August 7, 2017

Expanding the EITC: The Path to a Smarter Social Safety Net



Freshman congressman Ro Khanna, representing California’s 17th district, has been raising some eyebrows the past month with his discussion of an ambitious plan to strengthen America’s social safety net by massively expanding the Earned Income Tax Credit (EITC), a refundable tax credit tied to earnings. Khanna’s proposal would increase EITC expenditure by roughly $1.4 trillion over ten years, making it more than twenty times bigger than the expansions supported by former President Obama and Speaker Ryan.  

Khanna recognizes that his bill is audacious as an actual policy. But if his primary goal is to make a statement about the circumstances faced by low-income Americans, many of whom are, in his words, “working hard and… not earning a middle-class wage,” then he’s already succeeded. The plan, which would double the maximum benefit for workers with children and make it six times higher for childless workers, is meant to compensate for the wage stagnation that has taken place since 1979. It gives “a 20 percent raise to the bottom 20 percent of households in the income distribution,” Khanna explained.

While Khanna’s specific proposal is a moonshot, expanding the EITC has been on the table for some time now and often receives bipartisan support. Liberals approve of the EITC because it is a highly effective anti-poverty measure, while reform minded conservatives are attracted to the program’s strong work incentives and boosts labor force participation.

In 2015, the EITC paid out $67 billion in benefits and lifted 6.5 million people out of poverty, 3.3 million of whom were children. Without the credit, the poverty rate in the in the U.S. would have 9.4 percentage points higher. The EITC also lessened the severity of poverty for 21.2 million people, including 7.7 million children, which has been shown to substantially improve families’ quality of life. Under Obama and Ryan’s proposed changes, which were far more modest than Khanna’s, the EITC would have brought an additional 600,000 childless workers above the poverty line and prevented 5.2 million people from sinking deeper into poverty.

There is no question that the EITC is immensely successful in reducing the number of poor people in the United States. The fact that it encourages people to work is an added bonus. For instance, between 1992 and 1999, the employment rate of single women with children increased by a remarkable 20 percentage points.

Politicians frequently credit this development to a combination of a strong labor market and the welfare reforms of that period. However, research has found that the EITC expansions of the late 1980s and early 90s were the single most important factor in explaining the increase in labor force participation by female heads of household from 1993 to 1999, indicating that the program has a strong positive effect on employment for certain populations.  

The explanation for this is simple: when the government subsidizes a worker’s wages, each additional dollar that person makes on the job is more valuable than it otherwise would have been. To illustrate, if the government is giving someone 30 cents for every dollar they make, a $10,000 salary from an employer ends up being $13,000 after taxes. This gives individuals increased incentive to enter the labor market.  

Aside from the inherent benefits of a tighter, and more frictionless labor market, it should hearten fiscal conservatives to know that the EITC also decreases cash welfare use. The expansions of the 1990s allowed roughly half a million people to find adequate employment and get off cash welfare. University of Chicago economist Jeffrey Grogger found that the changes to the EITC contributed as much to the decline of cash welfare usage by female-headed households as the welfare reforms of the same period.  

Of course, none of this is to say that the program is entirely without flaws. The most frequently cited criticism concerns the EITC’s error rate, which the IRS has estimated to be 22 to 26 percent. It’s important to keep in mind that most of these errors are due to unintentional mistakes in applications rather than fraud. The rules surrounding EITC eligibility are complex and often poorly understood by recipients and professional tax preparers alike. As such, this problem cannot be solved by cutting benefits or tightening eligibility requirements, which some anti-EITC advocates have suggested. Overpayments will continue to happen so long as the program’s guidelines remain complicated, and the IRS underfunded.

To get to the heart of the improper payment issue, the Treasury Department under Presidents Obama and Bush put forth a number of error-reduction and EITC simplification proposals that were intended to reduce the incidence of applicant mistakes. The first round of EITC simplifications was adopted in 2001 and led to a 13 percent decrease in overpayments, indicating that these ideas have potential. Congress could look into developing further simplifications, yet progress on this front has all but stalled.

Much can also be done to improve the benefit itself. Conservatives want to eliminate the marriage penalty, under which dual-income married couples receive smaller tax credits than they would get if they filed separately. Advocates for expanding the EITC also point to the fact that under the current maximum credit amounts, a childless worker can receive no more than $510 — a scant offering compared to the $3,400 maximum for workers with one qualifying child. Additionally, childless workers must have an adjusted gross income of less than $15,010 to qualify for the benefit, whereas someone with one child can make up to $39,617.

Demonstrating bipartisan support for improving the program, former President Obama and House Speaker Paul Ryan advanced nearly identical proposals to increase the maximum benefit for childless workers to $1,000 and decrease the minimum qualifying age from 25 to 21. The Treasury estimated that the measures would lift roughly half a million people out of poverty and lessen the depth of poverty for another 10.1 million. These are certainly worthy pursuits.

And yet, it’s clear that  incremental reforms like these don’t go far enough. Regardless of the political prospects of Khanna’s particular plan, something of its magnitude is necessary to fill the trillion dollar gap in active labor market policy spending that the U.S. has relative to the OECD average. Even in a time of heightened partisanship, policymakers from both sides of the aisle should be able to recognize the merits of expanding a pro-work, anti-poverty program that improves the lives of millions of workers and children. Why not let it improve the lives of millions more?

Katy Li is a Poverty and Welfare Intern at the Niskanen Center