TANF), the states have the authority to determine if the receipt of an EITC is taken into consideration in determining eligibility or benefits. Currently, no state does so. However, an EITC refund that is saved may become an asset and could be used in determining TANF eligibility and benefits.
State EITC Provisions. Currently 16 states and the District of Columbia offer an EITC for state taxes. Of these jurisdictions, six have a nonrefundable EITC, 10 have a refundable EITC, and one (Maryland) has both a refundable and nonrefundable EITC. Fifteen calculate the state EITC using the federal EITC. Wisconsin differs as it does not give childless tax filers a state EITC, and New Jersey provides the credit if income is less than $20,000. In addition, Minnesota offers an EITC for state taxes (to tax filers eligible for the federal EITC) that is computed similarly, but independently of the federal EITC, and Indiana computes the credit as a percentage of $12,000 less the earned income.
For states with an EITC that is calculated based on the federal EITC, a change in the federal EITC will generally flow through and change the state EITC unless the state takes positive legislative action to alter or prevent the change. Table 8 outlines the EITC provided by states, relationship to the federal EITC, and refundability of the state EITC.
Table 8. State EITC Programs State
State EITC-Percent of
State Federal EITC Refundable
Colorado 10.0 Yes
District of Columbia 25.0 Yes
Illinois 5.0 No
Indiana 3.4% of the amount by which
$12,000 exceeds earnings No
Iowa 6.5 No
Kansas 10.0 Yes
Maine 5.0 No
Maryland 50.0 (nonrefundable) No
16.0 (refundable) Yes
Massachusetts 15.0 Yes
Minnesota Calculated independently of Yes
federal credit. Tax year 2002 -
1.9125% of first $4,460
for childless tax filers;
8.5% of the first $6,680 for
one child; and 10.0% of the
first $9,390 for
two or more children.
New Jersey 15.0 if gross income is $20,000
or less Yes
New York 30.0 Yes
Oklahoma 5.0 Yes
Oregon 5.0 No
Rhode Island 25.5 No
Vermont 32.0 Yes
Wisconsin 4.0 for one child; 14.0 for
two children; and 43.0 for
three or more children. No EITC
for childless tax filers. Yes
Source: Table prepared by the Congressional Research Service.
Issues The structure, impact, and administration of the EITC are reflected in the major policy issues -- work incentives, marriage penalty, anti-poverty effectiveness (family size), compliance, and the use of paid tax preparers.
Work Incentives. While the original purpose of the EITC was to return payroll taxes to low income workers, in its current form as a cash transfer program it provides assistance to working low income families to meet basic needs. As such it may be viewed as creating an incentive to work, both in participating in the labor force (beginning to work), and increases in work effort (more hours). Economic theory suggests that the phase-in range of the EITC (when income is below the maximum earned income) would create an incentive to begin work, and to work more hours by increasing the marginal return to work after taxes. This is because the EITC increases as work increases, and is reflected in the negative marginal tax rate during the phase-in range of the credit.
Conversely, the phase-out range of the EITC would create a disincentive to work because the more the individual works and earns the greater the individual is penalized (although the after-tax income is higher). The individual not only has to pay taxes at the statutory rate, but the earned income credit is reduced by the phaseout rate. This is reflected in a marginal tax rate for the phase-out period that is higher than the statutory tax rate. In the phase-out range, an individual may attempt to maintain a level EITC by reducing work hours (substituting leisure for work). However, many workers do not have the flexibility (in their jobs) to reduce hours.
Alternatively, the EITC can be viewed as a wage supplement for lower income workers. The wage supplement increases the hourly wage rate during the phase-in range, the supplement remains steady during the plateau, and during the phase-out range the wage supplement is reduced, reducing the hourly wage down to the level actually paid by the employer.
In evaluating the work incentives of the EITC it is important to remember that all of the benefits and costs of work are not reflected in the marginal tax rate. A family receiving TANF benefits may be required to work a stated number of hours to maintain certain non- cash benefits. However, by working those hours the family earns income that may reduce other non-cash benefits such as food stamps or housing allowances, and may require additional cash expenditures for child care, clothing, etc.
