Academic journal article Economic Perspectives

How Do EITC Recipients Spend Their Refunds?

Academic journal article Economic Perspectives

How Do EITC Recipients Spend Their Refunds?

Article excerpt

Introduction and summary

The earned income tax credit (EITC) is one of the largest sources of public support for lower-income working families in the U.S. The EITC operates as a tax credit that serves to offset the payroll taxes and supplement the wages of tow-income workers. For tax year 2004, the EITC transferred over $40 billion to 22 million recipient families (U.S. Internal Revenue Service, 2006b). Nearly 90 percent of program expenditures come in the form of tax refunds; the remaining 10 percent serve to reduce tax liability. While other income support programs distribute benefits fairly evenly across the calendar year, EITC payments are concentrated in February and March when tax refunds are received. Because the EITC makes one relatively large payment per year, it may provide low-income, credit-constrained households with a rare opportunity to make important big-ticket purchases.

Research on the EITC has tended to focus on the important labor supply effects of the program (Eissa and Liebman, 1996; Meyer and Rosenbaum, 2001; and Grogger, 2003). Relatively little is known about how recipient households actually use EITC refunds. In this article, we use data from the U.S. Bureau of Labor Statistics' Consumer Expenditure Survey (CES) over the period 1997-2006 to investigate how households spend EITC refunds. (1) Following the methodology of Barrow and McGranahan (2000), we rely on the particular timing of EITC payouts to identify the effects of the credit on expenditures. Barrow and McGranahan found that the EITC has a larger effect on spending on durable goods than on nondurable goods. In this article, we are particularly interested in determining what items within the durables and nondurables categories are purchased using the credit and whether these expenditures reinforce the EITC's prowork and prochild goals. Our primary finding is that recipient household spending in response to EITC payments is concentrated in vehicle purchases and transportation spending. Given the crucial link between transportation and access to jobs, we believe this finding is consistent with the EITC's goals. In the next section, we present a brief history of the EITC and the key features of the program. We then review prior research on the uses of the EITC by recipient families. Next, we introduce the CES data and the methodology we use to investigate the data. Finally, we present our results and discuss their implications.

History and structure of the EITC

Congress created the EITC in 1975 to offset payroll taxes paid by tow-income workers with children. The credit is structured as a supplement to earned income equaling a percentage of earnings up to a specific threshold (the "phase-in" range), at which point the credit amount stays constant for an additional amount of earnings (the "plateau" range). Then this maximum credit is reduced by a given percentage of earnings until it equals zero (the "phase-out" range). Income thresholds, the phase-in and phase-out rates, and, therefore, the credit amount also vary by the number of qualified children in a household and by marital status; and all these factors have varied over time. (2) Figure 1 graphs the EITC program parameters for selected years. The program is implemented as a part of the tax code, and recipients must file taxes in order to apply for the program. For tax year 2006, a single mother with two children earning between $11,340 and $14,810 would have received the maximum credit of $4,536.

The EITC began as a small program, but its generosity and coverage have expanded frequently in its 30-year history as is shown in figures 1 and 2. Particularly large expansions enacted in 1986 and 1993 led to rapid program growth. In 1994, childless families started to receive a small credit. In 1975, the EITC represented 3.1 percent of federal means-tested transfers and 9.7 percent of federal means-tested cash transfers; by 2002, these proportions had increased by three times and four and a half times, respectively, and the EITC was the second largest means-tested cash transfer program behind Supplemental Security Income (SSI). …

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