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States Should Prioritize Struggling Families With Targeted Tax Credits, Avoid Broad-Based Tax Cuts

This blog post reflects updated information about the Treasury’s final rule on the American Rescue Plan.

States can improve families’ economic well-being and make progress on racial and gender equity both now and into the future by enacting or improving tax credits that help struggling people meet their basic needs. Unfortunately, at least 12 states — including Kentucky, Mississippi, Oklahoma, South Carolina, and Georgia — are considering costly income tax cuts that would mostly benefit wealthy households and profitable corporations while widening racial and economic inequities. Idaho, Indiana, and Iowa have already enacted such plans. Policymakers should reject that approach and instead consider a broad range of investments that can help people and communities hit hardest by the pandemic and its economic fallout, including tax credits to help individuals and families make ends meet.

States have several options to enact or improve tax credits. Thirty-one states plus the District of Columbia and Puerto Rico have enacted an earned income tax credit (EITC), which boosts the incomes of people paid low wages. Nine states have enacted a child tax credit, which supports caregivers and their families and which the American Rescue Plan also temporarily expanded at the federal level. A number of states provide credits for renters and homeowners struggling with high housing costs, like property tax “circuit-breakers” and the District of Columbia’s Schedule H. The 13 states that still tax groceries may also consider a new or expanded grocery tax credit.

In part because people of color, women, and immigrants are especially likely to have lower incomes due to the historical legacies of systemic racism and discrimination, credits targeted to low-income households — as well as those without an earnings requirement, like the Rescue Plan’s expanded Child Tax Credit — are an important tool for advancing equity.

States should make these credits refundable — that is, recipients should be able to get the full amount of the credit no matter what they owe at tax time. For example, states should consider modeling a child tax credit on the expanded credit provided through the Rescue Plan, which is fully available to the lowest-income children without an earnings requirement. States also should avoid age restrictions on the credits. Some states offer property tax circuit-breakers only to seniors, for example, and most restrict EITCs for people not claiming children on their tax returns to people aged 25-64. (So did the federal EITC until the Rescue Plan temporarily addressed this problem.)

This is a good time for states to enact or improve these tax credits. Most states are seeing temporary budget surpluses due to better-than-expected revenue growth following the COVID-19 recession, much of which stems from the historically strong federal response to the crisis. While these temporary surpluses can’t be used to cover investments over the long term, the cost of enacting or improving these credits is typically small enough that states may be able to absorb it without specific additional revenue raisers when the surpluses are gone. Moreover, using temporary surpluses to seed permanent policy gains with substantial long-term benefits like an EITC or Child Tax Credit would be worthwhile even if the state must raise modest additional resources in the future.

Furthermore, the Treasury Department’s final rules regarding the Rescue Plan’s state fiscal aid make clear that states can enact or improve these targeted tax credits without running afoul of a provision limiting states’ ability to cut taxes while spending that aid. 

Several states, including Arizona, California, Hawai’i, Illinois, Maine, New Mexico, and Vermont, are weighing positive tax credit proposals this legislative session. And Utah recently approved a new 15 percent non-refundable Earned Income Tax Credit (although other aspects of its new tax plan tilt much more toward wealthy Utahns and will lose sizable revenue over time). Last year several states improved their tax credits for struggling families. For example:

  • Colorado funded its state Child Tax Credit, which policymakers had enacted but never implemented. The credit provides up to 30 percent of the federal Child Tax Credit, depending on a family’s income, to families earning up to $85,000, depending on their tax filing status. The state also temporarily increased its EITC from 15 to 25 percent of the federal credit (it will shrink to 20 percent starting in 2026) and made the credit for those without children in the home available to 19- to 24-year-olds on a permanent basis.
  • New Jersey improved its Child and Dependent Care Credit by making it fully refundable and boosting the size of the credit for families earning low incomes.
  • New Mexico improved its Working Families Tax Credit by increasing it from 17 to 25 percent of the federal EITC and by extending it to immigrants who file taxes with an Individual Tax Identification Number (ITIN) and to people aged 18-24 without children in the home. The same bill also more than tripled the state’s Low-Income Comprehensive Tax Rebate and tied it to inflation going forward so it won’t lose value over time.
  • Washington State finally funded its Working Families Tax Credit, which policymakers created in 2008 but never implemented due to the Great Recession and resulting budget shortfalls. The newly implemented credit provides larger rebates to families than what they likely would have received under the 2008 law and is available to immigrants who file taxes with an ITIN. It’s an example of how a tax credit like an EITC can work in a state without an income tax.

Unlike these tax credits, which are typically quite affordable and assist families that need help meeting their basic needs, recent proposals to slash income and corporate tax rates would weaken states’ ability to deliver quality schools, affordable health care, and functional infrastructure while worsening racial and income inequities. For example, the revenue shortfalls caused by big income and corporate tax cuts in states like Kansas, North Carolina, and Ohio after the 2007-09 Great Recession led to problems such as higher tuition for college students, millions of people without health insurance, and delays in highway repairs. They didn’t boost state economies either.

Furthermore, slashing income and corporate tax rates provides the biggest benefits to wealthy people, a group that’s disproportionately white due to ongoing inequities caused by the legacy of racism and continued discrimination. Changes to state tax codes should reduce these inequities, not worsen them. States should seize this opportunity to enact or improve tax credits that support struggling families.