by Joseph Coletti
Senior Fellow, Fiscal Studies, John Locke Foundation
A state EITC would inherit the costs of the federal program without adding to the benefits, making it of questionable value. Legislators would get more bang for the buck by increasing the child tax deduction or expanding the zero-tax bracket. Here’s why.
Despite bipartisan support for a federal earned income tax credit (EITC or EIC) because it rewards work, the net effect is not as clear and the case for North Carolina to supplement the federal credit has never made sense. Regardless, it is a topic for debate again. Gov. Cooper proposed adding a refundable EITC “to help more than 850,000 North Carolina families, nearly all of whom earn less than $50,000 a year.” The credit would reduce revenue in FY2021-22 by $146.5 million, or an average $172 per qualifying taxpayer.
The federal EITC provides an average $3,500 per qualifying taxpayer, with top payments of $6,728 for a family with three or more children. As its name suggests, the EITC is intended to reward work. As a person earns more, the tax credit increases, plateaus, and returns back to $0. The state credit would add 5% to the federal amount.
For a married couple filing jointly with two children with income of $36,000, the federal credit would be $3,655, the equivalent of five weeks’ work. The state credit would add $183, the equivalent of 10 hours’ work.
A taxpayer needs professional assistance either through an online service or a professional tax preparer to claim the right credit. The IRS “EITC tables” provides information on the “maximum AGI [adjusted gross income], investment income and credit amounts,” but it is a significant challenge to find the credit at any specific level of income, particularly in the phase-in and phase-out regions. Once a person finds the right place for actual assistance to claim the federal EITC, he or she must go through five pages of instructions, three pages of worksheets, and eight pages of tables with income broken down in $50 increments.
With the complications, it is relatively easy to improperly claim a child, miss a child, or just plain get the amount of the credit wrong. The Tax Foundation noted the most common cause of improper payments is two tapayers claiming a credit for the same child. Accounting Today wrote, “The Treasury Inspector General for Tax Administration, found that for fiscal year 2020, the IRS estimated that 24% ($16 billion) of the total EITC payments of $68.2 billion were improper.” The same report found that many tax returns that claimed the EITC did not have supporting income documentation through a Form W-2.
Although the Internal Revenue Service says it is not unfair in how it chooses to audit EITC recipients, Kim Bloomquist reported for Bloomberg that “the IRS audits EITC taxpayers at a rate four times higher than non-EITC taxpayers with similar incomes.” Those tax preparers who are needed to navigate the EITC are also more likely to make fraudulent claims according to a ProPublica report in 2018.
Most studies of the EITC have focused on how it draws single mothers into the workforce. The most recent and extensive of these continues to find that federal expansions do increase workforce particpation for low-income families. The downside is that the biggest increase in paid work is among “mothers with very young children,” which caused Jacob Bastian to wonder “whether this led to unintended consequences such as less parental time and investment into children.”
Chris Edwards noted, “People have an incentive to reduce hours worked in both the flat and phase-out ranges of the credit, and about three-quarters of people taking the EITC are in those two ranges. So a large majority of people taking the EITC have an incentive to work less, not more.” In addition, he and Veronique de Rugy found, “State EITCs increase marginal tax rates during the phase-out range, and thus add to work disincentives.” They add that the impact can be to subsidize low-wage employers. Nada Eissa and Hillary Hoynes, in one of the few studies to consider hours worked, found no effect of the EITC. Although federal increases cause more people to enter the workforce, Henrik Kleven found “no effect of state EITC supplements” on work.