The Earned Income Tax Credit

Since its introduction in 1975, the Earned Income Tax Credit (EITC) has helped lift working families out of poverty by returning payroll and income taxes to workers earning the lowest wages. Sometimes serving as a negative tax (returning more money than was paid), the EITC encourages low-income individuals to work while helping some of the poorest families escape the hardships of poverty.

Overall, the EITC has been quite effective. The EITC lifts about 4.4 million people out of poverty each year, half of whom are children. Poor families receive not only the benefit of the tax refund but also the benefits of work that the EITC encourages. Yet despite its overall success, the EITC is not a perfect solution, and specific problems need to be addressed.

The EITC is too complicated. With a different definition for eligible children than the Child Tax Credit and the dependant allowance, understanding how to file for the EITC can be incredibly difficult. The result is that two thirds of all EITC claimants hire someone to file their taxes. This is an unnecessary cost that could be eliminated by simplifying the eligibility requirements.

The complication also leads to improper utilization of the EITC. Between 15 and 20 percent of workers eligible for the EITC never file claims, while about 30 percent of those who do either file for too large a credit or are completely ineligible. By simplifying the tax filing process and increasing awareness about how the EITC works, more people who are entitled to the credit, and fewer who aren۪t, would be able to receive it.

Perhaps the most important change needed is to align the EITC with what we know about the family structures that are best for breaking out of poverty. Studies consistently show that married couples are far less likely to be impoverished, yet the EITC treats married couples unfairly. When a working mother gets married, the additional income of her husband is likely to prevent either of them from receiving the EITC, even though their household income is the same as their combined incomes before they were married. The average penalty for marriage in 2003 was more than $2,000. In order to best fight poverty, this marriage penalty has to be reversed. The total credit a married couple receives should be at least the same as they would have received were they filing as two unmarried individuals.

There have been some recent proposals to increase the credit for childless workers, primarily as a way to encourage males who are currently outside the mainstream job market to find employment. While there may be some merit in the proposal, it seems to rest on relatively untested assumptions about the kinds of incentives required to help the targeted population find work. Before embarking on experimental policy, we should fix the current problems with the EITC so that more of the currently eligible population can take advantage of it, and so that couples who decide to marry are not penalized financially for doing so.