Tax Credit or Income Transfer?

by Laurence M. Vance
by Laurence M. Vance

Whoever coined the saying "there is no such thing as a free lunch" never filed for the Earned Income Tax Credit. Although the tax season officially ends on April 15, many Americans will have to work well past that date just to pay their tax bill. Many Americans, that is, except those who receive the Earned Income Tax Credit.

Whenever one thinks of welfare and entitlement programs, the first thoughts that usually come to mind are things like food stamps, Head Start, and Medicaid, or acronyms like AFDC, WIC, and SSI. But one of the greatest forms of welfare – the ultimate free lunch – is the Earned Income Tax Credit (EITC in government jargon).

It has enjoyed bipartisan support in Congress. Economists from Berkeley and Harvard love it. Senators Russell Long and Lloyd Bentsen made it their "signature initiative." Nobel laureate Gary Becker praised it for aiding poor families without increasing reliance on public assistance. Business Week columnist and Wall Street Journal contributing editor Robert J. Barro claims that is discourages welfare. Ronald Reagan heralded it as "the best anti-poverty, the best pro-family, the best job creation measure to come out of Congress." Clinton’s Labor Secretary Robert Reich advocated its expansion, along with the minimum wage, to give everyone in the bottom half of society "a chance to get on the escalator." The IRS (publication 1622) advertises it as "The Tax Break for Hard-Working People." The government promotes this "tax credit" like it promotes none other. And unlike any other part of your tax return, you don’t even have to figure your EITC – the IRS will do it for you!

So then, what is the purpose of this universally-lauded "tax credit," and how does one qualify for it? According to the IRS:

The Earned Income Tax Credit (EITC), sometimes called the Earned Income Credit (EIC), is a refundable Federal income tax credit for low-income working individuals and families. Congress originally approved the tax credit legislation in 1975 in part to offset the burden of social security taxes and to provide an incentive to work. The credit reduces the amount of Federal tax owed and can result in a refund check. When the EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit.

Income and family size determine the amount of the EITC. To qualify for the credit, both the earned income and the adjusted gross income for 2003 must be less than $29,666 for a taxpayer with one qualifying child ($30,666 for married filing jointly), $33,692 for a taxpayer with more than one qualifying child ($34,692 for married filing jointly), and $11,230 for a taxpayer with no qualifying children ($12,230 for married filing jointly).

For 2004, some employees with at least one child living with them may be entitled to receive advance EITC payments in their paychecks. The employee must file Form W-5, Earned Income Credit Advance Payment Certificate, with an employer to receive the advance payments. The employer then pays part of the credit to the employee in advance throughout the year. The taxpayer claims the rest when filing the 2004 Federal tax return.

The EITC does not generally affect eligibility for Medicaid, Supplemental Security Income (SSI), food stamps, or low-income housing.

Some observations. First, if social security taxes are a "burden," then why not reduce the social security tax rates or eliminate the tax altogether? Second, why does the government have to provide people with "an incentive to work"? I thought eating was a good incentive to work? Does it not say in the New Testament "that if any would not work, neither should he eat" (2 Thessalonians 3:10)? Third, the EITC is only "for low-income working individuals and families." But these people hardly pay any taxes. The ones who actually pay most of the taxes in the country don’t qualify. The top 50 percent of income earners pay 96 percent of all federal income tax. The top 1 percent pay 36 percent, and the top 5 percent pay 55 percent of all federal income taxes. Fourth, the EITC "reduces the amount of Federal tax owed." It is not like a deduction for charitable contributions or medical expenses that lowers your income and therefore your taxes. Instead, it actually directly reduces your taxes. You don’t even have to itemize deductions to claim it. Fifth, "Income and family size determine the amount of the EITC." There is a notable difference between the EITC and other forms of welfare – there is no asset test or net-worth ceiling to qualify. Having two cars in the driveway, a yacht at the marina, and a plane at the airport does not exclude anyone from receiving the EITC. Sixth, the receipt of welfare in the form of the EITC does not hinder ones ability to receive other forms of government handouts. Eligibility for "Medicaid, Supplemental Security Income (SSI), food stamps, or low-income housing" is not generally affected by receiving the EITC. Seventh, the EITC is refundable; that is, you get what is left after it covers your taxes. But not only that, you still get it even if you don’t owe any taxes. This means that many people who don’t pay any federal income taxes still get a tax "refund." Thus, the EITC is the embodiment of the "negative income tax" advocated by Milton Friedman in his book Capitalism and Freedom. It would have the effect of establishing a floor below which no man’s income could fall, another anti-libertarian measure advocated by Friedman. But destructive tax policies are nothing new to Friedman, for as Murray Rothbard pointed out in his classic essay, "Milton Friedman Unraveled," "One of Friedman’s most disastrous deeds was the important role he proudly played, during World War II in the Treasury Department, in foisting upon the suffering American public the system of the withholding tax." And eighth, you don’t have to wait until tax time to get your EITC. You can get "advance EITC payments" in your weekly paycheck.

Although the income tax has been a reality since Wyoming became the thirty-sixth state to ratify the sixteenth amendment in 1913, the Earned Income Tax Credit has only been around for 30 years.

The year was 1975, the president was Gerald Ford, and the Congress was Democratic. Public Law 94-12 (H.R. 2166), better known as the Tax Reduction Act of 1975, was signed into law on March 29, 1975. Its $22.8 billion in tax cuts were supposed to stimulate the economy. A seemingly innocent provision of this Tax Reduction Act was a refundable end-of-year tax credit for low-income taxpayers that provided them with up to $400. The idea was a Republican one from the beginning, for President Nixon had proposed a similar negative income tax scheme.

