Taxes

The Earned Income Tax Credit: Small Benefits, Large Costs

No reason to chose between two bad options

|

Money
Dreamstime

When both liberals and conservatives like a government program, it usually means that it is expensive and expands the scope of government without delivering on its promises. The bipartisan support of the earned income tax credit is no exception.

The EITC is best described as an anti-poverty program that encourages people to work. In a new study published by the Cato Institute, Chris Edwards and I explain that based on a deep dive into the economic literature and the budgetary impact of the program, conservatives and liberals alike underestimate its cost while overselling its benefits. That is why we advise cutting the program.

The EITC is effectively a wage subsidy that gives low-income people a refundable tax credit for working, meaning that some working individuals who pay no income taxes are eligible to receive a payment from the U.S. Treasury. This payment acts as an incentive for poor people to seek work and keep working. These built-in work incentives explain why Republicans and Democrats claim that the EITC is one of our most successful anti-poverty programs and have regularly agreed to extend it. Unfortunately, the EITC is not what it seems to be.

First, it is extremely costly. After extensions in 1986, 1990, 1993 and 2009, the program will provide an estimated $69 billion in benefits to 28 million recipients for a cost of $60 billion in 2015. Though it is being administered through the tax code, the growth in its refundable portion has made it primarily a spending program. In fact, it is the largest federal cash transfer program for low-income households.

Those who would argue it is worth the cost because it is a proven way to encourage poor people to enter the labor force do overlook the fact that the program penalizes people who want to work more hours. Indeed, a large majority of people taking the EITC have an incentive to work less, not more. EITC's advocates also fail to mention its resulting negative impact on the United States' overall output and employment.

Also, there is a tremendous amount of fraud and there are many improper payments with the EITC. As we note, "the Internal Revenue Service reports that the EITC error and fraud rate in 2014 was 27 percent, which amounted to $18 billion in overpayments."

A 2013 report on the issue from a Treasury Department inspector general has striking numbers about the scale of the problem. According to the data, between 2003 and 2012, improper payments for the EITC alone amounted to somewhere between $110.8 billion and $132.6 billion. The reasons listed for the gigantic amount in improper payments range from the absurd complexity of the tax law to the structure of the program to the confusion among eligible claimants.

Unfortunately, fixing the problem won't be easy, because none of these factors alone is the primary driver of the EITC improper payments. The problem is caused by the combination of all of them.

The burden imposed by the program on the economy at large is important, too. Paying for the EITC requires the extraction of resources from the productive sector of the economy. This causes people to reduce their productive activities, such as working and investing, which in turn hurts the economy.

Conservatives' usual response is that in spite of these problems, it beats raising the minimum wage—a policy that actively destroys jobs. But there is no reason for us to choose between two bad options simply because one is slightly less bad than the other.

To be sure, offering to expand the EITC is easier than making the case that, for instance, a fundamental reform of the corporate income tax would have a significant and positive impact on workers' wages because that tax cut would be shared with workers in the form of higher wages. But political expediency won't achieve better policies. For all these reasons, we should cut the EITC, not expand it.

COPYRIGHT 2015 CREATORS.COM

Advertisement

NEXT: The GOP's Biggest Weakness: It's Out Of Touch With Policy Reality

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  1. Heavy on the hate light on the details.

    Documenting and detailing any perverse incentives would have been a better contribution than simply claiming that there were such incentives.

  2. I am failing to see how the Earned Income Tax Credit (EITC) is worse than other anti-poverty measures. Even if the benefits are overstated it still encourages people to go to work versus other kinds of measures which disincentive working altogether.

    How does it stop people from working more hours? Is there a simple cutoff point? Earn $14,999.99 and you get the full benefit, but hit $15,000 and the benefit goes away completely? If that’s the case wouldn’t it be a simple fix the gradually eliminate the credit as a taxpayer’s income increases?

    Can somebody explain this to me like I was Tony/Shriek/random sock puppet because I usually agree with Ms. de Rugy but I’m missing something here.

    1. I’m a bit confused about her cost and benefits line. Does the entire program cost 129BB with 69 of that benefits? Or is there some magic money multiplier that turns 60 into 69?

    2. No, as you would expect, there is a gradual phase out.

      From a policy perspective, EITC is effectively a mechanism for creating a higher minimum wage for people supporting a family. (You need to have dependents to qualify.) By paying the additional wages as a tax credit, you avoid the problem of making it harder for family wage earners to get jobs.

      That is, the actual closest alternative policy would be to institute a lower minimum wage for non-family-supporters, and a higher minimum wage for those supporting a family. This is sometimes seriously proposed as a lower minimum wage for teens/students. But such a bifurcated policy would obviously bias employers toward hiring lower-cost non-family-supporters, and make it harder for those supporting a family to get jobs.

      EITC, on the other hand, effectively pays family-supporters a higher minimum wage, but does so without making them more expensive for employers to hire than non-family-supporters.

      1. I figured the EITC had a gradual phase out, but was too lazy to check myself. I think a tiered minimum wage would be a disaster. We would probably be better off reducing other subsidy programs and upping the the EITC or switching to direct cash benefits. But I think most people are making the right decisions for themselves, and my betters the political class disagree so this will never happen. On a slightly related note wouldn’t the EITC work better at the state level than the local level since there are such huge disparities in cost of living between states (cities too but I cannot envision this working at that level)?

      2. I would not call it a gradual phase-out. The credit drops to zero fairly quickly after reaching the income level to get the maximum credit amount.

