March 22, 1999
A Missouri Earned Income Tax Credit
Would Build on the Strengths of the Federal Credit
by Nicholas Johnson
Earned Income Tax Credits provide tax refunds to working poor and near-poor families with children and boost the incomes of families seeking to work their way out of poverty. The federal government and 10 states, including two of Missouri's neighbors, Kansas and Iowa, already offer EITCs. Missouri Senate Bill 161 and House Bill 553 would create a state EITC through Missouri's state income tax.
A Missouri EITC would be based on the federal EITC, which is among the nation's most effective programs for lifting working families with children out of poverty and which has been shown to be a positive incentive for welfare recipients to enter the workforce.
A Missouri EITC would accomplish three key policy goals.
- A state EITC would reduce poverty among working families with children. More than three-fourths of Missouri's poor families with children include at least one working adult. On average those adults work 44 weeks out of the year. Yet for many families even the combination of the federal EITC and a full-time, year-round job are insufficient to support a family at the poverty line. Because it is targeted to low-income working parents, a state EITC would reduce the gap between working families' incomes and the poverty line and would even lift some families out of poverty.
- A state EITC would support welfare reform by further boosting the incomes of families that move from welfare to work. Recent academic research shows that an EITC has positive effects in encouraging parents to enter the labor force. Moreover, many welfare recipients enter the workforce at relatively low wage levels. An EITC would help meet the ongoing expenses associated with working, such as transportation and child care, and might allow families to cope with unforeseen costs that otherwise might drive them back onto public assistance.
- A state EITC would reduce state and local taxes paid by low- and moderate-income families. Although Missouri is generally a low-tax state, its state and local tax system relies heavily on sales, excise, and property taxes, which are more burdensome on low-income families than on higher-income families. Moreover, Missouri is among the 15 states with the highest state income tax burden on working-poor families. A state EITC would help prevent Missouri from taxing families deeper into poverty.
State Earned Income
SB 161 and HB 553, as introduced, each would create a refundable EITC equal to 20 percent of the federal EITC. That is, each family's Missouri EITC would equal 20 percent of the federal EITC for which that family qualifies. If the state EITC were larger than the family's state income tax liability, the family would receive a refund check.
Under these bills, the state EITC would give working poor families with two or more children a tax refund of up to $763 in 1999, while working poor families with one child would be eligible for a refund of up to $462. The maximum benefits would be targeted to families with incomes below the poverty line, but a Missouri EITC would also provide tax relief to families with incomes as high as $30,500 per year. Nearly 400,000 Missouri taxpayers, most of them working families with children, would benefit. The cost of the credit as proposed in SB161 is estimated by the state Office of Administration at $113 million in FY 2001.
The Federal Earned Income Tax Credit as Context
To understand why a Missouri EITC would serve important policy goals, it is useful first to look at the role played by the federal EITC. The federal EITC is a tax credit for low- and moderate-income workers, primarily those with children, designed to offset the burden of Social Security payroll taxes, supplement earnings, and complement efforts to help families make the transition from welfare to work. The EITC was enacted in 1975 primarily as a means of tax relief; for a decade, the credit received little attention and was not altered significantly. Starting in the mid-1980s, however, the EITC was expanded three times, in 1986, 1990, and 1993. (The 1993 expansion was phased in through tax year 1996; no further expansions are scheduled.) Through these expansions, the EITC became a central element of federal efforts to boost income from work and lessen poverty among families with children, often called the "make work pay" strategy.
The maximum EITC benefit for tax year 1999 is $3,816 for families with two or more children and $2,312 for families with one child. The greater EITC benefit for larger families reflects a recognition that larger families face higher living expenses than smaller families. Workers without a qualifying child also may receive an EITC, but the maximum credit for individuals or couples without children is $347 in 1999, much lower than the credit for families with children.
The actual EITC benefit that an eligible family receives depends on the family's income. For families with very low earnings, the value of the EITC increases as earnings rise. For example, families with two or more children receive an EITC equal to 40 cents for each dollar up to $9,540 earned in 1998, for a maximum benefit of $3,816. Families with one child receive an EITC equal to 34 cents for each dollar earned up to $6,800 of earnings, for a maximum benefit of $2,312. (Welfare benefits in Missouri and most other states, in contrast, fall quite dramatically as earnings rise.) Both types of families continue to be eligible for the maximum credit until income reaches $12,460.
