Boosting Incomes and Improving Tax Equity with State Earned Income Tax Credits in 2021
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The Earned Income Tax Credit (EITC) is designed to boost low-wage workers’ incomes and offset some of the taxes they pay, providing the opportunity for lower-income families to move toward meaningful economic security. The federal EITC has kept millions of Americans out of poverty since its enactment in the mid-1970s. Over the past several decades, the effectiveness of the EITC has been amplified as many states have enacted and expanded their own credits.
The EITC benefits low-income people of all races and ethnicities. But it is particularly impactful in historically excluded Black and Hispanic communities where discrimination in the labor market, inequitable educational systems, and countless other inequities have relegated a disproportionate share of people to low-wage jobs.
In the wake of the ongoing COVID-19 pandemic, families across the nation continue to struggle to meet their basic needs. The pandemic affected all communities, but low-wage households felt the hardest economic blow, and many still haven’t recovered. The August 2021 jobs report reveals that unemployment for white households is 4.5 percent. It’s nearly double for Black households at 8.8 percent and 30 percent higher for Hispanic households at 6.4 percent. Food insecurity and insufficient resources to pay rent or mortgage are widespread.[1] Proven and effective income supports—like the EITC—are more important than ever. Even during periods of economic growth, too many workers have faced low and slow-growing wages, while simultaneously feeling the squeeze of the growing costs of food, housing, childcare, and other basic household expenses. To make matters worse, in 46 states low-income households pay a higher share of their incomes in state and local taxes than the richest households.[2] This leaves working families with even fewer resources to make ends meet and contributes to ever-growing income and wealth inequality.
Expanding the EITC at the federal and state levels can increase the policy’s effectiveness. To this end, this policy brief provides an overview of federal and state EITCs and highlights recent trends to strengthen these credits.
The Federal Earned Income Tax Credit
The federal EITC has been supplementing and boosting the income of low-wage workers since 1975. Lawmakers have improved the credit since then so more working families have the means to live above the federal poverty threshold. Most recently, the American Rescue Plan Act of 2021 temporarily increased the federal credit for low-wage workers without children in the home and made it more widely available to them by expanding age and income limits. The Biden Administration’s American Families Plan would permanently extend this critical expansion, currently set to expire at the end of tax year 2021. Congress is currently debating the continuation of the enhancement in its budget reconciliation package.
The federal EITC delivered about $62 billion to 25 million working families and individuals in 2020, through claims on their 2019 tax returns.[3] The credit’s impact will undoubtedly grow in 2021. Used mostly as a source of temporary support, the EITC helps millions of families each year–including veterans making their way back into the civilian workforce–cope with job loss, reduced hours, or reduced pay. Recognized widely as an effective anti-poverty tool, the federal EITC, together with the federal Child Tax Credit (CTC), lifted an estimated 5.3 million people out of poverty in 2020, according to data from the Census Bureau.
The EITC is based on earned income, such as salaries and wages. For example, for each dollar earned up to $15,170 in 2022, families with three or more children will receive a tax credit equal to 45 percent of those earnings, up to a maximum credit of $6,827. Because the credit is designed to boost incomes for low- and moderate-income workers, income limits restrict eligibility for the credit. Families continue to be eligible for the maximum credit until income reaches $19,810 for single heads of household. Above this income level, the value of the credit is gradually reduced to zero and is unavailable when family income exceeds the maximum eligibility level. Single-parent households with three or more children earning more than $52,227 or more a year are ineligible as are married couples earning $58,277 or more. Absent federal action that would extend recent EITC enhancements, the credit will once again become much less generous for workers without children in the home: the maximum credit dropping to $551 (from $1,525) while single filers earning more than $16,210 (or $22,250 for married couples without children in the home) would again become ineligible.
State Earned Income Tax Credits
In addition to helping working families afford childcare, health care, housing, food and other basic necessities, EITCs at the state level play an important function in improving the equity of upside-down state and local tax systems. Unlike federal taxes, state and local taxes are regressive, requiring low- and moderate-income families to pay more of their income in taxes than wealthier taxpayers. According to ITEP’s 2018 Who Pays? report, the poorest 20 percent of Americans pay 11.4 percent of their incomes in state and local taxes. By contrast, middle-income taxpayers pay 9.9 percent and the wealthiest 1 percent of taxpayers pay just 7.4 percent of their incomes in state and local taxes. Heavy use of regressive sales and property taxes (all of which working families pay) drive the high state and local tax rates faced by the poorest households. A refundable state EITC is among the most effective and targeted tax reduction strategies to help offset these regressive taxes.
