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President Trump and some Members of Congress are promoting a payroll tax cut to respond to the growing coronavirus outbreak. But if they are looking to stimulate or steady the overall U.S. economy, they might explore a more productive solution—building on the earned income tax credit (EITC).
During a recession, policymakers should focus on enacting policies that can boost the economy and provide income security to people who are vulnerable. Because the EITC delivers targeted tax relief to low- and moderate-income workers, it would do both.
Providing income security
The EITC is the most widely received cash assistance program for low- and moderate-income working families. In 2020, the Tax Policy Center estimates over 27 million households will receive almost $69 billion in reduced income taxes and payments of tax refunds. The EITC rises by a fixed percentage from the first dollar of earnings until the credit reaches a maximum. Once a taxpayer’s earnings hit a phaseout range, the credit falls with each additional dollar of income until it disappears entirely.
Compared to other typical options to combat recessions, the EITC concentrates a larger share of its benefits on low- and moderate-income workers. Nearly 90 percent of EITC benefits go to the 40 percent of households with the lowest-incomes.
Unemployment insurance, designed to offset job loss, does not provide benefits to people who remain employed but whose work hours are cut. In contrast, a worker who loses hours might become eligible for the credit or eligible for a larger payment (if they are in the phaseout range of the EITC). While a person who loses their job entirely for the calendar year would be ineligible for the EITC (since it only goes to those who work), a two-earner family where one worker is laid off could benefit. The annual nature of EITC eligibility also means the credit will go to many who lose jobs – so long as the job loss is only for a portion of the year.
Boosting the economy
The EITC is much better targeted to low-income families than other tax cuts policymakers might look to in economic slowdowns, such as a payroll tax cut or having the Treasury send a check to all or even most families. As a result, it’s likely that additional subsidies directed at EITC recipients would be spent, rather than saved. That means expanding the EITC could have a bigger effect – per dollar spent – than broader measures.
Options for EITC recipients in a recession
One possible way to use the EITC to jumpstart the economy is to advance payments. Under current law, families receive the EITC only once each year, when they file their tax returns—something many have just done for tax year 2019. Thus, eligible taxpayers are not scheduled to receive another EITC payment until early 2021. However, Congress could allow eligible taxpayers to estimate their EITC for the coming year and receive an early payment. This wouldn’t necessarily increase government spending long-term, but it could direct cash in a timelier way to people likely to feel pinched if the economy slows.
Alternatively, policymakers could provide an additional payment to existing EITC recipients, based on claims made on income tax returns filed early in 2020. Under this design, low- and moderate-income workers would get an extra payment this year, without cutting into the EITC they will qualify for during next tax filing season.
Congress also could adopt a permanent structural change and have the IRS deliver EITC benefits throughout the year, a key feature of the Economic Security Project’s Cost-of-Living Refund. Such an advance payment mechanism would provide a ready-made solution to delivering cash to low-income workers now and in the future. Of course, this approach would require a way to prevent the IRS from making over-payments to taxpayers throughout the year.
Like all policies, using the EITC to deliver benefits during an economic downturn has some shortcomings. Under current law, workers without children at home qualify for very small benefits and only at very low income levels. And since only people who have earnings can qualify for the EITC, someone who loses a job for the entire calendar year would be ineligible for benefits.
The Cost-of-Living Refund could help close some of those gaps. The Cost-of-Living Refund would extend benefits to low-income caregivers and students, even if they did not work for pay during the year. The benefit amount under the Cost-of-Living Refund is based almost entirely on whether a person is single or married, without regard to the number of children in the household (similar to provisions in the LIFT Act). The credit would be available to younger workers without children and available to more elderly workers. Similar reforms are included in the LIFT Act and Working Families Tax Relief Act.
The EITC is not a perfect policy response to an economic slowdown. But, by advancing or increasing payments under the EITC, Congress could use an existing program to target anti-recessionary tax benefits to low- and moderate-income workers, and get the most bang for the fiscal buck.