Studies on the EITC and labor force participation have concluded that the EITC has a significant positive impact on participation in the labor force, particularly for single mothers.6 Some studies have concluded that there is a negative impact on work hours at the higher levels of income, but that the impact is not significant.7
Marriage Penalty. The structure of the EITC may, depending on the relative income levels of both parties, impose a "marriage penalty"8 on single low income parents if they choose to marry. For example, in tax year 2002 two single parents, each with one child and earned income of $15,000 would receive an EITC of $2,265 each for a total of $4,530. If they marry, their combined income is $30,000, and with two children, the EITC is $875. The EITC marriage penalty for the couple is $3,655. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16) began reducing the marriage penalty for the family by $210 in 2002. The EGTRRA provisions for marriage penalty relief will sunset at the end of 2010.
Empirical research has concluded that the structure of the EITC, through the phase-out and the marriage penalty, has a negative impact on the labor market participation of non-working spouses in two- parent families at higher income levels (levels of income in the plateau or phase-out range of the EITC).9
Anti-Poverty Effectiveness (Family Size). While the EITC is available at incomes above the federal poverty levels, to the extent the EITC is an anti-poverty program, one goal may be to keep families above the poverty level. The structure of the EITC with respect to family size has not changed since 1990. While benefits for most poverty related programs are related to family size, the family size adjustment for the EITC is capped at two children. As a result, a low income family with two children may remain above the poverty level because of the EITC, while families with three or more children at the same income level and EITC may slip below the poverty level. An example for tax year 2002 is shown in Table 9.
Table 9. Impact of Family Size on Net Income
after Taxes Relative to Poverty Level, 2001
Family 1 Family 2 Family3
two adults two adults two adults
two children three children four children
Income 20,000 20,000 20,000
Federal tax before
credits 16 0 0
Child credit
(regular credit
limited to tax before
credits) 16 0 0
EITC (2,981) (2,981) (2,981)
Additional child credit
(refundable portion
of credit) (1,000) (1,000) (1,000)
Net tax (3,981) (3,981) (3,981)
Payroll tax 1,530 1,530 1,530
Net income after tax 22,451 22,451 22,451
Poverty level/*/ 18,244 21,469 24,038
Net income after tax as
a percent of poverty
level 123.1% 104.6% 93.4%
Source: Table prepared by the Congressional Research Service.
FOOTNOTE TO TABLE
/*/The official poverty level for 2002 is not yet available, this is an estimate based on poverty thresholds in 2001.
END OF FOOTNOTE TO TABLE
Compliance
Compliance with the EITC provisions has been an issue for the program since 1990, when the Internal Revenue Service (IRS), as part of the Taxpayer Compliance Measurement Program (TCMP), released a study on 1985 tax year returns with the EITC. The study concluded that there was an over-claim rate of 39.1%. This overclaim rate however, did not reflect any later efforts by the IRS to collect on the over payments. Later studies by the IRS have resulted in lower over-claim rates. The 1997 and 1999 tax return studies9 estimated that the unrecovered over-claim rates were 23.8% to 25.6%, and 27.0% to 31.7%. These studies presented the rates as upper and lower bound-estimates because a number of individuals contacted as part of the study did not respond. The lower bound assumes that the over-claim rate for the nonrespondents is the same as for respondents, while the upper bound assumes that all the nonrespondents are over-claims.
In the 1999 study, 24.9% of over-claims (with errors known) were due to the child claimed not being the tax filers's qualified child. The most common qualifying child error was that the child did not meet the residency test, 6 months or 1 year depending on relationship. The second most common was the child not meeting the relationship test, particularly in the case of foster children where the child did not live with the tax filers for the full year or was not cared for as the tax filers's own child.
After errors in claiming an unqualified child, errors in income reporting accounted for 21.4% of the over-claims. Most frequent income reporting errors were underreporting of earned income and modified adjusted gross income. Another 17.2% of known errors were for a qualifying child also being the qualifying child of another tax filer.
As a result of the over-claim rates, there have been several legislative changes to improve EITC compliance. Among them are: the requirement that dependents have identification numbers (social security numbers); prohibitions of 2 to 10 years on receiving the EITC after improperly or fraudulently receiving the credit; for tax preparers due diligence requirements (maintaining certain paperwork); and permission for the IRS to match tax filers to the Federal Case Registry of Child Support Orders. (Maintained by the Department of Health and Human Services.)