For families with incomes above $12,460, the EITC phases out as earnings rise. Families with two or more children are eligible for some EITC benefit until income exceeds $30,580, while families with one child remain eligible for some EITC benefit until income exceeds $26,928. The federal EITC is a refundable credit, which means that if the credit amount is larger than a family's income tax bill, the family receives a refund check. This refundability allows families to take full advantage of the credit even if they owe little or nothing in federal income taxes.
The structure of the federal EITC thus boosts the incomes of working poor families, including those making the transition from welfare to work, as well as providing continuing assistance to working families with incomes modestly above the poverty line. Since many of these families still struggle to make ends meet and may be one or two paychecks away from needing to rely on assistance, the EITC helps families support their families through work and remain off welfare. (Research demonstrating that the EITC encourages welfare recipients to enter the workforce is discussed below.)
The fact that the EITC targets substantial benefits on families with earnings near the poverty line also makes it effective in lifting working families with children out of poverty. The President's Council of Economic Advisors reports that in 1997, the EITC lifted out of poverty 4.3 million people, including 2.2 million children, that would have been poor without it. The EITC lifts more working families out of poverty than any other government program.
The EITC is available to both single-parent and two-parent families with children. Two-parent families can receive the EITC whether both parents work or one parent works while the other parent stays home to care for the children, as long as the family's income is below the EITC limit. In this respect the credit differs from some other tax benefits for working families, such as the dependent care credit, where only families in which both parents work are eligible for the credit.
State EITCs in Other States
In the last two years, five states have enacted new EITCs or substantially expanded existing EITCs. Kansas, Massachusetts and Oregon enacted new EITCs. Minnesota expanded its average EITC for families with children by about two-thirds, and Maryland augmented its existing EITC to provide a refundable credit. EITCs have been enacted in states led by Republicans, in states led by Democrats, and in states with bipartisan leadership. The credits are supported by businesses as well as by social service advocates.
Nine of the 10 state EITCs piggy-back on the federal EITC; these nine states use federal eligibility rules and express the state credit as a specified percentage of the federal credit. (The exception is Minnesota, which follows federal eligibility rules, but has a slightly different benefit structure from the structure of federal credit.)
An EITC that piggybacks on the federal credit such as the credits in nine other states and the credit proposed in Missouri is relatively easy for a state to administer and also is easy for families claiming the EITC. To determine its state EITC benefit, a family need only write its federal benefit on its state return and then multiply the federal amount by the state EITC percentage.
A Refundable EITC Would Boost Incomes for Working Poor Families in Missouri
Despite the current economic expansion, the Missouri poverty rate remains substantial, about 10.2 percent. Among children, the poverty rate is even higher, an estimated 14 percent.(1)
What makes the EITC particularly useful as an anti-poverty tool is the fact that most poor families are already working. Among poor Missouri families with children, work not welfare is the norm.
- Some 227,000 Missourians, including about 136,000 children, live in a working family with income below the federal poverty line. (In 1999 dollars, that means living on an income of less than $13,300 for a family of three or less than $17,000 for a family of four.
- Those working-poor families represent about 79 percent of all poor families with children in Missouri.
- The average working-poor family in Missouri includes one or more adults who work 44 weeks per year about 10 out of 12 months.
- Among all poor families in Missouri, a clear majority 66 percent rely on earnings from a job for over half of their income. Only about 16 percent of poor families in Missouri get the bulk of their income from public assistance, either AFDC or SSI.
Most poor families with children, along with a large number of families with incomes somewhat above the poverty line, would be eligible for a Missouri EITC. A state EITC would lift the incomes of many poor families above the poverty line; for others, the poverty gap the amount by which their incomes fall short of the poverty line would be reduced.
Recent research on the effect of poverty on children has shown that when all other factors are controlled for, poverty can have a substantial effect on child and adolescent well-being. Children who grow up in families with incomes below the poverty line have poorer health, higher rates of learning disabilities and developmental delays, and poorer school achievement. They are far more likely to be unemployed as adults than children who were not poor. Lifting children out of poverty can have long-term positive effects on the state's economy and future budgetary expenditures.
A Missouri EITC Would Complement Welfare Reform
A Missouri EITC would build on the success of the federal EITC in combating poverty among working families with children. Closing or at least substantially reducing the poverty gap for many working families is well within the reach of most states.
