State Earned Income Tax Credits and Minimum Wages Work Best Together

PDF of this Report (10pp.)

By Erica Williams and Chris Mai

Updated September 3, 2014

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As states continue to recover from the recession, state lawmakers should look to help working families recover, too.  They can do this effectively by strengthening their states’ earned income tax credits (EITCs) and minimum wages.  EITCs and the minimum wage are twin pillars of making work pay for families that earn low wages.  They boost income, widen the path out of poverty, and reduce income inequality.  They also help to build a stronger future economy by putting children on a better path.  For low-income young children, there is evidence that the lift in family income can result in improved learning and educational attainment and higher future earnings in adulthood.[1]

Strengthening either a state’s minimum wage or a state EITC will boost incomes for low-wage working families, but these policy improvements are particularly effective in combination, for a number of reasons: 

  • State minimum wages and EITCs reach overlapping but different populations.  Each supports families and individuals that the other does not reach.  For example, EITCs primarily target low-income families with children and are available to working families earning more than three times a full-time minimum wage worker’s annual salary of $14,500.  The minimum wage targets the very lowest-wage workers, regardless of factors like total family income, family status, or age.
  • Increasing both at the same time provides added support to the working families who need it most.  Together, a minimum wage boost and a robust state EITC can move families beyond poverty and further down the road to economic security.  Also, a minimum wage increase provides the added benefit of increasing the EITC for some families.
  • The benefits of the two policies are timed differently.  An expanded minimum wage increases every paycheck, which helps with routine expenses, like food, monthly bills, and rent.  State EITCs are paid at tax time and can be used for larger, one-time expenses, like car repairs or a security deposit.  
  • Improving both together allows the public and private sectors to share the cost of boosting incomes for those who work.  The EITC is a cost largely borne by state government, and by extension state taxpayers.  The state minimum wage is borne principally by the private sector, especially employers and consumers.  Improving both policies spreads the cost of making work pay more broadly than does either policy alone.

Recent improvements to the federal EITC and the federal Child Tax Credit (CTC), as well as less recent increases in the federal minimum wage, have helped to move the after-tax incomes of families across the country closer to or above the poverty line.  But more needs to be done to get working families and individuals on a path to financial stability and self-sufficiency.  Inaction at the federal level to further improve the minimum wage and EITC should not stop state lawmakers from using their own policy tools to keep people working, increase incomes, and reduce poverty.  Many states have increased their minimum wage and a few states have enacted EITC improvements in 2014.  Three states — Maryland, Minnesota, Rhode Island — and the District of Columbia did both. Other states also should look to advance the two policies in tandem for the biggest impact.

Wages Have Stalled for Low-Wage Workers

Low wages make it hard for working families to afford basics like decent housing in safe neighborhoods, nutritious food, reliable transportation, and quality child care, as well as educational opportunities that can set families on a path to economic security.

The wages of workers paid the least are no higher than they were 40 years ago, after adjusting for inflation.  For the most part wages have been stagnant or declining over this period, with the only period of sustained growth coming in the late 1990s into the early 2000s.[2]  For example, the 20th percentile wage — that is, the wage that exceeds the bottom 20 percent of wages — was slightly lower in 2013 than 40 years prior in 1973.  In fact, it was 1 percent lower than in 1973 and about 6 percent lower than in 2007.  (See Figure 1.)

The stagnation in wages at the bottom of the wage scale helped widen the income gap between low- and high-income households between the late 1970s and mid-2000s.  (See Figure 2.)  That period of rising income inequality, in turn, added 5.5 percentage points to the poverty rate in 2007, when the Great Recession hit.  Put another way, if the incomes of all households had grown at the same rate between 1979 and 2007, more than 16 million fewer people would have been below the poverty line at the start of the recession (about 21 million, as opposed to the actual figure of 37 million).[3] 

The incomes of households across the income spectrum fell when the Great Recession hit, but in the first two years after the recession officially ended, average incomes among the top 1 percent began to rebound while they continued to fall for all other households.[4]  As a result, many working families and individuals have continued to struggle to make ends meet, despite a growing economy.

