One way the U.S. federal income tax system provides low-income families with financial support is through refundable tax credits. Families can claim refundable tax credits even if they do not owe any tax liability, which allows families with the lowest incomes to receive benefits. Two of the largest refundable tax credits are the Earned Income Tax Credit (EITC) and the refundable portion of the Child Tax Credit (also known as the Additional Child Tax Credit). Both credits target the working poor.
In tax year 2015, over 28 million families claimed the EITC and nearly 20 million families claimed the refundable portion of the Child Tax Credit. The average credit claimed per EITC and refundable Child Tax Credit beneficiary was about $2,440 and $1,350 per family, respectively (IRS, 2017).
Much of the existing literature on refundable credits focuses on the EITC. Studies have found that the EITC promotes the likelihood that single mothers work (Eissa and Liebman, 1996; Meyer and Rosenbaum 2000, 2001; Grogger, 2003) and has significant impacts on reducing the likelihood that low-income families are in poverty (Hoynes and Patel, Forthcoming). The literature also uses variation in EITC policy over time to estimate the impact of providing income support on a variety of outcomes. For example, researchers have found evidence that additional income support improves children's academic achievement, college attendance, and maternal and infant health (Dahl and Lochner, 2012; Evans and Garthwaite, 2014; Hoynes et al., 2015; Manoli and Turner, Forthcoming). These studies demonstrate that cash assistance targeted to low-income populations can be effective in improving their well-being along multiple dimensions.
People with the Lowest Income Get Left Behind
Tax returns must be filed to claim these benefits. However, those with the lowest incomes are not required to file a tax return. As an example, see the 2017 EITC schedule for unmarried filers with no children, one child, and two children in the figure below. The credit phases in with earnings, plateaus, and then phases out with earnings.
The vertical lines are the filing thresholds for single filers and head-of-household filers. This figure shows that large portions of the EITC schedule for unmarried filers fall below the filing threshold, especially for unmarried filers without children. This suggests that households at the very low end of the income distribution may be less likely to get the EITC because they are not required to file a tax return, but instead must actively choose to do so. In fact, a study by Plueger (2009) shows that non-filers made up two-thirds of eligible EITC nonparticipants in 2005.
Filing Can Improve Economic Well-Being Among Those with the Lowest Income
My recently published paper coauthored with Shanthi Ramnath, an economist with the Department of the Treasury, highlights the importance of filing a tax return for individuals in the lowest part of the income distribution (Ramnath and Tong, 2017). The research studied the anti-poverty effects of filing using variation in the incentive to file created by the Economic Stimulus Act of 2008, which provided a one-time stimulus check to low- to middle-income workers. To be eligible, workers had to have at least $3,000 in earnings in 2007. The stimulus checks generally ranged from $300 to $600 ($600 to $1,200 if married), though individuals with children were able to claim higher amounts. To get the stimulus check, individuals were required to file a 2007 tax return. This requirement caused individuals who were previously non-filers to enter into the tax filing population, according to our research. Furthermore, entering the filing population caused increases in the likelihood of filing future tax returns and increases in the likelihood of having wage earnings in subsequent years, meaning that filing prevented individuals from dropping out of the working population. Filing a 2007 tax return also caused wage earnings to be higher relative to those who did not file. Our research also finds that inducing low-income individuals into the tax-filing population via the stimulus increased the probability that individuals claimed the EITC, suggesting that once people enter into the filing population, they are more likely to claim benefits. These changes in future filing, workforce attachment, earnings, and EITC claiming reduced the likelihood that these new filers were living in poverty in future years.
Although the effectiveness of the EITC has been well documented, current discussions about tax reform in the United States generally leave changes to refundable credits off the table. Our study demonstrates that low-income workers with earnings below the filing threshold are targeted by anti-poverty tax transfers like the EITC, but these individuals may only learn about these benefits when they file. We also show that increasing the incentive to file draws people into the tax filing population. Based on our research, a couple of options could potentially improve the well-being of low-income populations.
