May 14, 2004

How State Earned Income Tax Credits Help Working
Families Escape Poverty in 2004

By Joseph Llobrera and Bob Zahradnik

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Earned Income Tax Credits provide tax reductions and wage supplements for low- and moderate-income working families.  The federal tax system has included an EITC since 1975, with major expansions in 1986, 1990, and 1993, and an additional expansion in 2001.  In 2002, more than 21 million families and individuals filing federal income tax returns — nearly one out of every six families who file — claim the federal EITC.

The EITC has been widely praised for its success in supporting work and reducing poverty.  The federal credit now lifts more children out of poverty than any other government program.  Some 4.9 million people, including 2.7 million children, were removed from poverty in 2002 as a result of the federal EITC.  The federal EITC also has been proven effective in encouraging work among welfare recipients; studies show it has a large impact in inducing more single mothers to work.  Support for the EITC has come from across the political spectrum.

The success of the federal EITC has led a number of states to enact state Earned Income Tax Credits that supplement the federal credit.


Why Consider a State EITC?

Several developments explain the popularity of state EITCs, including the continued prevalence of poverty among children, the importance under welfare reform of supporting families’ transition from welfare to work, and interest in tax changes that promote tax fairness.

State EITCs Reduce Poverty Among Children

In 2002, the Census Bureau reported that about one child in six still lived in poverty.  Most poor children lived in families with a working parent.

Earned Income Tax Credits can lift families out of poverty by supplementing their wages.

State EITCs Complement Welfare Reform

Although large numbers of welfare recipients have entered the workforce, many cannot make ends meet on their earnings alone.  State EITCs support families who enter and remain in the workforce.

State EITCs Provide Needed Tax Relief During Times of Fiscal Stress

State EITCs also pay a role in shaping state tax systems.  A number of states are responding to weak fiscal conditions by increasing taxes and fees.  Enacting a state EITC is a way to reduce, or at least avoid increasing, the already-substantial burden of state and local taxes on the poor.


Designing a State EITC

Table 1 lists the states that have enacted Earned Income Tax Credits.

Table 1
State Earned Income Tax Credits Based on the Federal EITC


Percentage of Federal Credit
(in 2004 except as noted)

Refundable credits:


10% (currently suspended; projected to be reinstated in 2006)

Dist. of  Columbia













Varies with earnings; average 33%

New Jersey

20% (if income < $20,000)

New York







4%  —  one child


14%  —  two children


43%  —  three children


Non refundable credits







Rhode Island***



20% effective in 2006

*Maryland also offers a non-refundable EITC set at 50 percent of the credit.  Taxpayers in effect may claim either the refundable credit or the non-refundable credit, but not both.
**Maine’s non-refundable EITC was reduced from 5% to 4.92% effective in tax years 2003, 2004 and 2005.  The credit will return to 5% in 2006.
***Rhode Island made a very small portion of its EITC refundable effective beginning in tax year 2003.


Financing a State EITC

The cost of a state EITC depends principally on four factors:  the number of families in a given state that claim the federal credit, the percentage of the federal credit at which the state credit is set, whether the credit is refundable or non-refundable, and how many state residents who receive the federal credit learn about and claim the state credit.  Because state EITCs are well targeted to low- and moderate-income working families, the cost may be relatively modest.  The annual cost of refundable EITCs ranges from about $14 million in Vermont to $501 million in New
. (A relatively straightforward procedure for estimating the cost of a refundable credit in each state is described in a CBPP paper entitled How Much Would a State EITC Cost?)

How the EITC Works

The federal Earned Income Tax Credit goes only to households with earnings, with the size of the credit initially rising as earnings increase.  The credit is capped at $4,300 for a family with two children and $2,604 for a family with one child; the credit then phases out gradually.  Families with two children may qualify if their incomes are as high as $35,458.  The credit is phased out at a slightly higher income level for married couple families than for other families.  Low-income workers without a qualifying child also may receive a federal EITC, but the maximum credit for individuals or couple without children is $390 in 2004, much lower than the credit for families with children.  The chart above illustrates the structure of the credit for families with children.

Most state EITCs are structured in the same way as the federal credit except that the amount of credit at each income level is lower.  The table below shows the amount of federal and state credit for families at various income levels.

Earned Income Tax Credit Amounts by Family Income Levels, 2004



Federal EITC

25% State EITC

15% State EITC

Family of four with two children





     Half-time minimum wage





     Full-time minimum wage





     Wages equal federal poverty line





     Wages equal 150% of poverty line










Family of three with one child





     Half-time minimum wage





     Full-time minimum wage





     Wages equal federal poverty line





     Wages equal 150% of poverty line










Center on Budget and Policy Priorities





Most state credits to date have been financed from funds available in a state’s general fund — the same funding source typically used for other types of tax cuts.  When an EITC is used to offset the effects of a regressive tax increase, such as a sales tax increase, as it has been in Indiana and Kansas, a part of the proceeds of the revenue increase may be set aside for the EITC.  New federal regulations offer the opportunity to finance a portion of the cost of a refundable credit from the federal Temporary Assistance to Needy Families block grant.  Whether general funds or block-grant funds are the most appropriate funding stream to use to finance the credit will depend on a number of factors, including the specifics of a state’s budget situation, the amount of unallocated TANF funds or “maintenance of effort” funds available to the state, and the state’s priorities for use of TANF funds.  Examples of states that have financed a portion of their state EITC with TANF or “maintenance of effort” funds include Indiana, Massachusetts, New Jersey, New York and Wisconsin.  No matter how it is financed, however, an EITC can complement a state’s welfare program by assisting low-income working families with children.

Refundable State EITCs Can Enhance Efforts to Help Families Build Assets a

Research indicates that tax refunds, including state EITC refunds, can be used to promote asset building in low-income families.  Data from various studies indicate that many low-income individuals value saving and assets.  For example, research suggests that low-income individuals can save and accumulate assets in Individual Development Accounts (IDAs). b  IDAs are special savings accounts designed to help low-income individuals build assets to reach certain goals such as buying a home, pursuing post-secondary education, or starting a business.  In addition, there is evidence that some low-income families save part of their tax refunds; one study found, for example, that 33 percent of the 650 EITC recipients examined planned to save a portion of their tax refunds. This suggests that tax refunds might be effectively linked to a variety of asset-building initiatives.

a For more information see “Promoting Asset Building through the Earned Income Tax Credit,” State IDA Policy Briefs, Vol. 1, No. 1, Center for Social Development and Corporation for Enterprise Development.

Schreiner, M., Clancy, M. & Sherraden M.  Saving performance in the American Dream Demonstration.  St. Louis, MO: Washington University in St. Louis, Center for Social Development, 2002.

Smeeding, T.M., Phillips, K. R., & O’Conner, M. “The Earned Income Tax Credit Experience: Expectation, knowledge, use, and economic and social mobility.”  National Tax Journal, 53 (4, Part 2), 1187-1209

End Notes:

[1] These figures were tabulated from the U.S. Census Bureau’s Current Population Survey, March 2003.  An additional 600,000 poor families had parents who were ill, elderly or disabled, and thus were not able to work.


[2] Center on Budget and Polity Priorities, State Income Tax Burdens on Low-Income Families in 2003.  April 2004.  This report is updated annually.


[3] Institute on Taxation and Economic Policy, Who Pays?: A Distributed Analysis of the Tax Systems in All 50 States, 2nd edition, January 2003.


[4] Rhode Island made a very small portion of its EITC refundable effective in tax year 2003.