The use of state EITCs to enable low-wage workers to escape poverty is of particular relevance to state welfare reform efforts. Many welfare recipients that take jobs continue to have very low incomes, often below poverty. Recent evidence from several states shows that although most welfare recipients who find jobs are employed close to full-time, many of them earn wages at or only modestly above the minimum wage. Moreover, many do not qualify for paid vacation or sick leave, forcing them to take unpaid leave for reasons such as a child's illness. A number of studies show that welfare recipients who find jobs have average earnings of $2,000 to $2,700 per quarter, or $8,000 to $10,800 per year; many earn less.(2) Earnings in that income range are insufficient to lift a single-parent family of three above the poverty line even with the federal EITC. A combination of the federal EITC and a state EITC, however, can close the poverty gap for many welfare recipients as they move into the workforce.
States have demonstrated a strong policy interest in subsidizing the efforts of welfare recipients to enter and remain in the workforce. For example, many states have expanded access to child care and to health insurance for working-poor families. In addition, many states allow an "enhanced earnings disregard" in their welfare programs, under which welfare benefits phase out gradually as family earnings increase, thereby helping ease the transition from welfare to work. Missouri has taken some steps in the direction of supporting the transition from welfare to work, such as expanding health coverage for low- and moderate-income working families. Missouri's welfare benefits, however, phase out completely at a relatively low income level, long before a family's earnings reach the poverty line. A state EITC would provide income support for poor families as they leave the welfare rolls for the workforce.
States also have an interest in supporting the work efforts of low- and moderate-income families who have long since left the welfare rolls or who have never received welfare benefits. EITCs help meet the ongoing expenses associated with working, such as transportation and child care, and may allow families to cope with unforeseen costs that otherwise might drive them onto public assistance.
Recent academic research on the EITC indicates that the EITC has positive effects in inducing more single parents to go to work and reducing welfare receipt. Harvard economist Jeffrey Liebman, who has conducted a series of studies on the EITC, has noted that the percentage of single women with children who work has risen dramatically since the mid-1980s. In 1984, some 72.7 percent of single women with children worked during the year. In 1996, some 82.1 percent did. This increase has been most pronounced among women with less education.(3)
During this same period there was no increase in work effort among single women without children. Why did the proportion of single women with children who work rise dramatically while the proportion of single women without children who work remained unchanged? Recent studies indicate the large expansions since the mid-1980s in the EITC for families with children played a substantial role.
Studies by Liebman and University of California economist Nada Eissa that find a sizable EITC effect in inducing more single women with children to work have been published by the National Bureau of Economic Research and the Quarterly Journal of Economics.(4) In addition, and of particular interest, is a study by Northwestern University economists Bruce Meyer and Dan Rosenbaum. Meyer and Rosenbaum find that "a large share of the increase in employment of single mothers in recent years can be attributed to the EITC." They find that the EITC expansions explain more than half of the increase in employment among single mothers over the 1984-1996 period.(5) These findings are consistent with other studies of the effects of the EITC.
Recent research also contains encouraging findings regarding another EITC issue whether the EITC reduces work effort among parents already in the labor force who are in the income range over which EITC benefits phase down as earnings rise. Some analysts have theorized that particularly among two-earner families in these income ranges, the EITC causes some reductions in hours worked, with the largest effects occurring among mothers in two-earner families who take advantage of the income the EITC provides to work less and spend more time with their children.
Research conducted to date on this issue does not bear out these theories. As Liebman notes in a recent paper: "While there is only limited evidence so far, the evidence that does exist suggests that the phase-out of the EITC has little or no impact on hours of work." He notes that he and Eissa examined taxpayers who were already in the labor force when more workers were placed in the EITC phase-out range as a result of the EITC expansions enacted in 1986. "We observed no decline in hours [of work]," he reports.(6)
Another encouraging new piece of research concerns how EITC recipients spend their credits. Among 800 EITC recipients in Chicago interviewed by Syracuse University researcher Timothy M. Smeeding and several colleagues, more than half used the EITC not just to meet day-to-day spending needs but also to make the kinds of capital or human investments that might enable them to leave poverty for good. For instance, five percent used their EITC refund for a security deposit or other costs associated with moving to a better neighborhood, ten percent used the refund to buy or repair an automobile so they could get to work, and another ten percent used the refund to make tuition payments for themselves or their children.(7)
A Missouri EITC Would Reduce Taxes for Low- and Moderate-Income Families
Missouri's overall tax burden has been generally found to be lower than the tax burdens in most other states.(8) Nonetheless, poor families in Missouri pay a substantial share of their incomes in state and local taxes.
