As the April 15 tax-filing deadline approaches, nearly 30 million low-income families will receive more than $64 billion in tax breaks from the federal Earned Income Tax Credit.
Policymakers from President Barack Obama to House Speaker Paul Ryan, R-Wis., would like to see those numbers expand. Under a variety proposals favored by both sides of the political aisle, much of that expansion would come from an increase in the EITC for workers without children. Income limits and eligibility criteria largely ensure that proposed expansions would accrue to the deserving “working poor.”
But expanding the EITC in this way ignores a longstanding problem with the EITC that Zackary Hawley and I outlined in a recent paper for R Street. Because the EITC relies on one-size-fits-all federal income limits and credit amounts, it effectively treats workers who live and work in different cities very differently.
Significant differences in the cost of living between different metro areas result in very real differences in how much the credit benefits the working poor in different cities. While the cost of feeding a family in Boston is 53 percent higher than it is in Jackson, Tennessee, the federal EITC does not recognize that difference when determining the size of the tax break. For a single taxpayer with one child, the real value of the EITC ranges from $4,131 in Harlingen, Texas, to $1,531 in New York City. These differences mean the EITC helps the working poor in low-cost areas much more than it does those in high-cost areas of the country.
These factors also limit one of the EITC’s most attractive features — that it encourages a worker to find and keep a job. EITC expansions are responsible for large increases in labor-force participation. The working poor in high-cost cities largely miss out on these benefits. For example, the EITC claims rate (the number of EITC claims per tax filer) in Memphis, Tennessee, is nearly three times greater than in San Francisco. Even controlling for other local economic factors, a 10 percent increase in the local cost of living reduces EITC claims by 7.5 percent, meaning that poor workers living in expensive cities are not reached by the policy.
Ignoring local labor-market conditions also makes the EITC’s so-called “phase-out” tax even worse. The phase-out tax kicks in when an EITC-eligible worker starts to earn more income. Eventually, they hit an earnings level where policy dictates they have to start paying back the credit. This payback acts like an additional tax on working. The Congressional Budget Office estimates that workers paying the phase-out tax (combined with the loss of other benefits) can face marginal tax rates in excess of 90 percent, even though such workers may earn less than $20,000 annually.
Because the EITC is not adjusted for local labor-market conditions, similar workers in different parts of the country are subject to the phase-out tax after working radically different numbers of hours. For example, a single parent working as a dishwasher (someone who is poor by any reasonable definition) and living in Brownsville, Texas, will likely never be subject to the phase-out tax. If that same single parent lived in San Francisco, he or she will be hit with the phase-out tax after working about 85 percent of their normal hours — drastically reducing their effective wage rate and destroying the incentive to work harder.
When policymakers consider expanding the EITC, a good place to start is to adjust for local labor market conditions. This would provide an equal benefit to workers who are in the same cost-of-living-adjusted income group. For the 30 million families expected to file for the EITC this tax season, it would mean their refund has the same purchasing power, regardless of where in the country that refund is being sent.
Andrew Hanson will be discussing his research on the Earned Income Tax Credit at April 11 briefing at the U.S. Capitol’s House Visitor Center, along with Angela Rachidi of the American Enterprise Institute, Oren Cass of the Manhattan Institute and Lori Sanders of the R Street Institute. Interested parties can RSVP here.