Investing in Work by Reforming the Earned Income Tax Credit

INVESTING IN WORK BY REFORMING THE EARNED INCOME TAX CREDITElaine MaagMay 20, 2015 TAX POLICY CENTER | URBAN INSTITUTE & BROOKINGS INSTITUTION1ACKNOWLEDGMENTSElaine Maag is a senior research associate in the Urban Institute’s Tax Policy Center. The report is an extension of earlier work based on the proposal presented by C. Eugene Steuerle in a paper with Maag, Adam Carasso, and Harry Holzer. Thank you to Leonard Burman, Frank Sammartino, and C. Eugene Steuerle for their thoughtful comments on an earlier draft of this paper, to Nguyen Hang and Ngan Phung for the revenue and distributional estimates contained in this paper, Thomas Callan for the labor force participation estimates, and Lydia Austin and Joanna Teitelbaum for creating the figures and formatting the paper. The findings and conclusions contained within are those of the author and do not necessarily reflect positions or polices of the Tax Policy Center or its funders. TAX POLICY CENTER | URBAN INSTITUTE & BROOKINGS INSTITUTION2SUMMARY & INTRODUCTIONThe earned income tax credit (EITC) lifts millions of working families out of poverty, but provides little support to workers without qualifying children. Members from both major political parties have called for reforming this important work incentive program to extend greater benefits to “childless” workers (workers without children or noncustodial parents). But simply expanding the current credit would tend to exacerbate other problems. This paper lays out an alternative approach: a new credit for low- and moderate-income workers that would address the shortcomings in the current system without adding to existing inequities.Rather than limiting EITC reforms to childless workers, the proposed plan calls for Congress to adopt a new credit based on personal rather than household earnings. It would be less complicated than today’s EITC, making compliance easier for individuals and administration easier for the Internal Revenue Service (IRS). It would provide substantial benefits to workers without qualifying children, balancing out the inequity between today’s treatment of workers who have children living in their home and those who do not. A worker credit also would mitigate some of the EITC’s other problems, including marriage penalties, work disincentives for secondary earners, and the high error rate associated with determining who has qualifying children. The worker credit would replace the EITC for childless workers, increasing the credit received by those workers. Families with children would be eligible for the new worker credit in addition to a reduced EITC. In most cases, families with one worker would receive total credits similar in size to what they receive now, and families with two workers would receive higher credits.Numerous research studies have shown that the EITC encourages parents with children to work. Many analysts believe that the credit could be reformed to provide the same work incentives to childless individuals and noncustodial parents. Improving the employment rates of noncustodial parents ought to be a goal of policymakers. Men who are not custodial parents are less likely to be employed than men who are living with their children. Some analysts suggest an increase in work among men could also increase marriage rates, increase child support compliance, and might also reduce crime rates.President Obama, Representative Paul Ryan (R-WI), and others have proposed ways to reform the EITC, ranging from simple expansions for families without qualifying children to wage subsidies delivered in monthly paychecks to all qualifying workers. Though these plans could provide substantial support to some low-income workers, they either exacerbate TAX POLICY CENTER | URBAN INSTITUTE & BROOKINGS INSTITUTION3problems with today’s EITC—creating a possible work disincentive for secondary earners or raising taxes for married couples relative to unmarried individuals—or are complicated to d e l i v e r.A worker credit based on individual earnings would provide benefits akin to an EITC to all workers, would be easier to administer than today’s EITC, and would avoid some of the problems introduced by simply expanding the current EITC. The downside to such a credit is that it would be costly—about $75 billion in 2015. A worker credit designed to fully offset the first $1,500 of payroll taxes (including employee and employer portions) for individuals modeled on the current EITC for families with one child would reduce tax revenues by $868 billion over the 10-year period from 2015 to 2024. Restricting eligibility would reduce the cost of a worker credit but also lessen some of the benefits. If limited to workers ages 21 to 67, the worker credit would reduce tax revenues by $674 billion over 10 years. These limits would result in many young parents receiving lower credits under this proposal than under current law. Another option would be to phase out the worker credits based on joint earnings an