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

Summary of
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.

Family-Size Adjustments

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.

Cost Considerations

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.

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 necessary computations.

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.

Child poverty has grown in part because more working families are poor.

EICs Help Offset Declining Wages

Declining wages have prevented working families from escaping poverty.

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.

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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.