Over the last few years, the president, lawmakers on both sides of the aisle, and the Bipartisan Policy Center (BPC) have all offered proposals to update or replace the Earned Income Tax Credit (EITC). We recently blogged about the EITC’s current structure and its advantages and drawbacks. In this post, we’ll detail some of the proposals for reform or replacement, including:
- President Obama’s proposal to expand the EITC for childless workers, which was included in his Fiscal Year (FY) 2015 budget.
- Senator Marco Rubio’s (R-FL) proposal to replace the EITC with low-income wage subsidies.
- Senate Budget Committee Chairman Patty Murray’s (D-WA) proposal to introduce a deduction for married couples with children and expand the EITC for childless workers.
- House Ways and Means Committee Chairman Dave Camp’s (R-MI) proposal in his comprehensive tax reform plan to make the EITC refundable against employment-related taxes.
- The Domenici-Rivlin Debt Reduction Task Force’s proposal to replace the EITC with a refundable earnings credit.
A Quick Refresher on the Current EITC
In general, the current EITC is a refundable tax credit that is worth a flat percentage (the phase-in rate or “credit rate”) of workers’ earnings up to a maximum benefit and then a progressively smaller amount of money past a certain threshold. The credit is currently fully refundable, so workers whose EITC benefits exceed their income tax liabilities get the difference back in their annual tax refund.
President Obama’s Proposal
In his FY 2015 budget, President Obama proposes to double the value of the EITC for those childless workers who already benefit and to allow more workers to access the credit. His plan would double the credit rate on earned income (for both phase-in and phase-out – thereby doubling the maximum benefit – allow a broader age range of workers to claim the credit, and make the credit available to workers at somewhat higher income levels.
Here’s an example: This year, a childless individual who makes the hourly federal minimum wage of $7.25 and works an average of 35 hours a week will earn approximately $13,195 over the course of a year – an amount that just exceeds the 2014 poverty line of $11,670. Under current law, that person would get a credit of about $120 from the EITC.1 Were President Obama’s plan to become law, that person would get a much larger credit of about $750.2
In the president’s budget, this proposal is estimated to carry a cost of roughly $6 billion per year. President Obama suggests paying for the expansion by taxing carried interest as ordinary income and by charging payroll taxes to particular self-employed individuals who avoid paying taxes by reclassifying income as distributions from pass-through entities.
Senator Marco Rubio’s Proposal
In an address on the 50th anniversary of the war on poverty, Senator Rubio discussed his ideas for reforming the EITC. Although he has not released many details on his plan, he did outline what he would like to see replace the EITC.
Senator Rubio proposes a wage supplement plan that would arrive monthly (instead of in an annual lump sum like the current EITC), possibly administered through the payroll tax system. Sending benefits monthly rather than annually would enable low-income workers to use the benefits for recurring expenses like rent and utilities.3
The wage supplement would apply equally to singles and married couples and those with and without children. Because Senator Rubio would like to make the reform budget neutral, however, it could only expand benefits to some cohorts (e.g., childless workers and married couples) by reducing benefits for others relative to current law. Additional aspects that Senator Rubio has not yet addressed include how the credit would be administered, who would be eligible, and what the value of the credit would be to them.
Chairman Patty Murray’s Proposal
Chairman Murray recently released draft legislation that would expand the EITC for childless workers and also create a new deduction for married couples who have young children and are both employed. The plan is based on the premise that changes in the structure of many American families – especially the fact that both parents work much more frequently in two-parent homes than used to be the case – have not been accommodated in the current tax code.
The structure of the American tax system introduces a “marriage penalty” – two married individuals with children who both work and file their taxes jointly often take home less money or receive fewer government benefits than two comparable single individuals. Moreover, two-earner families face work-related costs, like child care, that a one-earner married couple with children does not face.
For those families with income that puts them in the 25-percent bracket or above ($72,500 in 2013), higher tax rates phase in at lower levels of income for married couples than it would for two single individuals who make the same total amount. For those with lower incomes, the phase-out of means-tested benefits (including the EITC) is based on total family income, so the families face high effective taxation on a second worker’s earnings. A family in which the primary earner makes $25,000 per year may find its disposable income increased by less than 30 percent of what the second worker earns because of the loss of means-tested government benefits and the need to find childcare.