These trends have long-term implications.  The effects of low pay and poverty can last a lifetime for children.  Relative to their better-off peers, poor children do less well in school, complete fewer years of education, and work less (and earn less) as adults.  One reason appears to be that poor children are more likely to be in poor health, which can affect their ability to learn and sometimes carries into adulthood.[5]  Another reason is the stress associated with poverty.  Unsafe neighborhoods, unstable housing, hunger, and other negative experiences associated with poverty can have harmful physiological effects on children’s still-developing brains, impeding their social and emotional development and ability to learn.[6] 

State Lawmakers Have the Tools to Support a Broader Recovery

State lawmakers can partially address stagnant wages, poverty, and income inequality with two effective tools.  They can enact or expand a state EITC, and they can increase their state’s minimum wage and maintain its real value over time by indexing it to the rate of inflation.  Both policies would buoy workers and their families and help them meet basic needs. Low- and moderate-income households spend most of what they earn to meet needs, so boosting their purchasing power by strengthening state EITCs and minimum wages also would support local businesses and economies.

Enacting or Expanding a State EITC

Federal and state EITCs go to low-income working families and individuals.  Together with the federal credit, state EITCs:

  • Help working families make ends meet.   Refundable EITCs provide low-income workers with a needed income boost that can help them meet basic needs and pay for things that allow them to work, like child care and transportation.
  • Keep families working.  EITCs help working families get by on low wages, which helps them stay employed.  They are also structured to encourage the lowest-earning families to work more hours.  That extra time and experience in the working world can translate into better opportunities and higher pay over time.  Three of every five who receive the federal credit use it just temporarily — for just one or two years at a time — while they get on their feet.
  • Reduce poverty, especially among children.  The federal EITC is the single most effective tool the nation has for reducing poverty among working families and children.  It now lifts about 6.5 million people — around half of them children — out of poverty.  State EITCs build on that record.   
  • Have a lasting effect.  Low-income children in families that get additional income through programs like the EITC do better and go further in school.  And children in low-income families that get an income boost during their early childhood years work more and earn more as adults. (See Figure 3.)  This is good for communities and the economy because it means more people and families on solid ground and fewer in need of help over time.

State EITCs also help to address skewed state tax systems that require low- and moderate-income families to pay a larger share of their income in taxes than high-income families.  And they can give a boost to local businesses as working families benefitting from the credits spend money at establishments in their communities.  Twenty-five states and the District of Columbia have their own version of the federal credit.  (See Table 1.)  During the 2014 legislative session, several states including the District of Columbia, Maryland, Minnesota, Rhode Island, and Ohio, improved their EITCs.

Increasing State Minimum Wages and Indexing Them for Inflation

Like the EITC, higher minimum wages can boost income, lift workers and their children out of poverty, and set children on a better path in life.  Higher minimum wages also increase working households’ purchasing power, which is good for the economy.

The federal minimum wage is the nation’s wage floor.  Many states set their minimum wage equal to the federal minimum wage.  Other states have a lower minimum wage or no minimum wage at all, in which case the federal minimum wage becomes the default for most workers.[7]

Yet the federal minimum wage has not kept pace with increases in the costs of living.  It is currently 22 percent below its peak value in 1968, after adjusting for inflation.  Today, a full-time worker earning the minimum wage and supporting two children lives below the poverty line.

Recent calls to increase the federal minimum wage to $10.10 and index it to inflation by 2016 as laid out in the proposed Fair Minimum Wage Act (FMWA) would greatly improve the outlook for the nation’s lowest wage workers in sectors of the economy that have seen little to no wage growth.  Estimates by the Congressional Budget Office (CBO) show that the FMWA would increase wages directly for 16.5 million workers.[8]  The vast majority of these workers are adults and over half of them are women and full-time workers.  The raise would lift family incomes and, as a result, a total of 900,000 people above the poverty line.

The increase would give a boost to workers and households with somewhat higher wages and income, too.  CBO estimates that the wages of another 8 million workers earning slightly more than the proposed $10.10 per hour would go up.  All told, the raise would result in a net income gain for households with incomes up to three times the poverty line (about $72,300 for a family of four), or about half of the American population.[9]

States should not wait for the federal government to enact a minimum wage increase when they have the power to improve the lives of workers in their state now.  In 2014, most states considered increasing the minimum wage, and ten states — Connecticut, Delaware, Hawaii, Massachusetts, Maryland, Michigan, Minnesota, Rhode Island, Vermont, and West Virginia — plus the District of Columbia enacted a minimum wage increase.[10]

As of August 2014, 23 states and the District of Columbia had a minimum wage that was higher than the federal, although some do not index their minimum wages to inflation.  These ten states ? Alaska, California, Connecticut, Delaware, Illinois, Maine, Massachusetts, New Mexico, New York, and Rhode Island ? should take that additional step to ensure that their minimum wage keeps pace with the rising costs of living.  The 27 states that still have minimum wages at or below the federal minimum should improve their minimum wage to help working families meet their basic needs and get ahead.