In addition, some of the EGTRRA changes to the EITC definition of a qualifying child and the tie-breaker rules (rules for when more than one person can claim a child), may help in the future to reduce these problems. However, the general rate of over-claims has not changed significantly since 1990.
Paid Tax Preparers. According to the National Taxpayer Advocate,10 in the 2000 processing year, paid tax preparers filed 44% of the paper returns and 82% of the electronic returns claiming an EITC. A study by the Consumer Federation of America 11estimates that $994 million of the EITC is spent on tax preparation, electronic filing, check cashing, and refund anticipation loan fees. This estimate is based on fees of $85 for tax preparation, $40 for electronic filing, $67 for check cashing, and $75 for a refund anticipation loan.
There are a number of reasons why EITC recipients may use paid preparers including:
language difference;
literacy problems;
IRS's close review of EITC returns;
less effort (work) by the tax filer;
the belief that use of a pair preparer prevents errors; and
the belief that refunds are received faster.
The use of electronic filing will result in a faster refund, other things being equal, but use of a paid tax preparer does not necessarily result in fewer errors. In the 2000 processing year, of the EITC returns selected for examination (based on probability rules that the return contains unallowable or misreported items), 66.9% were done by paid tax preparers.
National Taxpayer Advocate's "Most Serious Problems"
Each year the National Taxpayer Advocate12 must report to Congress and analyze at least 20 serious problems taxpayers have with the tax system. The December 31, 2002 report contains 22 topics considered the "most serious problems" encountered by tax filers. Of these 22 problems, six are related to the EITC. A brief description of the six problems is as follows:
Tax filers must be prepared to substantiate 11 of the 15 eligibility criteria, and according to the report there is a burden on low income filers for documentation, a lack of consistency by the IRS in accepting verification of documents, and a lack of communication between the IRS and low income filers during audits.
The processes for examining EITC claims cause hardship and infringe on appeal rights. In particular, the holding of the entire refund, not just the EITC portion, until an examination is completed creates a hardship, and the combined letter for additional documentation and notice of appeal rights reduces the time period before a filer can receive a notice of deficiency.
There is a lack of response during examinations with tax filers failing to reach the individual IRS staff member listed on a notice and the IRS failing to return calls from tax filers, tax filers representatives, and the Taxpayer Advocate Service staff.
Additional oversight of EITC return preparers is needed as evidenced by the high percentage of errors (in 1999, 33% of the math errors related to the EITC were on returns done by paid preparers).
The length of time involved in EITC audits has adverse impacts on filers, since EITC correspondence audits require tax filers to submit additional documentation to substantiate their EITC claim. The audit is completed through the mail and during the review the EITC claim/refund is held. The report states that the average time for an EITC audit was 265 days in fiscal year 2001 and that 33,000 cases remained open for more than 1 year.13
The process by which filers can recertify for the EITC (after being disallowed from getting the EITC due to an improper or fraudulent EITC claim) has several problems including disallowance letters not providing adequate information on the documentation necessary to recertify, and indicators that a filer needs to recertify not being removed from a filer's record after recertification is completed.
The idea that became the EITC first arose during congressional consideration of President Nixon's 1971 welfare reform proposal. Nixon's proposal, the Family Assistance Plan, would have helped working poor, two-parent families with children by means of a federal minimum cash guarantee that would have replaced the federal-state welfare program of Aid to Families with Dependent Children (AFDC).
Work Bonus Plan (1972-1974 Proposals)
The EITC was patterned after a proposal, then known as a work bonus for the working poor, recommended by the Senate Finance Committee in April 1972. Though the idea originated as an alternative to the proposed Family Assistance Program, the work bonus provision was advocated as a "refund" of Social Security taxes paid by employers and employees on low annual earnings and was to have been available only for wages subject to Social Security taxation.
The Senate approved the work bonus plan in 1972, 1973, and 1974, but the House did not accept it until 1975.
Enactment of EITC in 1975
The Tax Reduction Act of 1975 (P.L. 94-12) included a provision that established, in Section 32 of the Internal Revenue Code, a refundable credit to tax filers with incomes below $8,000. This "earned income credit" was to equal 10% of the first $4,000 of any earnings (including earnings not subject to Social Security taxation) and thus could not exceed $400 per year. The credit was to be phased out, at a rate of 10%, for adjusted gross income (AGI) above $8,000.
