By Wyatt Clarke, 2015 Summer Fellow for the National Research Center on Hispanic Children and Families
Mariela, a hypothetical single mom with two kids, just filed her 2015 federal taxes. Her adjusted gross income this year was $25,000. She’s receiving a tax refund of over $4,000 (despite having paid no income tax), thanks, largely, to the Earned Income Tax Credit (EITC). But that’s not exactly the subject of this blog post. Instead, I want to talk about what would have happened if Mariela’s earned income had been one dollar more, or $25,001. Would she have had 1 dollar more to spend?
The answer requires some understanding about how the EITC works. It is a refundable federal tax credit that has been around since the 1970s and acts as one of the federal government’s biggest anti-poverty programs. It’s refreshingly simple: the IRS adds money to each dollar a worker earns up to an income limit. Above a higher income limit, the IRS starts to “phase out” – or take back – that money until none of the credit is left (see figure).
This can be an issue for Hispanic children and families. A disproportionate number of Hispanic kids – 30 percent, according to a brief we released in February – live in “near poverty.” That is, their household incomes are in the range of 100 to 200 percent of the federal poverty level. This closely overlaps with the EITC “phase out” zone. Let’s use the example shown in the figure above to think about what this might mean for Hispanic families.
The EITC adds 40 cents per dollar to the first $13,870 of earned income for a single mother of two, like our fictional Mariela. After that, Mariela’s credit stays at its maximum level until her earnings reach $18,110 (which is 90 percent of the 2015 federal poverty level of $20,090, for a single parent of two). Past that, the IRS “phases out” the credit at a rate of 21 cents per dollar earned until no EITC credit is left, when her earnings reach $44,454.
To think of this another way, imagine Mariela’s annual income as a jar that she fills up over the course of the year. At the beginning of the year while the jar is nearly empty, for every $1 that Mariela adds to the jar from her paycheck, the IRS adds an additional $0.40 because of the EITC. Later in the year, once the jar is a bit fuller, the IRS starts to take out $0.21 for every $1 that Mariela adds. (This corresponds to the downward sloping part of the figure; Mariela will still get a positive EITC credit from the IRS at the end of the year since her earnings are below $44,454, but the credit decreases by $0.21 with each additional dollar she earns.) Meanwhile, the IRS and Mariela’s state department of revenue are taking money out of the jar for taxes too. Toward the end of the year, after Mariela has added $25,000 of her own money to the jar, what would happen if she added one more dollar? Tax authorities would take away about $0.50 of that additional dollar earned.
So far, we are only thinking about money added and subtracted to Mariela’s jar by tax authorities like the IRS and her state department of revenue. However, at the beginning of the year, when Mariela’s jar was nearly empty, other parts of the government also contributed to her jar: Medicaid put in some money to cover health insurance, WIC covered part of her grocery bill, and CCDF may have provided a subsidy to cover part or all of Mariela’s kids’ child care. When Mariela considers adding that additional dollar beyond the $25,000 of earnings to the jar at the end of the year, she can expect the government to take some of that money back, too. When you take the subtraction of benefits from these safety net programs into account, according to the Congressional Budget Office, Mariela’s jar may only benefit $0.10 from the last dollar she contributes.
That’s a pretty high effective marginal tax rate: if a single mother of two participates in all the government programs available to her, for every dollar she earns between 100 and 200 percent of the federal poverty level, she loses around $0.50 to $0.90 in government benefits. This causes a host of problems but is not an easy policy puzzle to address. Math dictates that the only ways to lower effective marginal tax rates for near-poor families are to lower the benefit level for poor families (such that they wouldn’t be losing as much in government benefits as their income rose), or extend benefits to families with higher incomes. The first option would erase safety net programs; the second would bust the budget.
Regardless of policymakers’ concerns, though, the fact remains that one third of Hispanic children are growing up in families only slightly above the poverty level, with their parents likely to gain only $0.50 from the next dollar they earn.
Do you know of any innovative ideas to improve the tax code?
Wyatt Clarke is a father of one with a 2015 marginal tax rate of 50 percent. He was also a 2015 Summer Research Fellow at the National Research Center on Hispanic Children & Families and is currently a doctoral student in economics at the University of California-Irvine.