In-Work Benefits in the United States: The Earned Income Tax Credit

Abstract

The earned income tax credit (EITC) is or soon will be the largest cash or nearcash benefit provided to low-income households in the United States.' The EITC is a credit on the federal income tax available to working poor families with children. In I994 the credit equals 26-3 % of earned income (wages, salaries, self-employment income, and farm income) for taxpayers with one child, up to an earned income of $7,750; hence, the maximum benefit is $2,038 for families with one child. Because benefits increase with earned income (up to a certain point), the EITC seems to encourage work and therefore is a popular antipoverty programme. Taxpayers with one child and incomes above $7,750 but below $i i,ooo receive the maximum benefit. Taxpayers with one child whose incomes exceed $I I,ooo are in the phase-out range of the credit: their $2,038 credit is reduced by I5 98 cents for every dollar of income earned over and above $I I,ooo. Taxpayers with two or more children are entitled to a slightly larger credit ($2,528, or 30o0 %0 of $8,425), which is phased out at a I 7p68 0 rate. A small credit of at most $306 was available to childless taxpayers betnween the ages of 25 and 64 for the first time in I 994. Unlike most credits and deductions in the federal individual income tax system, the EITC is refundable that is, if the amount of the credit exceeds what the taxpayer owes, he or she receives a payment from the US Treasury for the difference. The EITC was adopted in I975 and was originally promoted as a way to relieve the burden of the social security payroll tax on low-wage working parents.2 The original EITC equaled IO 0 of earnings up to a maximum credit of $400 for taxpayers with children, and was phased out at a rate of IO cents per dollar of earnings (or adjusted gross income, whichever was higher) for incomes between $4,ooo and $8,ooo. The EITC has been increased many times since I975, though the largest changes occurred in I990 and I993. In i996 when the I993 legislative changes are fully phased in, the credit rate will be 40 0 of earnings for families with two or more children and 34 0 for families