Refundability is key to the EITC’s success, especially at the state level. If a credit is refundable, taxpayers receive a refund for the portion of the credit that exceeds their income tax bill. Refundable credits can therefore be used to help offset all taxes paid, not just income taxes, thereby offsetting some of the regressive effects of state and local sales, excise, and property taxes.
To date, nearly two-thirds of states (30 states plus the District of Columbia and Puerto Rico) offer EITCs based on the federal credit (see Appendix). With a few exceptions (California, Minnesota, and Washington State), most taxpayers calculate their state-level EITC as a percentage of the federal credit. This approach of linking state credits to the federal makes it easy for states’ taxpayers to claim the credit (since they have already calculated the amount of their federal credit) and straightforward for state tax administrators. However, states vary dramatically in the generosity of their credits. The EITC provided by the District of Columbia, for example, amounts to 40 percent of the federal credit this year and is set to increase to 100 percent of federal by tax year 2026, matching their existing 100 percent of federal for workers without dependents in the home). Meanwhile, five states have credits that are worth less than 10 percent of the federal credit. Five states (Hawaii, Missouri, Ohio, South Carolina, and Virginia) allow only a non-refundable credit, limiting the ability of the credit to offset regressive state and local taxes. Just this year, Delaware lawmakers signed legislation to allow EITC recipients to choose a non-refundable credit of up to 20 percent or a refundable credit of up to 4.5 percent of the federal EITC and Oklahoma restored the refundability of its EITC.
New Trends and Forward Momentum
Enacting New EITCs and Increasing the Size of Existing Credits
There have been a number of advancements in EITC policy at the state and federal level in recent years. This year alone, the District of Columbia once again lead the way in state-level EITC enhancements, making it the most effective EITC in the nation. Funds from the District’s tax increase on residents making more than $250,000 a year helped fund a 100 percent match to the federal EITC beginning in tax year 2026.
Washington state, now also exemplifying EITC best practices, modeled their Working Families Tax Credit after the federal EITC and enhanced it through added improvements: the inclusion of immigrant families and effectively eliminating the phase-in so that all families with any amount of earned income can qualify for the full value of the state’s credit. The state has had an EITC on the books since 2008. But it was not until this year that lawmakers took steps to improve its structure and fully fund its implementation.
In Missouri, the legislature passed a 10 percent non-refundable state-level EITC set to go into effect in 2023. While a major milestone, the nature of the non-refundable credit prohibits lower-income taxpayers from receiving a refund for the portion of the credit that exceeds their income tax liability. This leaves room for reform and a push for refundability in the years to come.
In addition to the notable enhancements in the District of Columbia, Washington state, and Missouri, a number of other states also increased their state-level EITCs this year: Colorado, Connecticut, Indiana, Maryland, and New Mexico. Meanwhile, both Oklahoma and Delaware recognized the importance of refundability.
- Colorado boosted its EITC to 20 percent (up from 15 percent) starting in 2022. The credit will temporarily increase even further (to 25 percent) between 2023 and 2025, before reverting to a 20 percent credit in 2026. The higher credit amount is coupled with an age expansion, lowering eligibility to permanently include adults without children in the home who are between the ages of 19 and 24, and extending benefits to ITIN filers.
- Connecticut lawmakers took steps this session to restore and slightly increase their state-level EITC to 30.5 percent (up from 23 percent).
- Indiana lawmakers increased their credit from 9 percent to 10 percent.
- Maine temporarily increased its credit for families with children from 12.5 percent to 20 percent for tax year 2021.
- Maryland lawmakers enacted temporary, yet highly effective, enhancements to their state-level EITC. They increased the credit to 45 percent of the federal credit and to 100 percent for workers without children in the home (capped at $530), with full refundability. The state also extended its EITC to immigrant workers who file taxes using an Individual Taxpayer Identification Number (ITIN) and previously expanded it to workers without children in the home aged 18 through 24.
