Half of the states and the District of Columbia have enacted earned income tax credits (EITCs) to supplement the federal EITC, the nation’s most effective tool for reducing poverty among working families and children. The federal EITC lifted 6.5 million people — half of them children — out of poverty in 2012, and it has lasting benefits for low-income children, helping them do better (and go further) in school and improving their earnings as adults.
State EITCs combat poverty further by reducing state and local taxes for low-income people and helping families keep working despite low wages. Like the federal EITC, a state EITC allows working families to keep more of what they earn and helps them meet basic needs.
Policymakers considering whether to create a state-level EITC can estimate its budget cost using a simple three-step process, as we explain in our updated paper:
Step 1: Estimate the total value of federal EITC claims in a given state for a future fiscal year. First, use IRS data to determine the value of EITC claims in a given state as a share of all U.S. EITC claims. Then, apply that percentage to the congressional Joint Committee on Taxation’s projected total cost of the federal EITC for the future year in question.
Step 2: Multiply the expected value of the state’s federal EITC claims by the percentage at which the state credit will be set. Most states’ EITCs provide benefits as a set percentage of the federal credit. So, to estimate the cost of a state EITC, perform the calculation of Step 2. That will estimate the cost of the state credit in a given fiscal year if everyone who received the federal credit also received the state credit.
Step 3: Adjust the estimate for the fact that not all federal EITC claimants will claim the state credit. In practice, a substantial portion of those who receive the federal EITC do not claim state EITCs. Especially in the first few years, the cost of a refundable state EITC will likely be lower than the full cost of the federal credit multiplied by the state percentage. To account for this, reduce the cost estimate by at least 10 percent.
We’ve estimated the costs to states of implementing a refundable EITC in fiscal year 2015 for tax year 2014 set at 5, 10, or 20 percent of the federal credit; other percentages may be calculated based on those numbers.
Click here to read the full paper.