“Look-Back” Tax Change Would Help Working Families, Economy

Bipartisan House and Senate bills would protect low- and moderate-income families from a financial hit at tax time next year by letting them base their Earned Income Tax Credit (EITC) and Child Tax Credit for tax year 2020 on their earnings in either 2020 or 2019, whichever would provide a larger credit.

In the past, policymakers have extended this credit-related “look-back” option to survivors of natural disasters, and the CARES Act of March gave businesses a similar option during the pandemic. By helping people who’ve lost substantial earnings in 2020 due to COVID-19 and the resulting deep economic downturn avoid losing part or all of their EITC and Child Tax Credit as well, policymakers would relieve financial pressures on low- and moderate-income families and help boost the economy.

When the economy slows, many people’s incomes fall as they lose jobs or work hours and, in turn, earnings. Some families that earned too much to qualify for the EITC before the recession may now be eligible. The credit boosts their income and prevents a larger drop in household spending, providing counter-cyclical support to a weak economy.

But many families that qualified for the EITC or Child Tax Credit before the recession risk losing part or all of their credits now because their earnings, which determine the size of the credits, have fallen. This dual financial hit — loss of earnings plus loss of tax credits — would further reduce a family’s ability to spend, further slowing the economy.

Preventing low- and moderate-income families from losing part or all of their EITC and Child Tax Credit would provide strong bang-for-the-buck economic stimulus, because lower-income families are likelier to spend rather than save any additional funds they receive. The stimulus would also be well timed: unemployment will still top 9 percent in early 2021 when families file their tax returns, the Congressional Budget Office estimates.

Policymakers have used the look-back option numerous times for survivors of natural disasters, starting in 2005 in response to Hurricanes Katrina, Wilma, and Rita. Most recently, 2019 legislation would allow any family that lived in a presidentially declared disaster zone in 2018, 2019, or early 2020 to use either its current (i.e., disaster-year) earnings or its previous-year earnings to calculate its EITC and Child Tax Credit. But the law only pertained to disasters occurring before January 19, 2020 — two months before millions of people began losing jobs and income due to the pandemic and recession. President Trump has declared the pandemic a national emergency, and families in every state should have access to this same look-back option.

To see how it would help families, consider these two examples:

• A family of four whose earnings fall from $50,000 in 2019 to $35,000 in 2020 would qualify for an EITC of $2,257 in 2020, after receiving no EITC in 2019. Its Child Tax Credit would be the same in both years. It would use its 2020 income when calculating its 2020 EITC, as under current law.
• By contrast, a single mother with two children whose earnings fall from $15,000 in 2019 to $5,000 in 2020 would see her EITC fall from $5,920 to $2,010 and her Child Tax Credit fall from $1,875 to $375 if she used her 2020 earnings to calculate those credits. That’s a loss of $5,410 in tax credits on top of her $10,000 loss in wages. But she could eliminate that $5,410 loss if she could use her 2019 earnings instead to calculate her credits.

That option next year could have lasting benefits for families. Parents’ job and income losses can have a “negative and persistent effect on children’s well-being,” research suggests, including poorer educational, health, and earnings outcomes later in life. Conversely, programs that protect family income from falling too low can improve children’s educational and other outcomes years later.

“The weight of the causal evidence indicates that income poverty itself causes negative child outcomes, especially when it…persists” for more years of childhood, while many programs that alleviate poverty (such as refundable tax credits) have been shown to improve child well-being, according to a 2019 report by the National Academy of Sciences. A nationwide look-back provision would lower poverty among adults and children even when the economy is growing, Columbia University researchers conclude. It would have an even larger impact during this current recession.

The CARES Act created an analogous relief mechanism for businesses, letting them not only deduct interest expenses of up to 50 percent of their adjusted taxable income in 2020 (versus 30 percent previously), but also letting them use their 2019 income to make this calculation. Due to the recession, many businesses will have much smaller taxable incomes in 2020 than 2019, so using their larger 2019 income will let them deduct more in interest expenses and therefore obtain larger tax refunds. The next coronavirus relief package should extend this kind of option as well to hard-pressed working families, who are among the hardest hit by the current health and economic crisis.