Chairman Murray proposes a deduction of 20 percent of the second (i.e., lower-earning) worker’s income (up to $60,000) for married couples with children under the age of 12. The deduction would begin to phase out for those with family incomes above $110,000. Additionally, this deduction would count before computing whether the couples are eligible for the EITC, so as to make more of them eligible for the credit.
In addition to this new deduction, Chairman Murray proposes to expand the EITC to childless workers in a similar manner to President Obama’s plan. Her proposed maximum credit is larger than the president’s ($1,350 compared to $1,005) and would phase out beginning at a lower level of income ($10,425 compared to $11,500).
This proposal has not been officially scored, but the economists who originally developed it, Melissa Kearney and Lesley Turner, estimated that the annual cost of the new deduction would be approximately $8 billion.4 BPC does not have an estimate for the cost of the expansion of the EITC in the proposal, but that portion would probably be roughly comparable to the cost of the president’s proposal – approximately $6 billion per year.
Chairman Dave Camp’s Proposal
As part of his recently released comprehensive tax reform plan, Chairman Camp proposes to reduce the value of the EITC to all current beneficiaries. The Joint Committee on Taxation estimates that if this provision were implemented, it would save the federal government approximately $217 billion from 2014 to 2023.
One of the original intentions of the EITC was to help offset the impact of regressive employment-related (i.e., payroll and self-employment) taxes. Chairman Camp’s plan would officially make the EITC a refundable credit up to the amount of those taxes and would require the Treasury Department to make recommendations on how to provide EITC benefits throughout the year rather than as part of individuals’ annual tax rebates.
Chairman Camp contends that rebating the payroll tax would be simpler than the current system, as well as more transparent and less prone to fraud.
Taxpayers who have at least one qualifying child would be eligible for a credit up to the size of both the employee and employer share of their employment-related taxes. Workers without any qualifying children would have their credit limited to just the employee share of employment taxes. Chairman Camp’s plan includes changes to the credit rates, credit maximums and income levels at which the phase-out begins:
The credit amounts and phase-out levels would be indexed to the Chained Consumer Price Index (CPI).
During a phase-in for tax years 2015, 2016, and 2017 only, the credit would be equal to 200 percent of combined employee and employer shares of the payroll tax, with the maximum credit increased to $3,000 for those with one qualifying child and $4,000 for those with more than one qualifying child.
The Domenici-Rivlin Debt Reduction Task Force’s tax plan included a proposal to replace the EITC (and to help offset the proposed elimination of personal exemptions and the standard deduction) with a refundable earnings credit that would be equal to 17.5 percent of the first $20,000 of earnings, indexed to the Chained CPI, for each worker (regardless of filing status). The structure of the credit would be similar to the Making Work Pay Tax Credit, which many individuals received in the form of reduced paycheck withholding in 2009 and 2010, as part of the American Recovery and Reinvestment Act (ARRA or the “stimulus”).
This reform would be beneficial because recipients would get the benefits in real time, via the adjustment to their withholding, instead of in a lump sum at the end of the year. Additionally, the incentives provided by the credit would be improved because there would be no phase-out that creates high effective marginal rates, individuals would better understand when they were receiving a credit because it would be part of the payroll system, and allowing each worker in a tax unit to separately benefit would eliminate the EITC’s role in the marriage penalty.
While the proposals described above differ in significant ways, there is a clear bipartisan desire to build on the principles and successes of the current EITC and to make it function even better for low-income, working Americans. We applaud these ideas and encourage policymakers to reconcile these proposals on a bipartisan basis to improve this federal program that affects the lives of millions of employed individuals and their families.
Alex Gold and Samantha Greene contributed to this post.
1 Maximum 2015 benefit of $503 minus income over $8,220 times 7.65 percent.
2 Maximum 2015 benefit of $1,005 minus income over $11,500 times 15.3 percent. On the other hand, many families that receive the EITC prefer a lump sum because it can be specifically allocated to large purchases or paying debt or large bills.
3 On the other hand, many families that receive the EITC prefer a lump sum because it can be specifically allocated to large purchases or paying debt or large bills.
4 Kearney and Turner also suggested that the cost of the proposal could be offset by scaling back the exemption that can be claimed by married individuals who have a spouse with no gross income. This offset is not included in Murray’s bill.