For example, Missouri is one of 19 states that levy income taxes on the working poor, and one of only 12 states that levy income taxes on families of four with incomes as low as 75 percent of the poverty line. Missouri's "income tax threshold" (the income level at which a family must begin paying income tax) for a family of four in 1998 was $12,000, well below the 1998 poverty line of $16,655. (See Table 1.) A Missouri two-parent family of four with income at the poverty line paid about $116 in 1998 income taxes more than poor families paid in most other states, and a significant amount for a family struggling to make ends meet.(9)
An EITC set at 20 percent of the federal credit, as recommended in HB 553 or SB 161, would increase the income tax threshold to about $21,700, which would make Missouri's threshold among the nation's dozen highest instead of among the dozen lowest. An EITC set at 10 percent of the federal credit would increase the threshold to $19,500, higher than the thresholds in a majority of other states.
Because it would be refundable, a Missouri EITC could also help offset the burden of other state and local taxes, which are more costly for the poor than the income tax and can easily cost a poor family several hundred dollars per year. A 1995 study found that the poorest one-fifth of Missouri married non-elderly couples paid 11.5 percent of their incomes in taxes, higher than the percentage paid by any other income group.(10) Since that study was conducted, Missouri has enacted tax cuts that benefit poor families, such as the increase in the dependent exemption and the reduction in the state sales tax on food. But poor families still pay substantial state sales tax on non-food items. They also pay local sales taxes (including local sales taxes on food), property taxes, gasoline and other excise taxes, and local payroll taxes. By relieving the income tax and helping to offset other taxes, a Missouri EITC could dramatically reduce the extent to which the state tax system pushes poor working families deeper into poverty.
State Income Tax Thresholds for Two-Parent Families of Four, 1998
1998 poverty line (estimated): $16,655
1 Alabama $4,600 20 North Carolina $17,000 2 Kentucky 5,000 21 Iowa
3 Illinois 5,200 21 Mississippi 17,200 4 Hawaii 6,100 23 Colorado 17,900 5 New Jersey 7,500 23 District of Columbia 17,900 6 Virginia 8,200 23 Idaho 17,900 7 Indiana 8,500 23 South Carolina 17,900 8 Montana 9,000 27 Nebraska 18,300 9 West Virginia 10,000 28 North Dakota 18,400 10 Michigan 11,800 29 Wisconsin 18,700 11 Missouri 12,000 29 Maine 18,700 12 Louisiana 12,300 31 New Mexico 20,300 13 Ohio 12,500 32 Kansas 20,700 13 Oklahoma 12,500 33 Massachusetts 21,100 15 Delaware 12,700 34 New York 22,800 16 Oregon 14,200 35 Arizona 23,600 17 Utah 15,200 36 Connecticut 24,100 18 Georgia 15,300 37 Maryland 24,300 19 Arkansas 15,600 38 Pennsylvania 25,000 38 Rhode Island 25,000 38 Vermont 25,000 41 Minnesota 25,200 42 California 36,100 Note: A threshold is the lowest income level at which a family has state income tax liability. In this table thresholds are rounded to the nearest $100. The 1998 poverty line is a Census Bureau estimate based on the actual 1997 line adjusted for inflation. The threshold calculations include earned income tax credits, other general tax credits, exemptions, and standard deductions. Credits that are intended specifically to offset the effects of taxes other than the income tax or that are not available to all low-income families are not taken into account.
Source: Center on Budget and Policy Priorities, State Income Tax Burdens on Low-Income Families in 1998: Assessing the Burden and Opportunities for Relief, Washington, D.C., 1999.
Cost of a Missouri EITC
The Office of Administration estimates that the Missouri EITC proposed in SB161 would cost $113 million in FY 2001 if 85 percent of taxpayers who use the federal credit also claim the state credit. The Office of Administration estimates the FY 2001 cost at $133 million if 100 percent of taxpayers who use the federal credit also claim the state credit. A participation rate as high as 100 percent is unlikely for a variety of reasons, especially in the first few years after enactment of the state credit when awareness of the credit may be limited. The figure of 85 percent cited by the Office of Administration in preparing the lower estimate accurately reflects the experiences of other states that have enacted EITCs, including New York, Wisconsin and Vermont, each of which have found that the cost of a state EITC in the first year after enactment was 80 to 85 percent of the cost of the federal credit multiplied by the state percentage. Therefore, the Office of Administration's estimate that the credit would cost $113 million in FY 2001 is likely to be correct. That estimate can also be used to calculate the cost of alternative levels of a Missouri state EITC. For example, based on that estimate, a Missouri EITC set at 10 percent of the federal credit would cost about $56.5 million in FY 2001.