Table 1
State EITCs and Minimum Wages in 2014
State EITC Minimum Wage Minimum Wage Indexed to Inflation?
Alabama None None No
Alaska None $7.75 No
Arizona None $7.90 Yes
Arkansas None $6.25 No
California None $9.00 No
Colorado 10% $8.00 Yes
Connecticut 27.5% $8.70** No
Delaware 20% (non-refundable) $7.75** No
District of Columbia 40%/100%* $9.50** Yes
Florida None $7.93 Yes
Georgia None $5.15 No
Hawaii None $7.25** No
Idaho None $7.25 No
Illinois 10% $8.25 No
Indiana 9% $7.25 No
Iowa 15% $7.25 No
Kansas 17% $7.25 No
Kentucky None $7.25 No
Louisiana 3.50% none No
Maine 5% (non-refundable) $7.50 No
Maryland 25%* $7.25** No
Massachusetts 15% $8.00** No
Michigan 6% $8.15** Yes
Minnesota Average 36%* $8.00/$6.50** Yes
Mississippi None none No
Missouri None $7.50 Yes
Montana None $7.90/$4.00 Yes
Nebraska 10% $7.25 No
Nevada None $8.25/$7.25 Yes
New Hampshire None $7.25 No
New Jersey 20% $8.25 Yes
New Mexico 10% $7.50 No
New York 30% $8.00 No
North Carolina None $7.25 No
North Dakota None $7.25 No
Ohio 10%* (non-refundable) $7.95/$7.25 Yes
Oklahoma 5% $7.25/$2.00 No
Oregon 8% $9.10 Yes
Pennsylvania None $7.25 No
Rhode Island 10%* $8.00** No
South Carolina None none No
South Dakota None $7.25 No
Tennessee None none No
Texas None $7.25 No
Utah None $7.25 No
Vermont 32% $8.73** Yes
Virginia 20% (non-refundable) $7.25 No
Washington Scheduled to be 10% when implemented $9.32 Yes
West Virginia None $7.25** No
Wisconsin 4% — one child
11% — two children
34% — three children
No credit for childless workers
$7.25 No
Wyoming None $5.15 No
* These states enacted legislation in 2014 increasing their EITCs. The District of Columbia expanded income eligibility for the EITC for childless adults and increased the credit to 100 percent of the federal from 40 percent. Maryland's EITC will gradually rise to 28 percent over the next four years. Minnesota increased the value of its EITC by 25 percent by increasing the size of the benefit and conforming to federal guidelines for married couple families. Ohio increased its credit to 10 percent from 5 percent of the federal credit, but the credit is still non-refundable. Rhode Island decreased the percentage of its EITC to 10 percent from 25 percent, but made it fully refundable, increasing the benefit for 75 percent of those who claim the credit.
** These states Increased their minimum wage in 2014. Connecticut, Delaware, the District of Columbia, Hawaii, Maryland, Massachusetts, Michigan, Minnesota, Rhode Island, Vermont and West Virginia all enacted multi-year increases. Source: National Conference of State Legislatures http://www.ncsl.org/research/labor-and-employment/state-minimum-wage-chart.aspx.

State EITC and Minimum Wage Improvements Go Hand in Hand

Three states — Maryland, Minnesota, and Rhode Island — and the District of Columbia increased both their state EITC and minimum wage in 2014.  While improving either policy helps low-wage workers, improving both policies in combination produces complementary benefits and goes much further to make work pay:

  • State EITCs and minimum wage reach overlapping but different populations.  The EITC and minimum wage are targeted differently, so enacting or improving both policies in tandem will reach more workers than either on its own.  For example, the EITC targets low-income working families with children, but offers little support to workers without children.  Workers without children working full-time, year-round at the minimum wage are eligible only for a federal EITC worth about $5.   And the EITC is unavailable to workers younger than 25 or older than 64.  Higher minimum wages go to workers with the very lowest hourly wages, regardless of age, presence of children, or total family income.