Extensions of EITC (1975-1977 Laws)
The Revenue Adjustment Act of 1975 (P.L. 94-164), Tax Reform Act of 1976 (P.L. 94-455), and Tax Reduction and Simplification Act of 1977 (P.L. 95-30) each extended the EITC by 1 year.
Permanent Status for EITC and Rise in Maximum Credit (1978 Law)
The Revenue Act of 1978 (P.L. 95-600) made the EITC permanent and increased the maximum credit to $500 and the eligibility limit to $10,000, provided for EITC payments in advance of the annual tax filing, and simplified eligibility determinations.
Under the 1978 law, the EITC was set at 10% of the first $5,000 of earnings (including net earnings from self-employment). The maximum credit of $500 was received for earnings between $5,000 and $6,000. For each dollar of AGI above $6,000, the EITC was reduced by 12.5 cents, reaching $0 at an AGI of $10,000.
Rise in Maximum Credit (1984 Law)
The Deficit Reduction Act of 1984 (P.L. 98-369) raised the maximum credit by 10%, from $500 to $550 by establishing the EITC at 11% of the first $5,000 of earnings. Earnings between $5,000 and $6,500 qualified for the maximum credit of $550. For each dollar of AGI above $6,500, the law required that the EITC be reduced by 12.22 cents. As a result, the credit was completely phased out when AGI reached $11,000.
Indexation of EITC and Rise in Maximum Credit (1986 Law)
Effective with tax year 1987, the Tax Reform Act of 1986 (P.L. 99-514) increased the EITC from 11% of the first $5,000 of earnings to 14% of the first $5,714 of earnings. The act also began indexing the credit for inflation. This was done by indexing the maximum earned income eligible for the credit and phase-out income level by using the change in the average Consumer Price Index (CPI) for the 12-month period ending August 31 of each year, from the CPI for the 12-month period ending August 31, 1984. In addition, the starting point of the phase-out income level was increased for 1987 and 1988. The 1986 Act also lowered the phase-out rate from 12.22% to 10% beginning with the 1987 tax year.
The increase in the maximum earned income for the credit and the credit rate raised the EITC, while the reduction in the phase-out rate reduced the marginal tax rate on recipient earnings. The combination of a higher EITC and a lower phase-out rate increased the income eligibility level from $11,000 in 1984 to $14,500 (in 1984 dollars) for 1987. During debate on the Tax Reform Act of 1986, it was said that "the liberalization of the earned income credit will help to assure that low-income citizens are no longer taxed into poverty."15
Rise in Maximum Credit and Establishment of Family-Size Adjustment and Supplemental Credits (1990 Law)
Basic EITC. Because the EITC was originally established as a work bonus and advertised as an offset to the Social Security tax, it had not been designed to vary by family size. Thus, the larger the family, the less it met the family's needs. Proposals were introduced in the 101st Congress to vary EITC credit amounts by number of children, up to a maximum of two, three, or four children depending on the bill. These proposals intended to increase EITC's welfare role while continuing its provision of payroll tax relief and work bonuses. However, no one proposed that EITC family-size variations be modeled after AFDC, which varies for much larger family sizes. The EITC expansion enacted in the Omnibus Budget Reconciliation Act (OBRA) of 1990 (P.L. 101-508) took effect in 1991 and was to be completed in 1994. An adjustment for family size was introduced and the credit and phase-out rates for each of the family sizes (one child , two or more children) were increased each year. However, the planned rate increases for 1994 were superseded by a 1993 law. (See below.)
Supplemental Young Child Credit. Numerous proposals were introduced in the 101st Congress to establish refundable tax credits for families with young children. These proposals would have set credit amounts based on earned income and number of qualifying children. Both House and Senate passed such provisions in competing versions of child care legislation. These measures were seen as aiding lower income families in need of child care for preschool children.
Final action in OBRA of 1990 limited additional credits for young children to those under 1 year of age. Eligible families with such children had an extra 5.0 percentage points added to their credit rate in computing the EITC amount. This extra credit had a maximum amount in 1993 of $388, and was phased out by adding 3.57 percentage points to the family's phase-out rate. Thus, in 1993 families with one or more children under age 1 had a combined credit rate of 23.5% or 24.5%, depending on total number of children, and a combined phase-out rate of 16.78% or 17.50%.
