The following is a summary of A Hand Up: How State Earned Income Credits Help Working Families Escape Poverty, 1996 Edition. This Center on Budget and Policy Priorities report was released originally in January 1996. We are posting the summary at this time because we have received numerous requests recently for information on establishing state EICs from interest groups and policymakers as they prepare for the 1997 legislative session in their state. The summary of A Hand Up provides background on the role state EICs can play in assisting working poor families and practical considerations for crafting a state EIC. The full report can be ordered through the Center's publication service
A HAND UP: How State Earned Income Credits
Help Working Families Escape Poverty, 1996 Edition
A parent working steadily no longer means that a family will be able to live above poverty. Even with the recent increase in the federal minimum wage to $5.15 an hour, for example, full-time, year-round work at the minimum wage will pay only 81 percent of the poverty line for a family of three in 1998. (That is the first full year following the implementation of the new minimum wage.) For a family of four, it will pay 63 percent of a poverty income. This means that children may grow up poor even if parents are trying very hard to make a living.
One strategy to "make work pay" enough to lift a family out of poverty has been supported over
the past two decades by both liberals and conservatives because it promotes the work ethic and
family values. It is the earned income tax credit.
The federal earned income credit was created by Congress in 1975 to help low- and moderate-income families with children. It is designed to:
The credit for families with children has been expanded three times: Under President Reagan in the
Tax Reform Act of 1986, as part of the budget agreements negotiated by Congress and President
Bush in 1990, and as part of President Clinton's budget package in 1993. In addition, the 1993
budget agreement established a modest new credit for low-income workers between the ages of
25 and 64 who do not have a qualifying child.
With the most recent expansion, it is estimated that some 11 million families with children will see their EIC benefits increased and 4.5 million workers without a qualifying child are expected to receive benefits for the first time. But even with this latest expansion and with the recent increase in the federal minimum wage, many families with minimum wage income as supplemented by the federal EIC will remain in poverty.
State EICs can help fill that gap. Over the last several years, EIC provisions have been incorporated into several state tax systems. Further proliferation and expansion of state-level earned income credits would contribute significantly to the goal of making work pay.
State Earned Income Credits: Their Function and Purpose
Seven states Iowa, Maryland, Minnesota, New York, Rhode Island, Vermont, and Wisconsin have their own EICs. All of the state EICs use the federal eligibility rules and express the state credit as a percentage of the federal credit. State earned income credits contribute to policy goals that are similar to the reasons for the federal EIC.
Two additional advantages make earned income credits particularly appropriate state policy.
At the state level, earned income credits are relatively new. Six of the seven states using EICs
adopted them since passage of the 1986 federal tax reform act.
How the Federal EIC Works
The federal EIC is a refundable credit that is administered through the federal tax system. A family's credit amount is determined by its earnings and the number of children it has. The credit amount for persons without a qualifying child is based on earnings.
A family or individual receives the full amount of the credit, even if the credit amount is greater than the family's income tax liability. The amount by which the credit exceeds taxes owed is paid as a refund. If a family has no income tax liability, the family receives the entire EIC as a refund.
The EIC expansions enacted in 1993 were scheduled to phase in through 1996. In tax year 1996, families with one child who have incomes up to $25,100 and families with two or more children with incomes up to $28,500 are eligible for the EIC.
Establishing a State EIC
State EICs generally conform to federal provisions. But there are four decisions to be made when considering a state EIC:
While the federal credit is refundable, state EICs may be either refundable or non-refundable.
Minnesota, New York, Vermont, and Wisconsin have refundable credits; Iowa, Maryland, and
Rhode Island have non-refundable credits.
The 1990 federal expansions added a small family-size adjustment to the EIC in recognition of the
additional costs associated with providing for larger families, and the 1993 expansion substantially
increased the family-size adjustment. The adjustment still is less than fully adequate. In 1996 the
maximum EIC benefit for families with two or more children exceeds the benefit for a family with
one child by nearly $1,400, but the poverty threshold is roughly $3,500 higher for a family of four
than for a family of three. The federal credit also provides no distinction between families with two
children and families with three or more children. States must decide whether to accept or augment
the federal family-size adjustment.
Refundable state EICs range from 15 percent to 25 percent of the federal EIC, while
non-refundable state EICs currently range from 6.5 percent to 50 percent of the federal credit.
States can establish and maintain their credit within desired cost limits by adjusting this percentage.
Workers Without a Qualifying Child
There are several issue states should consider when deciding whether to cover workers without
qualifying children under a state refundable EIC. On the one hand, state EICs for this group of
workers generally will be very small, because the federal credit is modest in size. Many eligible
workers thus may not claim the credit, especially since workers with incomes this low generally
owe no state income tax and are not required to file a state tax return. On the other hand, the cost
to states of this portion of the credit would be relatively small, and the credit would provide some
relief to a very low-income group of workers. Practical considerations such as ease and cost of
administration may be the deciding factors.
For tax year 1995, each of the state EICs except Wisconsin's covers workers without qualifying children.
The Need for Outreach
Earned income credits have a high participation rate. Some 80 to 86 percent of eligible families appear to receive the federal credit. State EICs have high participation rates as well.