        ‘(You need to have dependents to qualify.) ‘

        That is not true. A single taxpayer can get up to $496 in EITC for tax year 2014. Also, the proper term is not dependent but qualifying child, which is a subset of dependent. Not any dependent will get you additional EITC.

    3. When I was receiving the EITC, I never felt an incentive to work less hours. For one thing, most years I never thought about the EITC until tax season, and more importantly, it was a credit that came once a year. I got paid every two weeks. If I was offered more hours, the money was a lot more useful sooner rather than later.

      1. It is my understanding you can get the EITC benefit on each paycheck, if you wish.

        1. No, only upon filing a tax return.

  3. Getting $69 Billion in benefits for a cost of $60 Billion seems like the most efficient government program ever, I can certainly think of about a million other things to complain about before that.

    1. I take that to mean $69 billion in benefits for an administrative cost of $60 billion; a total of $129 billion. I wonder how that compares to other subsidies.

      1. Actually I think it is $69 billion in benefits – of which $60 is ‘refunds’ (ie spending). The remaining 9 is foregone taxes. If only those poor people paid more taxes to be reduced, the program would be much more efficient. An EITC that is limited to billionaires might not cost anything (and even if it did would clearly create job growth or free trade or reduce cronyism or somesuch) so should be implemented immediately.

  4. The author makes the claim — without presenting any evidence to support it, whatsoever — that reform (presumably meaning reduction) of the corporate income tax would lead companies to share the savings with workers as higher wages.

    I actually support corporate income tax reform, but why should we ever expect the savings to be shared with workers as wages — and certainly, why should we expect such as a significant fraction of the use of the savings?

    We are not in anything close to such a tight employment market that competition is obviously going to drive such. And the record of the last several decades indicates that cost savings (primarily through technology/productivity increases) have overwhelmingly been allocated to corporate profits, not to wages, and certainly not to low-wage workers.

    So why should we expect tax savings to behave differently?

    1. I was basically thinking the same thing. If you lower costs for a business through corporate tax reform (which I support) they will likely use the new margin to lower prices to be more price competitive, not give it to workers. I usually like Veronique de Rugy’s work, but this article missed the mark for me.

      My company and all of our top competitors pass any cost savings to our customers and shareholder – customer prices never drop as fast input costs so shareholders will get a little extra. As an example we use a ton of natural gas, it’s probably our biggest input cost after labor, and when natgas prices drop our customers start demanding discounts. Employees will sometimes get one off bonuses, but we certainly do not get higher base wages because costs dropped.

      1. Then she was probably referring to real wages. All businesses drop prices, cost of living goes down, nation’s workers get more stuff.

      2. Having been a CEO let me suggest they are most concerned about hitting an earnings target, and are willing to either lower prices or pay higher wages to do so, if it will help achieve the objective.

        Nothing is automatic.

        Everything is dynamic.

  5. So, do you mean the EITC is a bad idea or the EITC as currently implemented? Can it be ‘fixed’?

  6. Just a little information concerning the EITC. You don’t have to have children to qualify, but you have to make VERY little money and the credit is pretty small. The benefits are structured as a “bell curve”, starting at $1 and going up to over $6,000 for incomes in the sweet spot then decreasing as the income goes up. The maximum income for a family is over $43K and the sweet spot ranges from $13K to almost $20K. A married couple with 3 kids in the sweet spot would EITC and child tax credit, totaling between $9K and $10K. I have had people explain to me that they figured out the maximum amount they could make and still get maximum benefits, so, when the year to date amount hits that point, they just stop working and take a vacation on the taxpayers’ dime. I have seen people who treat the program responsibly, making their major necessary purchases and paying annual insurance premiums with the credit. I’ve also heard people planning to blow the whole thing a a trip they could never afford otherwise. I think the fact that it comes as one big check encourages misuse of the money and gives it much more psychological power than it should have.

  7. how about simply eliminate all welfare to encourage people to work? Wow, look, zero cost and zero government involvement.

  8. Unfortunately, fixing the problem won’t be easy, because none of these factors alone is the primary driver of the EITC improper payments. The problem is caused by the combination of all of them.

    Eliminate the entire program. Force recipients to apply to existing overlapping programs. If no overlapping programs exist (unlikely), refer to religious or other social charity.

  9. My main argument against the EITC has always been that no one, as in NO ONE, understands it.

    If you think that is hyperbole, then try this. NO ONE who actually receives the EITC understands it.

    Therefore a question for Veronique. If a program for making work pay was so simple everyone in the country understood it, would it change your critique? Perhaps this one … http://rickstewart.com/content/income-inequality

    1. Agree, One of the biggest misconceptions I came across (in the several years that I did tax prep for low income people)was that it was only for single people with qualifying children; not married couples filing jointly. I heard several clients state that did not get married or got a divorce solely so they could get the EITC. They were shocked when I told them they could have gotten a bigger EITC if they had filed married filing jointly.

  10. A fraud rate of 25% spells success for the statist

  11. OK, 69 Billion paid out to 28 Million recipients averages to $4.73 per week each. Can that be any kind of incentive to do or not do anything at all?

    1. NO, move that decimal! Not used to so many zeros!

  12. Start working at home with Google! It’s by-far the best job I’ve had. Last Wednesday I got a brand new BMW since getting a check for $6474 this – 4 weeks past. I began this 8-months ago and immediately was bringing home at least $77 per hour. I work through this link, go? to tech tab for work detail,,,,,,,

    ———- http://www.4cyberworks.com

Please to post comments

Comments are closed.