This extra credit was ended effective for tax year 1994 by OBRA of 1993 (P.L. 103-66).
Supplemental Health Insurance Credit. A new refundable credit aimed at helping parents finance health insurance for their children was included in the Senate-passed OBRA of 1990. The House did not include such a provision, but it was accepted by House-Senate conferees. The supplemental health insurance credit applied to earnings up to the maximum amount to which the EITC applied and was then reduced over the same income range used for the EITC phase-out. The rates set for the child health insurance credit and its phase-out were 6.0% and 4.285%, respectively. These percentages were added to those that applied to a family for the basic EITC and, if eligible, the young child credit. The maximum amount of the supplemental health insurance credit in 1993 was $465. The credit could not exceed the health insurance premiums actually paid by a family during the tax year. Unlike the basic EITC, this supplemental credit could not be received in advance of the annual tax filing.
The health insurance credit was ended, effective in 1994, by OBRA of 1993.
Expansion of Credits, Coverage of Childless Adults, and Repeal of Supplemental Credits (1993 Law)
President Clinton began his term in office in 1993 with a pledge to use the EITC to eliminate poverty for families with a member working full-time at the minimum wage in order to "make work pay." Fulfillment of his pledge required a proposal to raise the EITC credit rates, especially for families with two or more children. His proposal was enacted as part of OBRA of 1993 (P.L. 103-66) with little change by Congress. President Clinton also proposed extending the EITC for the first time to low-income working adults with no children to offset tax increases in OBRA of 1993, and Congress adopted this proposal with only minor changes. To offset part of the EITC expansion's cost, and to meet the criticism of the EITC's growing complexity, Congress also passed the President's proposal to repeal the supplemental credits for young children and for child health insurance premiums as part of OBRA of 1993.
Credit for Families. The EITC parameters for families were significantly changed by OBRA 1993. The credit rates were increased from 23% to 34% in 1996 for a family with one child, and from 25% to 40% for a family with two or more children. The phase-out rate for families with one child was slightly lowered (from 16.43% to 15.98%) and the phase-out rate for families with two or more children was increased from 17.86% to 21.06%.
Extension of EITC to Childless Households. The Clinton Administration proposal enacted in OBRA of 1993 extended the EITC for the first time to workers who have no children. The main rationale for this credit was to offset partly the effect on low-income workers of a gasoline tax increase included in OBRA of 1993. The 1993 law provided, effective in 1994, a credit of 7.65% of the first $4,000 of annual earnings, for a $306 maximum credit. It is phased out at a 7.65% rate, beginning at an income level of $5,000 and ending at $9,000. The maximum earned income and the phase-out income level are adjusted annually for inflation.
This credit applies to adults ages 25 to 64 who are not claimed as dependents on anyone's tax return. The age limits were imposed by Congress to exclude two groups (students under age 25, retirees over age 64) whose incentive to work was not regarded as an important priority.
Coverage of Overseas Military Personnel (1994 Law)
Before 1995, the EITC had always been restricted to families residing in the United States. This rule excluded from EITC otherwise eligible lower income American military families living in foreign countries. A provision in the 1994 legislation to implement the General Agreement on Tariffs and Trade (P.L. 103-465) provides EITC eligibility for qualifying families outside the United States if their foreign residence is because of a U.S. military assignment. This provision became effective in 1995.
This law also included measures to: (1) deny the EITC for wages earned by prison inmates; and (2) deny eligibility to anyone who spent part of the tax year as a nonresident alien.
Eligibility Limit Based on Investment Income (1995 Law)
Limitation of EITC eligibility by a filing unit's income has always been based on the greater of AGI or earnings. However, following up on a proposal in President Clinton's FY1996 budget, Congress enacted in 1995 (P.L. 104-7) a new limitation tied to investment income. This provision prohibits EITC claims by tax filers whose annual investment income exceeds $2,350. Investment income is defined to include taxable interest and dividend income, tax-exempt interest income, and net income from rent and royalties not derived in the normal course of the filer's business. This provision took effect in 1996. (It was modified in August 1996 action. See discussion below.)