- Expand the childless EITC. The childless EITC targets individuals with the lowest income and is the least generous. While the maximum credit is quite large for families with children, ranging from $3,400 for a family with one child to over $6,300 for a family with three or more children, the maximum credit for childless claimants is only $510. Policymakers from both sides of the aisle have proposed expansions to the childless EITC in the past, demonstrating that there could be scope for compromise on this front. Our findings suggest that increasing the benefit to filing, perhaps through an expansion of the childless EITC, could potentially draw more low-income individuals into the tax filing population, and thus improve their economic well-being.
- Outreach to low-income populations. Our study shows that incentivizing low-income individuals to file a tax return increases their future likelihoods of filing and claiming the EITC. This could suggest that these individuals were previously unaware about tax transfer benefits. Outreach to non-filers could be done to generate greater awareness, and research shows this can be effective. In particular, Guyton et al. (2016) conduct a randomized control trial to demonstrate that sending one-time reminders to low income non-filers about their potential EITC increases their propensity to file and claim benefits.
As the debate over tax reforms continues, determining ways to help the most disadvantaged segment of the population should be considered. These two potential options would increase the incentive to file or promote awareness about tax transfer benefits. Our study demonstrates that promoting entry into the tax-filing population has persistent effects on economic activity and poverty. If these proposed policy changes increase entry into the tax-filing population, they could generate positive impacts in the longer term.
-  There is also a separate schedule for families with 3 or more children that is not included in the figure above.
-  Head of household filers are unmarried filers with dependents. The filing thresholds were calculated by taking the sum of the standard deduction and one personal exemption.
-  For example, both President Obama and Republican House Speaker Paul Ryan have proposed expanding the childless EITC.
- Dahl, Gordon B., and Lance Lochner. 2012. “The Impact of Family Income on Child Achievement: Evidence from the Earned Income Tax Credit.” American Economic Review 102 (5): 1927-1956.
- Eissa, Nada, and Jeffrey B. Liebman. 1996. “Labor Supply Response to the Earned Income Tax Credit.” The Quarterly Journal of Economics 111 (2): 605-637.
- Evans, William N., and Craig L. Garthwaite. 2014. “Giving Mom a Break: The Impact of Higher EITC Payments on Maternal Health.” American Economic Journal: Economic Policy 6(2): 258-90.
- Grogger, Jeffrey. 2003. “The Effects of Time Limits, the EITC, and Other Policy Changes on Welfare Use, Work and Income Among Female-Headed Families.” The Review of Economics and Statistics 85(2): 394-408.
- Hoynes, Hilary W., Douglas L. Miller, and David Simon. 2015. “Income, the Earned Income Tax Credit and Infant Health.” American Economic Journal: Economic Policy 7(1): 172–211.
- Hoynes, Hilary W. and Ankur Patel. Forthcoming. “Effective Policy for Reducing Poverty and Inequality? The Earned Income Tax Credit and the Distribution of Income. Journal of Human Resources.
- Guyton, John, Dayanand Manoli, Brenda Schafer and Michael Sebastiani. 2016. “Reminders and Recidivism: Evidence from Tax Filing & EITC Participation Among Low-Income Nonfilers. NBER Working Paper no. 21904. Cambridge, Mass.: National Bureau of Economic Research, January.
- Manoli, Day, and Nick Turner. Forthcoming. “Cash-on-Hand and College Enrollment. Evidence from Population Tax Data and the Earned Income Tax Credit. American Economic Journal: Economic Policy.
- Meyer, Bruce D., and Dan T. Rosenbaum 2000. “Making Single Mothers Work: Recent Tax and Welfare Policy and its Effects.” National Tax Journal 53(4, part 2): 1027-1062.
- ———. 2001. “Welfare, the Earned Income Tax Credit, and the Labor Supply of Single Mothers.” Quarterly Journal of Economics 116(3): 1063-1114.
- Plueger, Dean. 2009. “Earned Income Tax Credit Participation Rate for Tax Year 2005 (PDF).”
- Ramnath, Shanthi P. and Patricia K. Tong. 2017. “The Persistent Reduction in Poverty from Filing a Tax Return.” American Economic Journal: Economic Policy 9(4): 367-394.
- (IRS) Statistics of Income—2015 Individual Income Tax Returns Line Item Estimates. 2017. Washington, D.C.: Internal Revenue Service.
Patricia K. Tong is an economist at the RAND Corporation.
This commentary originally appeared on Council on Economic Policies on November 21, 2017. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.