Making tax cuts work for working families
by Max Sawicky

While few were looking, the Earned Income Tax Credit (EITC) became the United States' second largest program (after Medicaid) in aid of the poor. The EITC is available to low-income working families with children, and the program's budget runs to over $30 billion a year. It is a popular enough program that there has even been talk of expanding it.

The EITC is a refundable tax credit. This means that those who owe little or no income taxes can still benefit. If the credit exceeds federal income tax liability, the taxpayer gets a check for the difference from the Internal Revenue Service. The refundable nature of the EITC is crucial because many low-income families owe little or no federal income tax. Nonrefundable credits (such as for child care expenses) are not as helpful to these families.

Consider a single mom with two children. In 1999 her standard deduction is $6,350, and she gets three exemptions at $2,750 each, for a total of $14,600 in tax-free income. But that's not all. She gets two child credits of $500 each, which effectively shields another $6,667 in income from tax. So this mom has to earn more than $21,267 to benefit from any other nonrefundable credits.

But should someone who earns over $21,000 a year and owes no income tax still get a refundable credit? Sure, if you consider that such a worker still pays $3,213 in payroll taxes. A refundable credit has the effect of relieving some of this payroll tax burden, which for a majority of taxpayers actually exceeds income taxes.

One shortcoming of the EITC is that its benefits do not increase if a family has more than two children. The Clinton Administration proposed to extend benefits to families with a third child. The cost of this reform in the context of the total federal budget was quite small -- around $2 billion annually in a total budget of about $1,800 billion. This would have been a painless reform, given that a budget surplus of $280 billion is expected for the current fiscal year.

While such a reform would be an improvement, the EITC could be made even more beneficial by merging it with the child credit and the dependent exemption, resulting in a single "Unified Universal Child Credit" (UUCC) for working families. For a mother with two children, the credit would rise to a maximum of $4,500 as her labor income increased. Unlike the EITC, this proposed credit would not phase out at higher levels of income. Instead, it would phase down to no lower than $2,600.

One advantage of this approach is that there is less of a penalty in the form of lost benefits if the family breadwinners increase their wages, either by working more hours or receiving higher hourly pay. A second advantage is that it helps to lower the so-called "marriage tax" penalty, especially for single mothers who would like to marry. Much is made in public debates of marriage penalties under the income tax. The reality is that marriage penalties are greatest, in terms of percent-ages, for those with the lowest incomes.

The proposed UUCC would add benefits for each additional child, no matter how many are in the family. This change also reduces marriage penalties, especially when two existing families with dependent children are merged in marriage.

The UUCC proposal is expensive, however, when compared to the Clinton Administration's plan, costing approximately $30 billion a year. But this shouldn't be problematic given that the federal government is running huge budget surpluses. There is more than enough money to pay for such a proposal.

An expanded EITC also would provide new fiscal flexibility to states that currently have their own tax credits or are contemplating such reforms. With some redesign, the states could continue to piggy-back on the federal credit and have some extra resources to commit to children in other ways. Making good-quality child care more available and affordable is an obvious choice for state-level improvement.

In public debates, much is made of the budget priority presented by future generations. Now, when federal and state revenues are relatively plentiful, the hue and cry for tax relief can be directed to this goal, by helping working families with children.

It is an encouraging sign that media coverage of the UUCC proposal has been strong. The proposal has been given serious examination in the New York Times, Business Week, Tax Notes, the Gannett News Service, and the Washington Post. And on Capitol Hill, Rep. Dennis Kucinich (D-Ohio) has been preparing legislation that embraces the reforms embodied in the UUCC proposal.

Budget surplus estimates of $4.7 trillion are likely to increase to well above $5 trillion over the next 10 years when the Congressional Budget Office and the Office of Management and Budget issue new numbers in January 2001. Some kind of large tax cut is probably inevitable under these circumstances. And, the UUCC is the best kind of tax cut for working families. It simplifies the tax code, improves work incentives, and reduces marriage penalties.

Return to EPI Journal Winter 2001