Exclusive Commentary

Extending Tax Credits for Low-Income Families, By Elaine Maag, Research Associate, Urban-Brookings Tax Policy Center and Urban Institute

- Posted July 19, 2010

Policymakers should be thinking hard about low-income families and the tax code these days. In 2010, the federal income tax system will still deliver substantial assistance to low-income families with children through refundable tax credits.


Some commentators may not recognize the significance of these tax measures, but refundable tax credits can substantially reduce poverty among families with children.


In fact, absent any changes to the poverty measure except the inclusion of tax credits in a family’s available resources, the Tax Policy Center estimates a third fewer children would be in poverty.


The reality is that these tax credits are among the most potent anti-poverty programs we have for families with children.


But without legislative action, some aid targeted to the poorest families will disappear as two key pieces of legislation expire in 2011: the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 and the American Recovery and Reinvestment Act (ARRA) of 2009.


The drop in benefits to low-income families will be precipitous. And although the facts surrounding these tax measures can be complex and daunting, it is worth taking the time to be clear about their effects for low-income families.


In 2010, a family with poverty level wages ($14,570) and two children under age 17 can increase its income by more than 50 percent with tax credits. The Earned Income Tax Credit (EITC) is worth $5,036, a Child Tax Credit (CTC) totals $2,000, and a Making Work Pay (MWP) credit provides an income boost of $400 for a single parent or $800 for a married couple with at least one worker.


Absent legislative changes, the MWP credit created by the ARRA will disappear and the CTC will revert to its pre-EGTRRA level of $500 per child and become largely nonrefundable, as it was prior to the EGTRRA legislation. Nonrefundable credits can only offset taxes owed, whereas refundable credits can go to people who do not owe income taxes.


In cases where a family does not owe income taxes, refundable credits are received as a tax refund. If the CTC reverts back to being largely nonrefundable, few low-income families will benefit from it since they do not have positive taxes that the credits can offset.


The EITC currently augments income by as much as 34 to 45 percent of earnings, depending on the number of children in a family—up to $3,050 for a one-child family, $5,036 for a two-child family, and $5,666 for a family with three or more children. And the EITC is fully refundable, so eligible families receive the full credit regardless of tax liability.


Once families qualify for the maximum credit, they keep getting it until their earnings reach $16,450, or $21,460 if married. At that point, the credit starts phasing out at a rate of about 16 cents for each additional dollar earned for families with one child and 21 cents for each additional dollar earned for families with at least two children.


In 2011, the EITC for married couples will begin phasing out at the same point it does for single parents.  Families with at least three children will go back to receiving the same credit as families with two children.


In 2010, the EITC will deliver $53.6 billion to 33.5 million low-income children. If legislators do not extend current policy, 1.4 million children will see their benefits disappear and 13.5 million will see their benefits decreased.

The CTC provides a credit of up to $1,000 per child and is partially refundable.  Over 50 million families receive a credit of 15 percent of earnings over $3,000—though only about a third of this aid goes to families with incomes below $30,000. A family’s credit equals the sum of their nonrefundable and refundable credit amounts.


In 2011, the CTC is scheduled to revert to its pre-EGTRRA level of $500 per child, and only some families with at least three children will qualify for a refundable CTC.


This is actually two legislative changes. First, EGTRRA expanded the CTC to $1,000 per child and made the credit partially refundable on earnings exceeding $10,000. That $10,000 threshold was adjusted for inflation so that in 2010, the threshold would have been around $12,000. In 2009, ARRA reduced that threshold to $3,000.


Both pieces of legislation expire at the same time.

The fully refundable MWP boosts earnings by up to 6.2 percent. It provides much more total assistance than the EITC, some $60 billion in all, but goes to almost all workers. Only about a third of the aid goes to families with incomes below $30,000.


Legislators face three decisions as the CTC provisions expire: should the $1,000 per child credit remain in place or should the CTC revert to being worth half that as it was before EGTRRA, should the current rules for broad refundability be extended and, if so, at what level?


Extending current rules for refundability would continue the credit for lower income families, who likely need it most. Further, the lower the threshold for refundability, the more benefits go to the poorest families. Under EGTRRA, refundability only starts when earnings exceed about $12,000. ARRA dropped that threshold to just $3,000.


If both EGTRRA and ARRA provisions are allowed to expire, the CTC will provide $13.2 billion to 19.7 million families. The vast majority, 89.4 percent, will go to families with at least $30,000 in income.


If legislators extended EGTRRA provisions – including not only the expanded refundability but allowing the credit against the Alternative Minimum Tax and the larger $1,000 credit – the CTC would deliver an additional $30.7 billion. There would be 20.1 million more children eligible for benefits than if the EGTRRA provisions expire and an additional 51.8 million children would receive higher benefits.


The extension of CTC related ARRA provisions (the lower threshold for refundability) would deliver $8.2 billion more in benefits than simply extending the EGTRRA provisions. 10.2 million children would receive higher benefits and 59.6 million children would be eligible for benefits.


Congress could go even further and help an additional 8.4 million children and boost benefits for 5.8 million more if it simply eliminated the threshold and made the credit refundable from the first dollar of earnings similar to the EITC. That option would deliver $10.5 billion in benefits, relative to extending only EGTRRA.


Given increasingly tight budgets, the expansion or even continuance of any program deserves thoughtful consideration. Policymakers could lower the thresholds where the CTC begins to phase out in order to pay for expansions for lower income families. Doing so would target limited resources at those most in need.


Using the tax code to deliver assistance to low-income families makes good sense.


For starters, the credits discussed here are designed as work incentives. Many studies show that, unlike traditional spending programs, the EITC does indeed encourage people – particularly single moms – to enter the labor force. This is a major reason why the EITC enjoys bi-partisan support.


On top of that, the tax system provides an administratively convenient way to aid low-income working families. Unlike most other agencies, the IRS has reliable employer-provided information on earnings, the basis for credit eligibility. And it’s easier for low-income families to claim credits on their tax returns than to apply for assistance in person at welfare offices—a major reason why more eligible people receive tax credits than Temporary Assistance for Needy Families (TANF) or food stamps (now Supplemental Nutrition Assistance Program (SNAP) benefits).


That being said, tax credits can be blunt instruments for distributing assistance. They typically arrive once a year, after tax claims have been filed, rather than throughout the year. A regular income stream might help low-income families more than a lump sum does. Also, error rates on the EITC are higher than for traditional welfare programs. But increasing participation in the Advanced EITC option, which allows eligible families to get part of their credit delivered through the year, in addition to simplifying eligibility rules could solve both problems.


That’s why policymakers should extend the EITC and CTC provisions in the EGTRRA and also keep the ARRA rules for the CTC in place. They should also consider making the CTC more generous toward low-income families by reducing the refundability threshold to $0. This would both help low-income people survive and simplify the tax code.


Our tax system delivers substantial assistance to low-income families, and the amount has increased in recent years. Turning back the clock now to reduce or eliminate that assistance could wreak financial hardship on the low-income families who rely on tax credits to boost their incomes.


Elaine Maag is a Research Associate at the Urban-Brookings Tax Policy Center and at the Urban Institute.