Revisions of EITC in the Welfare Reform Bill (1996 Law)
Although not proposing specific legislation, the FY1997 congressional budget resolution (H.Con.Res. 178) "assumes reforms of the Earned Income Credit . . . to eliminate fraud and abuse within the program, to better target to low-income working families with children, and to coordinate the credit with the $500 per child tax credit that also is assumed in this budget." In followup, Congress included EITC savings in the welfare reform measure (H.R. 3734) signed by President Clinton on August 22, 1996 (P.L. 104-193). These provisions are described below.
Deny EITC to Undocumented Workers. This provision requires tax filers to have valid taxpayer identification numbers (usually Social Security numbers) to be eligible for the EITC. Social Security numbers are issued only to persons who can document their age, identity, and U.S. citizenship or legal alien status. It becomes effective for tax returns due more than 30 days after the enactment date. This measure helps the Internal Revenue Service (IRS) gain compliance from tax filers lacking valid numbers before accepting their EITC claims.
Disqualified Income. Congress acted in March 1995 (see earlier discussion) to exclude from EITC eligibility all filers with "disqualified income," defined as income in excess of $2,350 a year from interest (taxable and tax-exempt), dividends, and net rents and royalties. The welfare reform bill broadened this definition to include net capital gains and net passive income. The maximum allowance for disqualifying income was reduced from $2,350 to $2,200 for 1996 and indexed for inflation in later years.
Broaden Income Used in EITC Phase-out. The EITC is phased out when the greater of earnings or AGI exceeds a certain level ($11,610 in 1996 for families with children). Broadening the definition of income used for EITC phase-out reduces the EITC for persons with income from the sources to be included. Effective for 1996, the welfare reform bill expanded the income used to phase out the EITC by netting out certain losses that are normally taken into account in calculating AGI. These losses are net capital losses, net losses from estates and trusts, net losses from nonbusiness rents and royalties, and half of net business losses.
Allow State Welfare Programs to Count EITC. The 1996 welfare reform bill (Personal Responsibility and Work Opportunity Reconciliation Act, P.L. 104-193) repealed AFDC. And in its place created the Temporary Assistance to Needy Families (TANF) program, a state-run system funded partly by federal block grants. This conversion to state control alters the EITC-welfare relationship. Federal law had required that the EITC be disregarded as income in determining eligibility for AFDC, Food Stamps, Medicaid, Supplemental Security Income (SSI), and housing aid. Lump-sum EITC payments had to be ignored in comparing applicants' assets to program asset limits for the month of receipt and the next month. (The Food Stamp program must ignore lump-sum EITC payments for 1 year.) Ending AFDC eliminates federal restrictions on states' treatment of the EITC for cash welfare (TANF) recipients. States may count the EITC as income available to families aided by TANF programs and reduce their welfare accordingly. Lump-sum EITC receipt may be counted by states as assets immediately available to state-aided families, thereby denying them that aid if counting the EITC causes their assets to exceed state asset limits. States adopting such policies may spend less on aid to needy families from their federal grants, in effect substituting the federal EITC for state welfare and lowering the income of those affected.
Denying Credit Based on Prior Claims (1997 Laws)
To improve compliance related to the EITC, the Taxpayer Relief Act of 1997 (P.L. 105-34), denied the EITC to tax filers for a specified period of time if the tax filers had previously made a fraudulent or reckless EITC claim. A tax filer is denied the EITC for 2 years after it has been determined that the tax filer made a reckless claim, and ten years after a determination that a tax filer has made a fraudulent claim. The Balanced Budget Act of 1997 (P.L. 105-33) provided initial funding for a 5-year initiative by the IRS to improve compliance for the EITC.
Reduction of Marriage Penalty and Simplification of the EITC (2001 Law)
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16), to reduce the marriage penalty, increased the phase-out income levels for married couples filing a joint return by $1,000 for tax years 2002 through 2004, $2,000 for tax years 2005 through 2007, and $3,000 beginning in tax year 2008 (indexed for inflation). The bill also simplified the definition of earned income to reflect only compensation included in gross income; based the phase-out of the credit on adjusted gross income instead of expanded (or modified) gross income; and eliminated the reduction in the EITC for the alternative minimum tax.
