Now that the calendar has turned to 2024, it’s time for people to start thinking about filing their taxes. For low-income individuals, tax season is an opportunity to access benefits that are tied to tax returns, most notably the Earned Income Tax Credit.
Although the federal Earned Income Tax Credit is an extremely important anti-poverty policy, it has some noticeable gaps in who it serves. For example, the credit amount is extremely small for people who don’t have any dependent children. Similarly, the phase-in rate for the credit is fairly slow, meaning the lowest earners don’t receive the maximum benefit.
The good news is that states can design their own tax policy, and they aren’t obligated to follow the federal government's lead when promulgating state taxes and tax credits. In 2014, the California Legislative Analyst’s Office put together a report on some different choices states could make with their Earned Income Tax Credits.
Currently, the most common policy for states is to make their credit a percentage of the federal credit. This puts more money in the pockets of low-income individuals, but it does nothing to address any design shortcomings of the federal Earned Income Tax Credit outside of the size of the benefit.
One alternative policy is to target Earned Income Tax Credit benefits toward lower income individuals. As the EITC currently exists, people don’t receive full benefits until they’ve made over $10,000 of earned income. This notably doesn’t include things like social security or supplemental security income, meaning many people who need support the most are not receiving it.
In theory, this encourages people to continue to seek work in order to maximize their benefits. However, people who are unable to find adequate work get left with a noticeably smaller tax return. If states took it upon themselves to increase the rate at which their EITC phases in, they could provide a decent benefit to the lowest earners without compromising the incentive created by the federal EITC, potentially even increasing work incentives for low-income earners.
It is also worth recognizing that the importance of labor supply can sometimes be overstated in the discourse surrounding poverty policy. Labor supply considerations are important, but participating in the labor market is not the only way individuals can provide benefits to society.
Another option laid out by the California Legislative Analyst’s Office is for the state to target its Earned Income Tax Credit at individuals who do not have any dependent children. Currently, the maximum credit for an individual with no children is $600, and benefits phase out after earning $15,000. The benefit jumps to almost $4,000 with a single dependent, with benefits continuing to be paid for households over $45,000 of earned income.
States could either increase the benefits for people without children, or they could lengthen the income window where those people are able to receive benefits. Both options would make the EITC a much more effective anti-poverty policy.
Considering the labor supply angle, this change would likely increase the incentive to work in most cases. That is because the current EITC for individuals without children is so small that there isn’t much benefit to working a job just to qualify for it. Simply increasing maximum income where people could claim this credit would encourage more people to find work.
State policymakers have a lot of options when it comes to defining their state’s tax policy. Despite the fact that this report is almost a decade old, it highlights the fact that creative and thoughtful policy choices can help fill in the gaps created by federal policy.