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Should We Pay the EITC All at Once?

Adam Rust's picture

Posted April 17, 2012

The New York Times has a great article in today's A section that discusses the EITC. It is a fair story. The author managed to see the program without rose-colored glasses. She gives the EITC credit for alleviating poverty, but she acknowledges that it is mainly a patch to help low-income filers get through hard times,

rather than a program that lifts those families out of poverty.

The Earned Income Tax Credit amplifies the wages paid to low-income families. It provides a refundable credit on a formula that expands for the number of dependents carried by a filer and shrinks as a person's income approaches a need-based ceiling. For households filing "married filing jointly with three or more children, the maximum income is $50,270 in 2012. A single person filing with no dependents must have less than $13,980 in earned income.

Use of the EITC is fairly widespread, but its use is usually not permanent: According to a study reference in the story, three in five filers that get the EITC stop claiming it after two years, but one in two families claimed the credit as some point in time between 1989 and 2006.

Economists love the EITC because it manages to combat poverty without impacting employment. Many people argue that raising the minimum wage reduces the demand for employees. There is some logic to that argument, because it will make it that much more attractive for employers to find ways to substitute the use of labor for the use of equipment. Other places in the tax code already make that an attractive solution - you can depreciate your investments but not your wage costs.

In New York, a minimum wage worker makes $7.25 per hour. Factored over the course of the year, this amounts to $15,080 per year. For a single parent with two children, though, the state and federal EITC raise his or her hourly wage to $10.56 per hour or to an annual pay package of $21,726.

The EITC does not impact how firms make employment decisions.

The New York Times built their report around the personal experience of Karen Spain, a seasonal employee with the Reinvestment Partners' Voluntary Income Tax Assistance Clinic in Durham. Spain was once employed in IT at Nortel where she earned $85,000 per year. But until she received her EITC payment, she was driving on old brakes, late on rent for three months, and going without car insurance.

The author frames her finances in the context of an economy where the notion of full employment is gradually shrinking.  But she draws a careful line on just how much she extols its virtue by emphasizing that only about ten percent of all EITC payments are ever set aside for savings. The two concepts contribute to the same picture of an economy that is gradually leaving more people behind but where current government tax policy contributes to ameliorating the situation year by year.

It is always a legitimate question to ask "how could this be done better?" One idea could be to find a way to break up the payments. Spain received one-third of her total after-tax income in just one check. The whole idea undermines the likelihood that the EITC will provide a real cushion. Instead, it becomes a once-a-year boom. Pawn shops, furniture stores, used car lots acknowledge that their revenues are seasonal. Here is an excerpt for the annual report filed this year by Rent-a-Center:

Our revenue mix is moderately seasonal, with the first quarter of each fiscal year generally providing higher merchandise sales that any other quarter during a fiscal year, primarily related to federal income tax refunds.

It is not unusual to see a buy-here-pay-her car dealer put a tax preparation shop inside their store during the first two months of tax season. The preparers do not stay much longer because the overwhelming number of EITC recipients file before March 1st. Today is tax day, but it is certainly not much of an EITC day. January 28th is national EITC day.

The rush to get a refund creates the opening for businesses that charge too much to file simple returns. No tax prep firm can lobby for their filings to come back more quickly, but all kinds of shops make this claim. The only way to hurry up a return is to e-file. With that comes the demand for the refund anticipation loan. Although banks will effectively be prohibited from making RALs after this week, it has been a practice that has added between $50 and $150 to the ultimate cost of a return. A RAL allowed a filer to get their money in about a day, as opposed to the norm of as many as fifteen days. This year the IRS has been especially slow. Last year, Spain paid $550 to have her taxes prepared. Given that she has worked as a manager in an auto parts store until her recent stint at the VITA site, it is likely that she had a relatively simple return. She says she paid extra to get her refund back sooner. How much is not said.

One significant take-away from her story is that she must have also paid quite a lot to get her return prepared. It is hard to imagine why someone would pay more than $400 for a standard return by a filer that did not itemize, but that is probably what happened to Spain last year.

Taken together, the next step in reforming the EITC seems relatively clear: the payments should be spread out over the course of the year rather than in one enormous lump sum.