Examples of How a Missouri EITC Would Affect Families
To understand the effect of a Missouri EITC on individual families, it is useful to consider some examples.
- A family of four with two children and one parent working full-time, year-round, at $6.75 per hour substantially above the minimum wage would have earnings of about $14,000 per year. After subtracting federal payroll taxes and Missouri income taxes and adding the federal EITC for which that family would qualify of $3,492, cash income would be about $16,400, about $600 below the poverty line for a family of four. The proposed Missouri EITC set at 20 percent of the federal credit would give that family an additional $700, enough to bring the family income just above the poverty line.
- A single parent with one child working at the minimum wage ($5.15/hour) nearly full-time 36 hours per week, 48 weeks per year would have earnings of about $8,900. (This level of earnings is typical for welfare recipients entering the workforce, in part because the jobs that many welfare recipients take do not offer paid sick leave or vacation, requiring them to take unpaid leave to tend to a sick child or to attend to other family emergencies.) After subtracting federal payroll taxes and adding the federal EITC for which that family would qualify of $2,312, cash income would be about $10,500, about $400 below the poverty line for a family of two. Under SB 161/HB 553, the family would qualify for a Missouri EITC of about $489, enough to bring the family income above the poverty line.
Additional examples of EITC amounts are provided in Table 2.
Earned Income Tax Credit Amounts, by Level of Earnings, 1999
Gross Earnings Federal EITC Missouri EITC Set at
20% of Federal Credit
(SB 161/HB 553)
Family of four with two children No earnings $0 $0 $0 Half-time minimum wage $5,350 $2,140 $428 Full-time minimum wage $10,700 $3,816 $763 Wages equal federal poverty line $17,000 $2,860 $572 Wages equal 150% of poverty line $25,500 $1,070 $214 Wages equal 200% of poverty line $34,000 $0 $0 Family of three with one child No earnings $0 $0 $0 Half-time minimum wage $5,350 $1,819 $364 Full-time minimum wage $10,700 $2,312 $462 Wages equal federal poverty line $13,300 $2,178 $436 Wages equal 150% of poverty line $19,950 $1,115 $223 Wages equal 200% of poverty line $26,600 $52 $10
1. The data in this section were calculated by the Center on Budget and Policy Priorities from the U.S. Census Bureau's Current Population Survey, 1996 through 1998.
2. These studies are summarized in Welfare Recipients Who Find Jobs: What Do We Know About Their Employment and Earnings?, Center on Budget and Policy Priorities, November, 1998.
3. Jeffrey B. Liebman, "The Impact of the Earned Income Tax Credit on Incentives and Income Distribution," October 1997.
4. See for example, Nada Eissa and Jeffrey B. Liebman, "Labor Supply Response to the Earned Income Tax Credit," Quarterly Journal of Economics, May 1996, 112(2), pp. 605-637.
5. Bruce D. Meyer and Dan T. Rosenbaum, "Welfare, The Earned Income Tax Credit, and the Labor Supply of Single Mothers," November 1997.
6. Liebman, op. cit.
7. Timothy M. Smeeding, Katherin E. Ross, Michael O'Connor and Michael Simon, "The Economic Impact of the Earned Income Tax Credit (EITC)," forthcoming.
8. For example, the National Conference of State Legislatures recently used the latest available U.S. Census Bureau data to compare total state and local tax collections in each state relative to state personal income and relative to state population. Under either measurement, Missouri's tax burden was about 10 percent below the national average, ranking in the bottom third of all states. Scott Mackey and Jennifer Grooters, State-Local Tax Levels, NCSL, November 1998.
9. Center on Budget and Policy Priorities, State Income Tax Burdens on Low-Income Families in 1998: Assessing the Burden and Opportunities for Relief, Washington, D.C., March 1999.
10. Citizens for Tax Justice/Institute on Taxation and Economic Policy, Who Pays?, Washington, DC, 1995.