    On the other hand, the EITC remains available to families as their incomes increase, albeit at gradually declining levels and only up to a point (more than three times a full-time minimum wage worker’s annual wage of $14,500), while a minimum wage affects workers with the very lowest wages and those with wages slightly higher than the minimum wage.  (Of course, some minimum wage workers are also in families with higher incomes).  The EITC also reaches some workers not covered by minimum wage laws such as domestic workers and farm workers.
  • Increasing both at the same time provides added support to the working families who need it most.  Families making income modestly above the poverty line often are still unable to meet their basic needs.  Improving state EITCs and minimum wages together not only helps more families climb out of poverty, it also helps working families get further down the road to economic security. [11]

    For example, a two-parent, two-child family with one full-time, year-round minimum wage worker that claims the federal EITC still has after-tax income below the poverty line (less than $24,000 for a family of four).  Adding in a state EITC set at 30 percent of the federal credit still leaves the same family just shy (at 94 percent) of the poverty line.  Alternatively, boosting the family’s hourly wage to $10.10, through a minimum wage increase, would raise its income to slightly above (111 percent of) poverty.  But a working family that benefits from both policies (a state EITC set at 30 percent of the federal credit and a minimum wage boost to $10.10) takes a bigger step forward, seeing its income rise by almost one-fifth, to 117 percent of the poverty line.  (See Figure 4.)

    In addition, for families with very low earnings, a higher state minimum wage means a boost in their (federal and state) EITC, because their EITC increases with every additional dollar earned, until they reach the maximum credit.[12]  For example, even a small minimum wage increase from $7.25 to $7.75 for a single mother with two children working 35 hours per week would raise her federal EITC by $360.
  • The two policies’ benefits are timed differently.  The EITC offers an annual, lump-sum payment when a family files their income taxes.  This payment helps many families afford major expenses like car repairs or a security deposit that facilitates a move to a better neighborhood, or it can provide them with funds to build a savings account.[13]  An increase to the minimum wage, on the other hand, provides a boost year-round with every paycheck, helping working families afford monthly expenses like rent, utilities, and childcare.
  • A combination approach allows the public and private sectors to share the cost of boosting incomes for workers.  Advancing both the EITC and the minimum wage in the same general timeframe ensures that the cost of making work pay is broadly shared.  The EITC is a cost largely borne by state government, and by extension state taxpayers, while the cost of a state minimum wage is borne primarily by the private sector, especially employers and consumers.[14]  (It’s worth noting that where costs fall is not as straightforward as it might seem given the interplay of the two policies and other programs for low-income workers.  For example, a minimum wage increase will increase a federal and state EITC for some workers, increasing the cost of providing a state EITC but also adding federal EITC dollars into workers’ pockets and the state economy, some of which would be captured in state taxes.)   

A higher state EITC and a higher state minimum wage individually offer significant support to many low-income workers.  The benefits of raising the incomes of low-income working families are lasting, including improving the prospects for children later in their lives.  States are right to consider strengthening these policies, both of which reduce poverty and help make work pay.  But a strong state EITC and an increased minimum wage are even more powerful, and support a greater number of people, when combined. 

End notes:

[1] See discussion of the research in Chuck Marr, Chye-Ching Huang, and Arloc Sherman, “Earned Income Tax Credit Promotes Work, Encourages Children’s Success at School, Research Finds,” Center on Budget and Policy Priorities, Revised April 15, 2014, http://www.cbpp.org/cms/index.cfm?fa=view&id=3793.

[2] Josh Bivens, Elise Gould, Lawrence Mishel, and Heidi Sheirholz, “Raising America’s Pay: Why It’s Our Central Economic Policy Challenge,” Economic Policy Institute, June 4, 2014, http://www.epi.org/publication/raising-americas-pay/.

[3] Lawrence Mishel, Josh Bivens, Elise Gould, Heidi Shierholz, “The State of Working America, 12th Edition,” Economic Policy Institute, November 2012, http://www.stateofworkingamerica.org/subjects/overview/?reader. See chapter on Poverty.  CBPP calculation of the number of people who would have been above the poverty line using Census data on the rate of poverty and number of poor in 2007.

[4] Estelle Sommeiller and Mark Price, “The Increasingly Unequal States of America,” Economic Policy Institute, February 19, 2014, http://www.epi.org/publication/unequal-states/.

[5] Marr, Huang, and Sherman, 2014, and Arloc Sherman, Danilo Trisi, and Sharon Parrott, “Various Supports for Low-Income Families Reduce Poverty and Have Long-Term Positive Effects On Families and Children,” Center on Budget and Policy Priorities, July 30, 2013,  http://www.cbpp.org/cms/index.cfm?fa=view&id=3997.

[6] Sherman, Trisi, and Parrott, 2013.

