Here We Go Again

Legislation has been introduced this session to reinstate North Carolina’s Earned Income Tax Credit (EITC), which was ended on January 1, 2014 as part the historic conservative Tax Reform package that was passed in 2013. Despite its innocuous name, this idea is simply another government handout with serious and significant consequences for the state.

Senate Bill 181 and House Bill 499 (and its companion bill in the Senate, SB576) are the latest in nearly a dozen attempts over the last four biennia to reinstate North Carolina’s EITC — none have thus far succeeded (in the 2019-2020 biennium: SB734, HB238, SB137, SB50, and HB46; in the 2017-18 biennium: SB174 and HB238; in the 2015-16 biennium: HB1076, SB757, SB275, and HB27; and two bills in the 2013-2014 biennium, HB152 and SB185, aimed to delay the sunset provision for five years, from January 1, 2014 to January 1, 2019).

North Carolina’s version of the EITC was first enacted in July 2007 by the General Assembly, a year before the Great Recession hit. Fiscal conservatives opposed the extension of North Carolina’s EITC’s program in 2013 as being reckless and unsustainable: between 23 and 28 percent of all state EITC claims were paid in error.

According to one estimate, because of errors and fraud, state EITC programs cost taxpayers more than $1.3 billion. A report by the United States Treasury Department’s Inspector General showed that 25% of EITC payments were made in error, amounting to more than $13 billion in wasted taxpayer dollars (by way of comparison, the food stamps program has an error rate of below five percent).

And from a 2015 Cato Institute report:

“The EITC has a high error and fraud rate, and for most recipients it creates a disincentive to increase earnings. Also, the refundable part of the EITC imposes a $60 billion cost on other taxpayers, reducing their incentives to work, invest, and pursue other productive activities.

We conclude that the costs of the EITC are likely higher than the benefits. As such, the program should be cut, not expanded. Policymakers could better aid low-income workers by removing government barriers to investment, job creation, and entrepreneurship.”

Background

The Earned Income Tax Credit (EITC) is a public assistance program for lower-income folks who are employed. There are many other types of government assistance programs for lower-income people who do not or cannot work (currently, the federal government spends $1 trillion a year on anti-poverty programs, not including Social Security and Medicare); but to qualify for the EITC, you must have a job — hence the term “earned income.” The EITC is calculated as a percentage of that earned income.

The EITC comes in two forms: the federal EITC and, in some cases, a state EITC. 28 states and the District of Columbia currently offer their own EITC payments on top of payouts from the federal EITC program.

The federal EITC program was first established in 1975 during the Ford administration as an attempt to reduce poverty in a time of rising food and energy prices. It has been expanded greatly by every Congress since: in fiscal year 1976, its total value was $1.1 billion; as of December 2020, its value was approximately $62 billion.

Although the EITC was intended as a temporary program, in the 1990s, it became a major component of federal efforts to reduce poverty. It is now the country’s largest anti-poverty cash entitlement program: nationwide, as of December 2020, about 25 million taxpayers received about $62 billion in EITC.

Both the federal EITC and the various state EITCs come in the form of what’s called a “refundable tax credit.”

A tax credit is an amount that’s deducted from the amount of taxes you owe. For example, if you owe $100 in taxes but you qualify for a tax credit of $25, you would only owe $75.

Despite its name, a tax deduction isn’t actually deducted from the amount of taxes you owe. A tax deduction is an amount that reduces the taxable income on which your taxes are based. For example, if your annual income was $50,000 and you claim a deduction of $5,700, then your taxable income would be $44,300 ($50,000 minus $5,700 = $44,300). Put another way, a deduction is an amount of your income that cannot be taxed.

Depending on what tax credits and deductions are claimed, the amount of tax a person owes (called the “tax liability”) even can get down to zero.

Refundable tax credits like the EITC are contrasted with nonrefundable tax credits. The vast majority of government tax credits are nonrefundable — meaning that although they reduce a person’s tax liability, the amount isn’t refunded to the taxpayer. With a refundable tax credit like the EITC, it is.

A “refundable tax credit” is not just an amount that is deducted from the amount of taxes you owe, it is directly paid back to an individual — hence the term “refundable.” Basically, rather than withholding the tax, the money is available with your paycheck. (Not to confuse the matter even more, but strictly speaking, the amount that is paid back through a refundable tax credit isn’t really refunded — it is paid beforehand. A refund suggests paying something in to get something back. But unlike a “tax refund” — the total amount you overpaid in taxes with every paycheck throughout the year and which the government owes you back — recipients of refundable tax credits like the EITC can get their check before paying anything in — if they pay anything in at all.)

For the 2020 tax year, the federal EITC payment to a single person (or couple) filing without qualifying children is $1,502. The federal EITC payment goes up to $3,584 with one child; $5,920 with two children; and $6,660 with three or more children. In North Carolina, 890,000 North Carolinians claimed the federal Earned Income Tax Credit last year with an average amount of $2,506.

To qualify for the federal EITC program, a person must be working and their earned income and adjusted gross income (2020 tax year) must be less than:

  • $50,954 ($56,844 married filing jointly) with three or more qualifying children
  • $47,440 ($53,330 married filing jointly) with two qualifying children
  • $41,756 ($47,646 married filing jointly) with one qualifying child
  • $15,820 ($21,710 married filing jointly) with no qualifying children

Additionally, investment income (including interest, dividends, capital gains, and royalties) cannot exceed $3,650 as of tax year 2020.

Eligibility requirements for state EITC programs generally mirror that of the federal program. In other words, if you are eligible to receive federal EITC payments, you are also eligible to receive additional money under a state’s EITC program (if one is offered). If the federal government expands its EITC eligibility to include more people (which it has many times), the state’s EITC programs are forced to grow at the same time.

The states which offer their own EITC payments (on top of the federal EITC payment) calculate their amounts based on a percentage of the federal EITC. It varies greatly by state: on the high end of the scale, Maryland’s EITC pays an additional 50% of the federal EITC, the District of Columbia’s pays an additional 40% of the federal EITC, Minnesota’s pays an additional 35% of the federal EITC, and New York’s pays an additional 30%. On the lower end of the scale, Maine and Oklahoma pay an additional 5%, and Montana’s pays an additional 3%.

When the EITC was first instituted here in 2007, North Carolina paid out at an additional 3.5% of the federal EITC; the amount was then increased in the 2008 short session to pay out at 5% of the federal EITC. In 2012, the Obama administration expanded eligibility for the federal EITC program; in response, in 2013, the General Assembly trimmed back the rate at which the state paid out its EITC benefits from 5% to 4.5%.

In 2013, the average payout of North Carolina’s state EITC benefit was about $120 a year, or 34¢ a day. The total cost of the program to North Carolina’s taxpayers was over $100 million.

This session’s Senate Bill 181 would reinstate North Carolina’s EITC at 5% of the federal EITC; House Bill 499 (and its companion bill SB576) would reinstate the program at a whopping 20% of the federal payment.

Instead of bowing to political pressure, the General Assembly should continue to pursue tax reform that benefits all North Carolinians. The reform majority has our state’s economy humming. The EITC is an unnecessary, harmful idea.

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