Appendix 2. History of the EITC Parameters
Since its inception in 1975, the EITC has evolved from a small program to refund a portion of social security taxes to the largest anti-poverty entitlement program. The credit has change through changes in eligibility and in the values of the parameters used to calculate the credit. Table 10 shows the changes to the parameters for the EITC for tax years 1975 through 2003.
Table 10. EITC Parameters, 1975-2003
Credit Maximum Phase-out Income
rate earned Maximum Phase-out income where
(%) income credit/a/ rate(%) level EITC=$0
For families with children:
1975 10.0 4,000 400 10.0 4,000 8,000
1976 10.0 4,000 400 10.0 4,000 8,000
1977 10.0 4,000 400 10.0 4,000 8,000
1978 10.0 4,000 400 10.0 4,000 8,000
1979 10.0 5,000 500 12.5 6,000 10,000
1980 10.0 5,000 500 12.5 6,000 10,000
1981 10.0 5,000 500 12.5 6,000 10,000
1982 10.0 5,000 500 12.5 6,000 10,000
1983 10.0 5,000 500 12.5 6,000 10,000
1984 10.0 5,000 500 12.5 6,000 10,000
1985 10.0 5,000 500 12.22 6,500 11,000
1986 10.0 5,000 500 12.22 6,500 11,000
1987 14.0 6,080 851 10.0 6,920 15,432
1988 14.0 6,240 874 10.0 9,840 18,576
1989 14.0 6,500 910 10.0 10,240 19,340
1990 14.0 6,810 953 10.0 10,730 20,264
For families with one child:
1991 16.7 7,140 1,192 11.93 11,250a 21,250 /a/
1992 17.6 7,520 1,324 12.57 11,840a 22,370 /a/
1993 18.5 7,750 1,434 13.21 12,200a 23,050 /a/
1994 26.3 7,750 2,038 15.98 11,000 23,750
1995 34.0 6,150 2,094 15.98 11,290 24,396
1996 34.0 6,350 2,152 15.98 11,650 25,100
1997 34.0 6,500 2,210 15.98 11,950 25,800
1998 34.0 6,650 2,271 15.98 12,300 26,500
1999 34.0 6,800 2,312 15.98 12,500 26,950
2000 34.0 6,900 2,353 15.98 12,700 27,450
2001 34.0 7,100 2,428 15.98 13,100 28,300
2002 34.0 7,350 2,506 15.98 13,550b 29,250 /b/
2003 34.0 7,500 2,547 15.98 13,750b 29,700 /b/
For families with two or more children:
1991 17.3 7,140 1,235 12.36 11,250a 23,122 /a/
1992 18.4 7,520 1,384 13.14 11,840a 22,370 /a/
1993 19.5 7,750 1,511 13.93 12,200a 23,050 /a/
1994 30.0 8,425 2,528 17.86 11,000 25,300
1995 36.0 8,600 3,110 20.22 11,290 26,673
1996 40.0 8,890 3,556 21.06 11,650 28,495
1997 40.0 9,100 3,656 21.06 11,950 29,290
1998 40.0 9,350 3,756 21.06 12,300 30,095
1999 40.0 9,500 3,816 21.06 12,500 30,580
2000 40.0 9,700 3,888 21.06 12,700 31,152
2001 40.0 10,000 4,008 21.06 13,100 32,121
2002 40.0 10,350 4,140 21.06 13,550b 33,150 /b/
2003 40.0 10,550 4,204 21.06 13,750b 33,700 /b/
For childless adults:
1994 7.65 4,000 306 7.65 5,000 9,000
1995 7.65 4,100 314 7.65 5,130 9,230
1996 7.65 4,200 323 7.65 5,300 9,500
1997 7.65 4,300 332 7.65 5,450 9,750
1998 7.65 4,450 341 7.65 5,600 10,050
1999 7.65 4,500 347 7.65 5,700 10,200
2000 7.65 4,600 353 7.65 5,800 10,400
2001 7.65 4,750 364 7.65 5,950b 10,750 /b/
2002 7.65 4,900 376 7.65 6,100b 11,100 /b/
2003 7.65 5,000 382 7.65 6,250b 11,250 /b/
Source: Table prepared by the Congressional Research Service.