- Lawmakers in New Mexico increased their state credit, known as the Working Families Tax Credit, from its current 17 percent to 25 percent by 2023. They also extended eligibility to ITIN filers and younger workers, 18 through 24, without children in the home.
Delaware passed legislation to allow EITC recipients to choose a non-refundable credit of up to 20 percent of the federal credit or a refundable credit of up to 4.5 percent of the federal EITC.
In Oklahoma, lawmakers restored refundability to their state-level EITC. The credit, set at 5 percent of the federal, was made non-refundable in 2016 in response to a budget shortfall. Restoring refundability goes a long way in ensuring that recipients can receive their full credit, regardless of whether it exceeds the personal income taxes they owe.
Three states—California, Maryland, and New Mexico—opted to further improve the economic security of their lowest-income residents, on a temporary basis, by providing one-time cash payments to their state EITC recipients. In California, the income-boosting payment also extended to filers with Individual Taxpayer Identification Numbers (ITINs) who were largely left out of the 2020 federal stimulus relief and are too often left out of key policies that aim to mitigate poverty.
Expanding Eligibility to Immigrant Workers
In 2020, Colorado and California became the first states to expand their state-level EITCs to include immigrant families who work and pay taxes but are excluded from the federal credit. These families file taxes using Individual Taxpayer Identification Numbers (ITIN). This year, five additional states—Maine, Maryland, New Mexico, Oregon, and Washington state—have followed their lead.
Individual Taxpayers Identification Numbers (ITINs) are tax processing numbers made available to certain immigrants, their spouses, and their dependents who do not have Social Security Numbers. However, like U.S. citizens, noncitizens who live, work, or invest in the United States pay local, state and federal taxes—and yet they remain left out of public benefits, including the federal EITC. In response to this inequity, lawmakers in six states have taken steps to ensure that their state EITCs benefit one of the most vulnerable and hardest hit populations. States can take steps to extend the reach and impact of their state EITCs by expanding eligibility to include ITIN filers.[4]
Expanding Age Eligibility and Increasing the Credit for Childless Workers
There have also been recent efforts to permanently expand the EITC for workers without children in the home. While the federal EITC provides a great deal of help for families with children, the impact of the permanent credit is limited for those without children; the maximum credit is much smaller and the income limits are more restrictive. For instance, a worker without dependent children in the home who is working full-time at the federal minimum wage is ineligible for the EITC. Yet, if the same worker had children they would receive the maximum EITC. Under the current system, these low-wage workers continue to be taxed deeper into poverty.
If the EITC component of the American Families Plan Act is not extended beyond 2021 and made permanent, we’ll revert to a federal EITC where workers without children in the home under 25 and over 64 years of age receive no benefit from the existing federal credit to which the majority of state credits are tied.[5][6] These workers are noncustodial parents, young workers who are just getting a foothold in the job market, and older workers who need to keep working well past the traditional retirement age and who often struggle to make ends meet.
Seven states have now recognized the need to allow young workers to enjoy the benefits of the EITC.
Maryland, New Jersey, New Mexico took steps this year to permanently lower the age of their existing credits to include 18 through 24-year-old workers without children in the home. These states join California and Maine, both of which include 18-24 year old workers without children in the home, and Colorado and Minnesota, with age eligibility beginning at 21 and 19, respectively. New Jersey, in its recent budget agreement, lowered the age eligibility from 19 to 18 and expanded the credit to those 65 and older. California led the way on removing the age cap for older workers, making the state-level credit available to older workers who remain in the workforce past age 64.
At the state level, the District of Columbia has led the way in expanding eligibility for workers without children in the home. Since January 2015, more of this population qualify for DC’s EITC (and receive a larger credit) thanks to higher income eligibility thresholds and a credit expanded to 100 percent of federal. California, Maryland and Minnesota joined the District of Columbia in their 2018 expansions to younger workers. California completely eliminated the age requirement for its EITC for workers without dependents in the home. This action expanded the EITC to young workers between 18 and 24, and workers over 65. California adjusted its state-level EITC income limits to reflect the state’s minimum wage increase to ensure that those working full-time for minimum wage are eligible to receive the credit. Maryland and Minnesota legislators also removed the state EITC’s minimum age requirement by using some of the revenue gained from the 2017 federal tax cut. In 2019, Maine lawmakers lowered the minimum age to 18 and increased the share of the federal credit workers without dependents in the home receive to 25 percent of the federal. State lawmakers can work to correct this inequity and greatly benefit childless adults in their states by enacting reforms that would expand age eligibility and increase the credit for this population that has historically been left behind.