Public Law 94-164 (H.R. 9968), enacted as a Christmas present on December 23, 1975, extended the EITC for the 1976 tax year as well. This was followed by Public Law 94-455 (H.R. 10612) on October 4, 1976, which extended the EITC through the tax year 1977. Of the approximately $1.2 billion in EITC credits given in each of the first three years, over 70 percent was forwarded as a refund check because only 30 percent of the credit was needed to completely eliminate the taxpayers entire bill.

Public Law 95-30 (H.R. 3477), signed by President Jimmy Carter on May 23, 1977, extended the EIC through 1978. But then Public Law 95-600 (H.R. 13511) made the EITC a permanent fixture on IRS tax forms. And like every other government welfare program, the benefits went up. The new rate was 10 percent of earned income if one made $5,000 or less. Thus, the maximum a family could receive went up 25 percent from $400 to $500. A partial EITC credit was given on incomes up to $10,000.

Things remained the same until July 18, 1984, when President Ronald Reagan signed Public Law 98-369 (H.R. 4170), otherwise known as the Deficit Reduction Act of 1984. This increased the EITC benefit to 11 percent with a maximum of $550.

The cost of the EITC nearly doubled during the first decade of its existence, increasing from $1.3 billion to $2.5 billion. And if that wasn’t enough, substantial expansions to the EITC program were implemented in 1986, 1990, and 1993.

Beginning with the 1987 tax year, the EITC escalated. Public Law 99-514 (H.R. 3838), signed by President Reagan on October 22, 1986, as the Tax Reform Act of 1986, increased the EITC to 14 percent with a maximum of $851. The figure then rose steadily to a maximum of $953 in 1990, with a partial benefit available for incomes up to $20,264.

In 1990, President George Bush signed Public Law 101-508 (H.R. 5835), which greatly expanded the EITC system for the next three years. Not only did benefits go up, more dollars were awarded if one had two children instead of one. Also new was an additional credit of up to $357 if a child was under one year of age, and a maximum credit of $428 if any health insurance premiums were paid to cover a child. By 1993, the maximum EITC was up to $1,511.

Although the EITC was introduced under Ford, and increased under Carter, Reagan, and Bush, it skyrocketed under Clinton. The Omnibus Reconciliation Act of 1993 increased the maximum EITC payment over $1000 to a whopping $2,528. In 1995 this went up to $3,110, and in 1996 the maximum EITC one could receive increased to $3,556. Also introduced in 1994 was an EITC payment for a single person with no dependents.

If Republicans put into practice their campaign rhetoric, then the Republican control of the Congress for the last ten years should have resulted in at least a reduction of the EITC program, if not its outright elimination. Such has not been the case, however, for the program now costs more than the federal AFDC budget, and has even spread to the states. Seventeen states now offer tax credits for "working families" based on the federal EITC.

Like any other government program, the cost of the EITC has gone up every year. The maximum available payout has increased from a modest $400 in 1975 to a whopping $4,204 for 2003.

The cost of the EITC program will continue to escalate since any talk of a reduction in this program will be labeled "balancing the budget on the backs of the poor." The feeble GOP attempts at EITC reform were denounced by President Clinton as a tax hike. From the fiscal year 2004 "Budget of the United States" (Analytical Perspectives, Table 6-1), U.S. Treasury Projections of future Federal EITC Costs are as follows:

And not only is the EITC program expensive, it is rife with fraud. In 1994, former Senator and Treasury Secretary Lloyd Bentsen stated: "By the time we release the 1996 budget – early next year – we will develop measures to deny the Earned Income Tax Credit to illegal aliens. The IRS estimates that over 150,000 illegal aliens claimed the EITC this year for last year’s taxes." A February 2002 IRS study reported that in the 1999 tax year approximately $9 billion or 30 percent of the 1999 tax year EITC should not have been paid. Fraud is so rampant in the EITC program that President Bush proposed in his fiscal year 2004 budget a $100,000 million appropriation for additional staff to police the EITC program.

The EITC should not be reformed or reduced, it should be eliminated. But it should not be eliminated because it is a refundable tax credit or because it is too expensive or because it has a high rate of fraud. It should be eliminated because it is a massive income redistribution scheme. Clinton’s Secretary of Health and Human Services, Donna Shalala, described by The Washington Post as "one of the most successful government managers of modern times," maintained that the EITC "gives a tax refund to the working poor." But the EITC is not a tax refund, one does not have to be working to receive it, and neither does one have to be poor. And since a worker can get advance EITC payments included in his paycheck, the EITC is the equivalent of a pay increase, courtesy of hard-working taxpayers. But because it is now a major cornerstone of the welfare state, neither a reduction in the maximum EITC amount nor the complete elimination of the EITC program is on the Congressional agenda.

It is high time that the EITC program be exposed for the income redistribution program it really is. A better name for it would be UITP: the Unearned Income Transfer Payment. But until the members of Congress commit to the wholesale dismantling of the welfare state, the EITC, like the income tax itself, is here to stay.

April 14, 2004

Laurence M. Vance [send him mail] is a freelance writer and an adjunct instructor in accounting and economics at Pensacola Junior College in Pensacola, FL. Visit his website.

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