Significant outreach efforts need to accompany state EICs for two reasons.
There still are a number of eligible working poor families with children who do not receive
the federal EIC, often because they have no income tax liability and do not file a tax return to
claim the EIC.
Some families receiving the federal credit may have incomes below the level at which filing a
state tax return is required. If they do not know they are eligible for a state EIC, they may
not file a state tax return to claim the credit.
Some families receiving the federal EIC may not know the amount of their federal benefit
because the Internal Revenue Service computes it for them. They may think they are not
eligible for a state EIC because they cannot enter their federal EIC amount on their state
income tax return.
States instituting EICs can undertake a variety of outreach strategies to address these problems.
Low-income working families may be alerted to file for benefits through other benefit or service
programs, in stores where they shop, at businesses where they work, or through the media.
Taxpayer assistance programs, informational material, and hotlines may help families make the
The EIC Ameliorates Poverty and Complements Welfare Reform
Earned income credits can be effective in combating trends that have led to a high child poverty rate, in boosting the incomes of low- and moderate-income workers, and in complementing other efforts to help welfare recipients make the transition to work.
The poverty rate for children in 1995 stood at 20.8 percent, higher than any other age
group. By contrast, 11.3 percent of persons 18 and older were poor that year.
Poverty has increased more among children in recent decades than among any other age
group. Between 1970 and 1995, for example, the child poverty rate increased by 48
percent, compared with a 27 percent increase in the poverty rate for adults aged 18 to 64
and a 57 percent drop in the poverty rate for the elderly.
Child poverty has grown in part because more working families are poor.
The poverty rate for families with children in which the head-of-household worked climbed
from 7.7 percent in 1979 to 10.6 percent in 1995, an increase of 38 percent.
In 1992, approximately 9.6 million poor children nearly three out of every five lived in
a family where a household member worked.
EICs Help Offset Declining Wages
Declining wages have prevented working families from escaping poverty.
Labor Department data show that after adjustment for inflation, the average hourly wages
paid to non-supervisory workers have been lower since 1993 than in any year since 1964.
Wages for these workers fell even during the recovery of the 1980s and early 1990s.
Census Bureau data show that the proportion of full-time year-round workers who have
"low earnings" those whose earnings were too low to lift a family of four above the
poverty line rose from 12.1 percent in 1979 to 16.2 percent in 1994, an increase of
Recently enacted legislation will raise the federal minimum wage to $5.15 an hour in
September 1997. Yet earnings from full-time year-round work at the federal minimum wage
will equal just 81 percent of the poverty line for a family of three in 1998, the first full year
following the minimum wage increase. Throughout much of the 1960s and 1970s, full-time
work at the minimum wage generally was enough to lift a family of three out of poverty
without considering other sources of income. The decline in the value of the minimum wage
has affected a large share of the working poor, since the majority of poor workers have
earnings at or near the minimum wage.
EICs Can Co
mplement Welfare Reform Efforts
The erosion in wages for workers near the bottom of the earnings scale means that many welfare
recipients who find work continue to face difficulty supporting their families while meeting the
expenses of work such as child care and transportation. Welfare benefit rules in many states
compound the difficulties of making the transition by reducing benefits sharply for recipients who
find work, even part-time work at modest wages.
Families earning below-poverty wages are far less likely to qualify for AFDC benefits to
supplement their low earnings than they were a decade ago. In 1972, a mother with two
children and wages equal to 75 percent of the poverty line could receive some AFDC
benefits in 49 states to lift her closer to or above the poverty line. In 1980, she would have
been eligible in 42 states. By 1992, she could get AFDC in only three states.
State EICs can build on the strengths of the federal EIC and help address these problems.
Unlike welfare benefits, EIC benefits rise substantially when earnings rise for welfare
recipients who find work. In addition, EICs provide a continuing wage supplement for
low-income families who are not eligible for welfare but may be a paycheck or two away
from needing to rely on assistance.
At the same time, it is important to recognize that a state EIC alone cannot address the
obstacles to work that exist in the economy and in the AFDC program. A state EIC is likely
to work best as a complement to more targeted welfare reform policies, including those that
allow welfare recipients to retain more of their benefits when their earnings rise, when they
find work. If funding for a state EIC replaces spending for benefits or services for AFDC
families including education, training, child care assistance, and continuing health care
coverage services many families would find it more difficult, rather than easier, to make
the transition to work.
* * * *
State EICs build on the strengths of the federal EIC and serve several important purposes. State
EICs provide a wage supplement that reduces barriers to work for welfare recipients. They also
help working families who are not on welfare meet the ongoing costs of work and unforseen costs
that sometimes drive families back onto public assistance. State EICs are a cost-effective strategy
for reaching the broader goals of welfare reform and the alleviation of child poverty. Refundable
state EICs also can help relieve the burden of regressive state and local sales, excise, and property
taxes on low-income working families. In sum, state EICs should be viewed as an important part of
progressive tax reform, as a policy to assist all low- and moderate-income families, and as one element of efforts to help families make the transition from welfare to work.