FOOTNOTES TO TABLE
aThe credit maximums for 1991-1993 do not include the two supplemental credits that were available to some EITC recipients in those years. The young child supplement added 5 percentage points to a family's credit rate; the child health insurance supplement added up to 6 points.
bBeginning in tax year 2001, the phase-out income level for married couples filing a joint tax return is $1,000 higher than shown in the table.
END OF FOOTNOTES TO TABLE
FOOTNOTES
1An eligibility rule that an unmarried filer must meet the requirements for "head of household" tax filer status to be eligible for the EITC was dropped by Omnibus Budget Reconciliation Act (OBRA) of 1990. This status was difficult for many low-income working mothers to meet since many of them received more than half their cash income from AFDC, which is not regarded as self-support income by the IRS in determining "head of household" status.
2Childless adults cannot receive the EITC through advance payments.
3The impact of indexing on the changes to the EITC between 2001 and 2002 is detailed in CRS Report RS21352, The Earned Income Tax Credit (EITC): Changes for 2002 and 2003, by Christine Scott.
4John Karl Sholz, "The Earned Income Credit: Participation, Compliance, and Antipoverty Effectiveness," National Tax Journal, Mar. 1994, v. 47, no. 1, p. 63-87.
5U.S. General Accounting Office, Earned Income Tax Credit Participation, GAO-20-290R, Dec. 14, 2001.
6Bruce D. Meyer, and Dan T. Rosenbaum, "Making Single Mothers Work: Recent Tax and Welfare Policy and Its Effects," National Tax Journal, Dec. 2000, v. 53, p. 1027-1043. Moffitt, Robert, Welfare Programs and Labor Supply, National Bureau of Economic research Working Paper 9168, Sept. 2002.
7 Stacy Dickert, Scott Houser and John Karl Scholz, "The Earned Income Tax Credit and Transfer Programs: A Study of Labor Market and Program Participation," Tax Policy and the Economy, James M. Poterba (ed.), National Bureau of Economic Research and the MIT Press,1995, p. 1-50. V. Joseph Hotz, and John Karl Sholz, "The Earned Income Credit," National Bureau of Economic Research Working Paper 8078, Jan. 2001.
8The "marriage penalty" is the difference between the tax liability for a married couple (filing a joint tax return) and the sum of the tax liabilities for each person if they each filed using the single filing status.
9Nada Eissa, and Hillary Williamson Hoynes, "The Earred Income Tax Credit and the Labor Supply of Married Couples," National Bureau of Economic Research Working Paper 6856, 1998. V. Jospeh Holz, John Karl, "In-Work Benefits in the United States: The Earned Income Credit," The Economic Journal, Jan. 1996, v. 106, no. 434, p. 156-169.
9 Internal Revenue Service, Department of the Treasury, "Compliance Estimates for Earned income Tax Credit Claimed on 1999 Returns," Feb. 28, 2002, p. 18.
10National Taxpayer Advocate, Internal Revenue Service, Department of the Treasury, FY2002 Annual Report to Congress, p. 70.
11 Consumer Federation of America and the National Consumer Law Center, "Tax Preparers Peddle High Priced Tax Refund Loans: Millions Skimmed From the Working Poor and the U.S. Treasury," Jan. 31, 2002, p.10.
12 The National Taxpayer Advocate heads an independent program with the Internal Revenue Service (IRS) known as the National Taxpayer Service. The program is designed to handle taxpayer complaints not resolved through normal IRS procedures and to analyze problems encountered by taxpayers with the IRS and suggest solutions for the problems.
13National Taxpayer Advocate, Internal Revenue Service, Department of the Treasury, FY2002 Annual Report to Congress, p. 77.
14This legislative history of the EITC is a shortened version of the more detailed history in CRS Report 95-542, The Earned Income Tax Credit: A Growing Form of Aid to Low-Income Workers, by James R. Storey.
15In floor statement of Senator Matsunaga, Congressional Record, daily edition, Sept. 26, 1986. p. S13818.
END OF FOOTNOTES
- AuthorsScott, Christine
- Institutional AuthorsCongressional Research Service
- Subject Area/Tax Topics
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 2003-7292 (33 original pages)
- Tax Analysts Electronic Citation2003 TNT 55-14