APPENDIX 3
THE EARNED INCOME TAX CREDIT (EITC)
Note by Assistant Clerk
The EITC is a refundable tax credit that supplements the
earnings of low-income workers. The EITC is designed to provide
a work incentive and to redistribute income to low-income workers.
Its introduction in 1975 was aimed at reducing the burden of the
Social Security Tax on low-income workers, but it has since become
a central part of the federal anti-poverty effort.
The credit can be used to offset federal tax liabilities
or, for credit amounts in excess of income tax liability, to provide
refunds. The credit is claimed annually. Claimants can apply for
advance payment, although take-up of this option is very low.
The amount of the credit depends primarily on the level of
earnings and the number of children in the family:
Income Limitations: Applicants are eligible if they
have:
no children and an income below $9770;
one child and an income below $25,760;
two or more children, and an income below $29,290.
Amount of credit: The federal programme has three
distinct ranges, depending on income and number of children:
Subsidy Range: Each additional dollar is subsidised
by the credit. As workers earn an additional dollar of income,
their credit increases by 40 cents, up to a maximum credit of
$3,560. Currently, the subsidy range extends up to earnings of
$8,900 for a family with two or more children (families with one
child and individuals receive a smaller credit).
Flat Range: Workers with two or more children earning
between $8,900 and $11,620 receive the maximum credit of $3,560.
Families with one child receive a maximum credit of $2,152. In
this range, increased earnings do not change the credit amount.
Phase-Out Range: The credit is gradually phased out
as earnings increase. The phase-out starts at $11,620, just over
the amount received for full time work at the minimum wage. As
wages increase, the credit is phased out at a rate of 21 cents
per dollar earned. The credit is completely phased out at an income
of $28,524.
See Appendix 6 For chart showing EITC tapers.
Advance Credit: Applicants with qualifying children
can apply for up to 60 per cent of eligible credits distributed
evenly over each pay period during the year. Take-up of this option
is reportedly very low, at 0.3 per cent. Suggested reasons for
this low take-up have included: claimants not being aware of the
advance credit option; claimants preferring to receive the credit
in an annual lump to be used to pay off credit cards, purchase
large items, or pay for vacations; concerns that if they claim
incorrectly, claimants may be faced with a large tax bill in April,
and claimants not wishing to tell their employers that they are
on EITC.
In 1993, President Clinton's Omnibus Budget Reconciliation
Act extended and simplified the EITC. The Act increased the maximum
credit rate by almost $1,500, and the income level at which individuals
can qualify for the credit. The Act also allowed certain low-income
taxpayers without children to receive the credit for the first
time.
Take-up: In 1997, the EITC provided an average $1,450
for nearly 19 million workers and their families. EITC has an
uptake rate of between 80 and 86 per cent of eligible taxpayers,
which is slightly higher than take-up of AFDC, and about 20 to
30 per cent higher than food stamp take-up rates. Most non-participation
is thought to be people whose eligibility is minimal. All taxpayers
fill in a tax return form, and EITC claims are integrated into
this process.
Compliance Issues: Internal Revenue Service (IRS)
data indicate that in the years up to and including 1993, approximately
one-third of EITC recipients were ineligible for the credit. Most
of the ineligible recipients were eligible in terms of income,
but wrongly claimed children on their tax returns. The US rules
governing the circumstances under which taxpayers may claim their
children are complicated, and it is therefore unclear whether
non-compliance is due to error or fraud. It has been estimated
that 60 per cent of ineligible recipients had children living
in the household, so in fact only 13 per cent of EITC dollars
went to homes without any children.
In recent years, IRS has taken steps to reduce error rates.
For example the social security number of children claimed on
tax returns is checked against the master list of social security
numbers before a tax refund cheque is sent out. In April 1997,
IRS released a new study of EITC error rates, which concluded
that IRS efforts had reduced the EITC overpayment rate to 24 per
cent.
Individual States can also operate their own EITC schemes
in addition to the Federal scheme. State schemes tend to be much
more limited in scope, notably the Wisconsin EITC has a maximum
credit of $1529 per annum.
January 1998
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