As a followup to my February 17th post, entitled NC EITC is not the answer, I thought I would expand on my reasoning on why I do not favor the earned income tax credit (EITC). Beyond the improper or fraudulent payments amounting to almost one-quarter of credits paid, the EITC discourages many workers from working more or pursuing a higher paying job.
EITC summary
Briefly, the EITC is a credit to encourage the poor to work. If someone has no earned income (generally wages or self-employment income), they get no EITC. As they earn more and have more children, the credit gradually increases to a maximum of $6,242 in 2015 for a married couple filing a joint return with three or more qualifying children. For each dollar earned over $23,649, the married couple loses some EITC until it is all gone once they have income above $53,266. The amounts are different for single taxpayers and those without fewer then three children.
I think we can all agree that at some point people make enough they do not need a tax credit to encourage them to work. Where is the magic number where they no longer need the government’s encouragement? It varies based on living costs and on each persons view of what is enough to live on. I would hope we can all agree someone making $1 million does not need the EITC to encourage them to work.
Encourages work
A married couple with at least three qualifying children making zero gets no EITC credit. If one or both spouses goes to work and earns at least $13,850 but less than $23,649, they get an EITC of $6,242. Earning the minimum means the federal government gives them $6,242 or almost 46% of their wages. A pretty good incentive for one of them to find a job. Adding an NC credit at 10% like Progressive Pulse recommended results in an additional $624 in EITC for a total of $6,866 or almost a 50% tax-free raise beyond the $13,850 in wages.
An aside
Lets be realistic, who can support themselves, their spouse and three or more children on income of $20,280 after taxes? (Gross wages of $13,850 + federal EITC $6,242 + proposed NC EITC $624 – Social Security & Medicare tax of $1,060). Rent and some food take care of all of that, rent might take care of all of it and more. That seems to be the reason Congress left the maximum at $6,242 until the family makes more than $23,649. Even at $23,649 the net after income and payroll tax is only about $28,706. Still extremely difficult to take care of a family of five. Note I am ignoring the child credits and any other credits since this post is about the EITC.
Discourages work
So what does Congress do to help the family of five try to cover their expenses beyond $28,706 net of taxes? Congress punishes them for earning more. Yes, punishes them by taking away some of the EITC credit. Lets say our example family of five starts making $33,850. A raise of about $20,000 versus $13,850. That is good, right? Our family now owes $126 of federal income tax and $1,084 of NC income tax. They also owe $1,530 more in Social Security and Medicare taxes.
Look at this chart:
See the peak? An effective marginal income tax rate of over 36% for the next $1,000 earned above $52,000. In 2015, the 35% bracket starts at $411,500 for a married couple filing a joint return. The next $1,000 the couple makes above $411,500 causes an extra $350 of income tax. But a couple making the next $1,000 above $52,000 will pay $361 of tax on that next $1,000. That is not right! Oh, but yes it is right. The EITC causes the marginal income tax rate the EITC middle class to pay a higher marginal rate than a couple making as much as $464,850 (the top of the 35% bracket).
So if a married couple with three or more qualifying children qualifies for the EITC, they are strongly encouraged to work from zero to about $25,000. Then the way the EITC phases out as income increase, they are being discouraged from earning more as their marginal tax rate goes to 21%. It only gets worse until about $54,000 when their marginal tax rate finally falls back to 15%. Interestingly, for 2015 the federal poverty income for a family of five is $28,410. So the EITC is designed to raise taxes on some people making less than the federal poverty level income.
Conclusion
There has to be a better way than wasting at least $14.5 billion (in 2013) on improper EITC payments and then adding insult to injury by charging high marginal income tax rates on people trying to lift themselves out of poverty. I will leave it to others to come up with a better plan. My feeling is the tax law is the wrong place to try to provide incentives and assistance to the working poor.
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