Local Level EITCs
A few localities also have their own version of an EITC, most notably New York City and Montgomery County, Maryland, proving that a local level credit could also be powerful. Chicago’s local-level EITC has moved toward advanced EITC payments to help workers make ends meet throughout the year with a pilot project. The District of Columbia, similarly, has a newly enacted temporary monthly payment. Local level EITCs are a good option for all localities to consider.
Adding Immediate Flexibility to Earned Income Tax Credits
As we continue to deal with the public health and economic fallout of the COVID-19 pandemic, lawmakers across the country are looking for ways to best support families who are struggling to meet their most basic needs. As the name suggests, eligibility for the EITC is dependent upon earning income to qualify. So during an economic slowdown and in the face of rising unemployment, lawmakers should consider temporarily modifying the structure of their EITCs to reflect the realities of our current economy.
There are a handful of steps that federal or state lawmakers can take to ensure that low-income families, some of whom have seen their earnings disappear as a result of this crisis, continue to receive this vital lifeline. Lawmakers could allow recipients to use a prior year income—acknowledging a more normal year for earnings—therefore allowing families to claim the larger of what they calculated under ordinary rules, or what they would have received if they had the same level of earnings last year.
Lawmakers could also temporarily modify the structure of the EITC to steepen the credit’s phase-in or eliminate it altogether. This ensures that low-income earners move more quickly toward the maximum credit even if they worked fewer hours and brought in a lower income in the current filing year. The Washington state credit, for instance, is based on EITC eligibility but offers a flat credit amount based on household size. Lawmakers could also temporarily expand the definition of “earned income” for purposes of the credit to allow taxpayers the option to include unemployment insurance (UI).
Each of these options would protect EITC recipients faced with income and work disruptions from the coronavirus pandemic. Without such action, low- and moderate-income families could face a lower EITC during upcoming tax seasons, at a time when families are struggling to find work, put food on the table, and pay their bills.
Improving Tax Equity with State Earned Income Tax Credits
There are a number of best practices that states can explore when looking to increase the impact of their state-level EITCs—including full refundability, increasing the size of the credit, extending eligibility to ITIN filers, adding age enhancements, taking steps to boost the credit for the lowest-income families and address issues brought about by the COVID-19 pandemic and accompanying recession. These actions chip away at the racial and wealth inequities of state and local tax systems and help families meet their basic needs. Whether enacting an EITC in states that do not yet have one or expanding an existing credit to more workers trying to get by on low wages, lawmakers would be wise to continue the highly effective and positive trend of strengthening and enacting state EITCs.
Endnotes
[1] Center on Budget and Policy Priorities (CBPP). “Tracking the COVID-19 Recession’s Effects on Food, Housing, and Employment Hardships,” Updated September 4, 2020. https://www.cbpp.org/research/poverty-and-inequality/tracking-the-covid-19-recessions-effects-on-food-housing-and
[2] Wiehe, Meg, Carl Davis, Aidan Davis, Matt Gardner, Lisa Christensen Gee, Dylan Grundman, and Misha Hill. “Who Pays? A Distributional Analysis of the Tax System in All Fifty States, 6th Edition,” Institute on Taxation and Economic Policy, October 2018. https://itep.org/whopays/
[3] Internal Revenue Service. “Statistics for Tax Returns with EITC,” December 2020. https://www.eitc.irs.gov/eitc-central/statistics-for-tax-returns-with-eitc/statistics-for-tax-returns-with-eitc
[4] Community Change. “ITIN-EITC Fact Sheet,” April 14, 2020. https://communitychange.org/resource/itin-eitc-fact-sheet/
[5] Davis, Aidan. “Nearly 20 Million Will Benefit if Congress Makes the EITC Enhancement Permanent,” May 13, 2021. https://itep.org/nearly-20-million-will-benefit-if-congress-makes-the-eitc-enhancement-permanent/
[6] Davis, Aidan. “Expanding State EITCs: Age Enhancements and a Credit Increase for Workers without Children in the Home,” February 18, 2020. https://itep.org/expanding-state-eitcs-age-enhancements/