[7] Some workers are not covered by the Fair Labor Standards Act and are therefore are not covered by the minimum wage or other provisions of the Act. For a listing of workers exempt from the minimum wage, see: http://www.dol.gov/elaws/esa/flsa/screen75.asp.

[8] “The Effects of a Minimum-Wage Increase on Employment and Family Income,” Congressional Budget Office, February 2014, http://www.cbo.gov/sites/default/files/cbofiles/attachments/44995-MinimumWage.pdf.  It should be noted that the CBO study of the effects of the Fair Minimum Wage Act estimates a loss of 500,000 jobs, representing about 0.3 percent of workers.  However, the weight of careful evidence shows that claims of large job loss by those opposed to a higher minimum wage are overblown, particularly given the size of wage increases being proposed at the federal level.  Extensive and rigorous research should lead policymakers to heavily discount claims that employers will make large job cuts in response to a minimum wage increase.  Even evaluations that find (small) losses of jobs or hours show that raising the minimum wage boosts the pay of the vast majority of workers without significantly hurting their employment prospects.

[9] Arloc Sherman, “Why a Higher Minimum Wage Is a Net Win for Most Income Groups,” Off the Charts blog, Center on Budget and Policy Priorities, February 20, 2014, http://www.offthechartsblog.org/why-a-higher-minimum-wage-is-a-net-win-for-most-income-groups/.

[10] According to the National Conference of State Legislatures, 34 states considered minimum wage increases. For more detail on state minimum wage bills in 2014, see: http://www.ncsl.org/research/labor-and-employment/state-minimum-wage-chart.aspx.

[11] A recent study by David Neumark and William Wascher (2011) finds that a higher minimum wage enhances the employment and earnings boost that single mothers between the ages of 21 and 44 get from the EITC.  It also finds that for a subset of childless workers (primarily those who are poorly educated and between ages 21 and 34), the two policies may combine to reduce employment and earnings, for two reasons.  First, because the EITC is so effective at moving single mothers into the workforce, raising it can increase job competition and reduce wages for childless workers, who don’t benefit much from the EITC, especially those childless workers least valued in the job market.  This problem could be remedied by expanding the EITC for childless workers to more equally distribute the credit’s labor force inducing effects.  A stronger federal EITC for childless workers has been proposed by federal lawmakers, and the District of Columbia recently expanded its EITC for this group of workers.  The second reason the study’s authors cite is that a higher minimum wage can result in job losses for the same general group of individuals.  Other studies, however, have shown minimal negative employment effects of raising the minimum wage, and on net, an income boost for low-wage workers.  Strong supporting research includes David Card, 1992, "Using Regional Variation in Wages to Measure the Effects of the Federal Minimum Wage,” Industrial and Labor Relations Review, vol. 46, no. 1, pp. 22-37; and David Card and Alan Kreuger, 1995, Myth and Measurement: The New Economics of the Minimum Wage, Princeton, NJ: Princeton University Press.  For an in-depth discussion of a range of studies, see John Schmitt, 2013, “Why Does the Minimum Wage Have No Discernible Effect on Employment?” Center for Economic and Policy Research, http://www.cepr.net/documents/publications/min-wage-2013-02.pdf.

[12] For some EITC families with relatively higher overall family income from multiple workers, an earnings bump from a higher minimum wage could result in a smaller EITC if their income enters the range at which the credit begins to phase out, about $23,000 for a married couple family with two kids.

[13] See Ruby Mendenhall et al., 2010, “The Role of Earned Income Tax Credit in the Budgets of Low-income Families,” National Poverty Center Working Paper Series, http://npc.umich.edu/publications/u/working_paper10-05.pdf; Andrew Goodman-Bacon and Leslie McGranahan, 2008, “How Do EITC Recipients Spend their Refunds?” Economic Perspectives v32 n2, 2008, Federal Reserve Bank of Chicago, https://www.chicagofed.org/digital_assets/publications/economic_perspectives/2008/ep_2qtr2008_part2_goodman_etal.pdf; Smeeding et al., 2000, “The EITC: Expectation, Knowledge, Use, and Economic and Social Mobility,” National Tax Journal, http://ntj.tax.org/wwtax%5Cntjrec.nsf/B0B30A799E214A7785256AFC007F34C6/$FILE/v53n4p21187.pdf.   

[14] While the costs of both an EITC and a higher minimum wage ultimately are borne by individuals, a combined approach assures that precisely which individuals pay will be more varied than it otherwise would be.

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