Earned Income Tax Credit Recipients: Income, Marginal Tax Rates, Wealth, and Credit Constraints
Athreya, Kartik B., Reilly, Devin, Simpson, Nicole B., Economic Quarterly - Federal Reserve Bank of Richmond
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The Earned Income Tax Credit (EITC) has become the federal government's largest cash-assistance program for low-income families, making it the centerpiece of anti-poverty programs in the United States. Approximately 15 percent of households nationwide now qualify for the EITC (Hoffman and Seidman 2002). Moreover, unlike other government programs, the EITC is administered through the income tax filing process, which reduces any potential stigma associated with the program, and aids in ensuring high participation rates (Smeeding, Phillips, and O'Connor 2000). According to Eissa and Hoynes (2009), approximately $43 billion was allocated to 22 million families in the United States in 2007 through the federal EITC. This compares to $16.5 billion thatwas spent on more traditional welfare programs, such as Temporary Assistance for Needy Children (TANF).
The EITC is designed to augment income while encouraging work: The tax credit increases with earnings for low levels of household income. The size of the credit is such that, for low-income households that qualify, the EITC is a negative tax on earnings that often constitutes a significant portion of after-tax wage income. The EITC does appear to have been successful in both helping the working poor get out of poverty and encouraging work. Neumark andWascher (2001), Ziliak (2006), and Simpson, Tiefenthaler, and Hyde (2009) provide evidence that the combined federal and state EITC helps families rise above the poverty line. In fact, the EITC has been estimated to have helped five million people out of poverty in 2005, including 2.6 million children.1 Hotz and Scholz (2000) find that, compared to other povertyreduction programs, the EITC is effective in raising the standard of living for low-income households, while keeping administrative costs relatively low.
However, the EITC phases out with earnings, until eventually a household no longer qualifies for it. The structure of the phase-out means that families earning more than $41,000 in 2008 will not qualify for the EITC, while all those earning less will. In addition, the credit targets families with children, and increases in generosity with the number of children in the household. For example, households with two or more children (in tax year 2008) earning $15,000 could qualify for up to $4,824 in federal earned income credits. In contrast, a childless single filer can receive only one-tenth of this amount, or at most $438. Thus, for those households with children and low earned income, the full refundability of the EITC ensures that it will represent a substantial addition to income.
In this article, we summarize the details of the EITC and describe the population of EITC recipients. Using Current Population Survey data, we estimate earnings and EITC benefits received by EITC recipients at various ages. Naturally, we find that because of the eligibility requirements, the earnings of EITC recipients are relatively similar across the age of recipients, which makes them differ systematically from non-recipients of the same age-whose earnings show a more pronounced "hump shape" with age. We then discuss how the EITC affects marginal taxes in the United States and summarize its theoretical and empirical effects on household labor supply decisions. Finally, we compare wealth levels of EITC recipients with non-recipients using data from the Survey of Consumer Finances (SCF), and find significant differences in their wealth distributions, with EITC recipients being substantially poorer. The fact that EITC recipients have relatively low wealth levels and low earnings relative to others in their age group suggests that they may be more likely to be borrowing-constrained than non-recipients. In fact, we find some evidence for this in our analysis of SCF data.
1. HISTORY OF THE EITC
In Table 1, we briefly summarize the history of EITC legislation. The EITC started as a modest program as part of the Tax Reduction Act of 1975. …