Making work pay - expansion of the Earned Income Tax Credit

Washington Monthly, April, 1994 by Preston Lerner

The Earned Income Tax Credit is the Sara Lee of the federal tax code: Nobody doesn't like it--Democrats, Republicans, liberals, conservatives, neos, paleos, you name it. Described as a "work bonus" when it was instituted in 1975, the EITC is supposed to guarantee that Americans who work for a living don't have to raise their children in poverty. What's not to like?

In a perfect world, of course, we wouldn't need the Earned Income Tax Credit. Unfortunately, 5.5 million Americans live in households dangling below the poverty line even though the head of the household works full-time. Consider, for example, the plight of the minimum-wage slave. Even with the maximum food-stamp entitlement of $3,200 on top of an annual salary of $8,840, a family of four remains nearly $3,000 shy of the poverty threshold. Which is where the EITC is supposed to ride to the rescue.

In his presidential campaign, Bill Clinton vowed to "raise the Earned Income Tax Credit to make up the difference between a family's earnings and the poverty level." Now, the press isn't in the habit of applauding politicians for the promises they keep, but on the EITC, Clinton deserves praise. Although the plan approved by Congress in August wasn't as ambitious as the one the president had been pushing, it still injects an additional $20.8 billion into the program over the next five years. By 1996, when the expansion is fully phased in, an estimated $23 billion in EITC payments will be dispersed annually, making the program even more expensive than Aid To Families with Dependent Children.

Besides providing more generous benefits, the new EITC also expands the scope of the program to embrace an estimated 20.6 million taxpayers, up from 14.5 million in 1993. And while it doesn't completely bridge the gap between the minimum wage and the poverty line, it significantly narrows the margin. "We are incrementally attempting as a society to move beyond welfare to the subsidization of work, and I think that's good," says Gene Steuerle, a senior fellow at the Urban Institute. "But government programs come with trade-offs--administrative and enforcement costs--and this is no exception."

Although he generally supports the new and improved EITC, Steuerle has plenty of reservations about who the EITC helps, how much it helps them, and why it's such a ripe target for fraud. And like professional bakers confronted with a Sara Lee cheesecake, he, like many other economists, thinks he's got a better recipe.

But first, a few words from the IRS. Starting in 1996, when the new rate structure takes effect, taxpayers with two or more children will qualify for up to $3,370 as long as their income is between $8,425 and $11,000. Filers with one child and earnings between $6,000 and $11,000 may be eligible for as much as $2,040. The benefits phase out completely at $27,000 (for a two-child family) and $23,760 (for one child). Also, starting next year, childless workers aged 25 through 64 will for the first time be entitled to a much more modest EITC windfall if they earn less than $9,000.

Even this skeletal review undermines that favorite fulmination of the program's critics--that it discourages people from working. On the contrary, you can't qualify for the credit without working. This doesn't mean that the EITC is a cure for welfare. It isn't. And sure, at higher income levels, corner-cutters who pore over the tax tables may find that they can do slightly better by taking a higher tax credit rather than working a few extra hours a week. But the cure--a more gradual phase-out rate--is worse than the sickness: It will cause program costs to skyrocket, and it won't put a single extra penny into the pockets of the truly needy.

What about the flaws cited by other critics? Some, it turns out, are a bit vexing, others are not.

* The credit is underused: This one's gotten so much play that it's ceased to have much shock value--or to be entirely true. In fact, thanks to various public-education efforts, at least 75 percent and as many as 90 percent of all eligible taxpayers already receive the EITC. Still, millions of Americans trapped on the low-skills, low-wages treadmill are missing out on a benefit they ought to be getting. "None of the women here knew about it," says Sandra Villalobos, who runs a 110-unit housing project for low-income single mothers in Los Angeles. "I didn't know about it myself." Groups that ought to be targeted by future outreach programs include immigrants who don't speak English and others who don't pay income tax, but who still qualify for the EITC.

* The tax form is too complicated: "It's impenetrable," says Bob McIntyre, director of Citizens for Tax Justice. "I can do it, but I use a computer. That's probably why it has such a high error rate." Mind you, no short forms for EITC filers. Instead, they've got to fill out either a 1040 or 1040A and a Schedule EIC. And that's only after plowing through the Earned Income Credit workbook in all 36 pages of its mind-numbing glory.