Income, Taxes and the Working Poor:

A Review of Earned Income Tax Credits and Other Provisions
Impacting Low-Income Wage Earners and Working Families

May 1, 1999^1/

Income Tax Liability Thresholds
Earned Income Tax Credits
Additional Tax Credit Options
Conclusions

In recent years, North Carolinians and others across the country have repeatedly voiced their belief in, and support of, the intrinsic value of work as a part of the American way of life. This position has been echoed in both public policy and legislation. Limits on the duration of public assistance and employment requirements for public assistance recipients have been made primary goals of welfare reform efforts across the state and the nation. Eligibility requirements for many public assistance programs, including TANF and Food Stamps, now mandate work as the immediate and principal objective for virtually all recipients. North Carolina's Work First, First Stop and Food Stamp programs are clear reflections of this position.

At the same time, public leaders have recognized that the elimination of public assistance programs alone cannot achieve an end to poverty, provide the skills for employment success, or instill a positive work ethic. The long-term success of efforts designed to move families off public assistance, out of poverty and onto the road to self-sufficiency is dependent, to a significant degree, upon the development and maintenance of an economic environment in which low-income, working families are able to retain enough earnings to meet their basic needs. Good jobs and effective training are two ways of boosting income. Appropriately structured income tax laws may provide one way to preserve the value of those earnings. Conversely, taxation policies that remove the financial incentive to work may well prove to be counterproductive to self-sufficiency.

Income Tax Liability Thresholds

Since the 1986 enactment of federal income tax code reforms, federal income tax liability has been all but eliminated for families earning less than the poverty level. In the intervening years, a number of states, including North Carolina, have taken similar steps to ameliorate the impact of state income taxes on the working poor. Between 1991 and 1998, 20 of the 24 states that had below poverty liability thresholds for a family of four in 1991 raised those thresholds. However, only five of those 20 states, North Carolina, Massachusetts, Pennsylvania, Iowa and Kansas raised liability thresholds sufficiently to eliminate income taxes for families of four with poverty-level incomes. One state, Mississippi, had a threshold that was above the poverty level in the early 1990’s that fell below the poverty level during 1996 and 1997, and raised its threshold above the poverty level in 1998. ^2/

Income Tax Liability Thresholds for Two Parent Families of Four
	1991	1994	1995	1996	1997	1998
Average Threshold	$11,762	$13,088	$13,645	$14,210	$14,919	$16,393
Percent of Poverty Level	84.5%	86.4%	87.6%	88.6%	90.9%	98.4%
Number of States Below the Poverty Level	24	23	23	24	21	19
Poverty Level	$13,921	$15,141	$15,569	$16,036	$16,405	$16,655
North Carolina	$13,000	$13,000	$16,000	$17,000	$17,000	$17,000
Massachusetts	$12,000	$12,000	$14,000	$15,500	$17,400	$21,100
Pennsylvania	$10,800	$15,300	$15,300	$15,300	$20,600	$25,000
Iowa	$9,000	$15,300	$16,100	$16,400	$16,500	$17,000
Kansas	$13,000	$13,000	$13,000	$13,000	$13,000	$20,700
Mississippi	$15,900	$15,900	$15,900	$15,900	$15,900	$17,200

By 1998, of the 42 states (including the District of Columbia) ^3/ which employ an income tax ⁴, 22 states and the District of Columbia had implemented tax liability thresholds that were above the poverty level for low-income families.

While some states have adopted provisions that mirror those at the federal level, most have developed state specific thresholds. Such is the case in North Carolina. The North Carolina income tax liability threshold for single-parent families of three in 1998 was $13,900. This is approximately $900 above the estimated poverty level for 1998 and approximately $4,774 less than the average of all states with above poverty level threshold provisions. When the state income tax liability threshold for two-parent families of four for 1998 is considered, the $17,000 allowed by North Carolina's tax code is approximately $345 above the estimated poverty level and more than $4,317 below the average for all states with similar, above-poverty-level tax threshold provisions. Both North Carolina liability thresholds are above the average for all states having an income tax and were significantly above the average for states with thresholds beginning below the poverty level. However, it is important to note that North Carolina's thresholds are fixed and likely will require adjustment to remain above the poverty level in future years. North Carolina’s tax liability threshold for a two-parent family of four was $1,000 above the poverty level in 1996, $600 above the poverty level in 1997 and $345 above the poverty level in 1998. The poverty level has increased at approximately two percent a year since 1994. Without modification North Carolina’s tax liability threshold for two- parent families of four would be projected to equal the 1999 poverty level.

The tables on the following pages show the respective rankings of states and the comparative state income tax liability thresholds for single-parent families of three and two-parent families of four in 1998.
 
 

Earned Income Tax Credits

As stated earlier, the creation and maintenance of an environment that enables working families to meet their basic economic needs is central to the long-term success of any effort designed to promote self-sufficiency through work. State income tax thresholds are one demonstrated approach to the development of such an environment. Tax credits are another method that may be utilized towards this objective. The North Carolina General Assembly has mandated, as a part of the welfare reform initiatives enacted during the 1997 and 1998 legislative sessions, a study of "the efficacy of a state earned income tax credit that would enable working families to meet the requirements of the basic needs budget." The federal Earned Income Tax Credit (EITC) was selected as the point of departure for this study both because of its national scope and the fact that it frequently serves as a baseline for similar state legislation.

1. $10,030 where there are no children,

2. $26,473 where there is one child, and

3. $30,095 where there are two or more children.

Of the 42 states which collect an income tax, 18 (42.9 %) offer either State Earned Income Tax Credits (SEITC) or other State Low-Income Tax Credits (SLTC) directed specifically to low-income wage earners and working families. A number of states, including Delaware, Iowa, Maryland and Massachusetts base the SEITC on a percentage of the federal EITC. Other states, such as Georgia, Kentucky and West Virginia tie state credits to income and family size rather than the federal EITC. These credits range from the $5.00 awarded by Georgia for a single exemption to the Delaware and Maryland credits which return 50 percent of the federal EITC. Based on the 1996 maximum federal EITC amount of $3,600.00, this would include a range of SEITC's and SLTC's of from $5.00 to $1,800.00. The Maryland and Delaware credits are the highest, averaging $750.00 while the credits in the remainder of the states typically do not exceed $500.00. The table on the following page outlines current SEITC and SLTC provisions by state:

The simplest and most easily understandable method of creating a sliding scale SEITC is to allow a percentage of the federal credit to be claimed for state purposes. As indicated in the preceding table, all 10 of the states currently granting SEITC's utilize this method. These states, with the exception of Wisconsin, rely on federal eligibility guidelines regarding income levels and family size. Wisconsin has chosen to implement a family size adjustment for families with three or more children where the federal EITC does not define family size beyond two or more children. Other than Wisconsin, all of the states allow eligibility for workers without children.

The following table examines the size of the average family credit and the estimated cost to North Carolina of implementing a SEITC at the stated percentages of the federal EITC. State costs are reported in terms of the value of the average credit times the estimated number of eligible families. No attempt has been made to estimate any additional processing or related costs. The number of eligible families, (653,000) and the average federal family credit amount for North Carolina ($1,556) are based on 1998 data as reported by the North Carolina Budget and Tax Center.

Additional Tax Credit Options

While the SEITC provides an established method for assisting low-income families in retaining enough income to meet basic needs, other types of targeted tax credits present effective options for dealing with specific employment barriers. For example, childcare is one of the most frequently encountered employment barriers for families at all economic levels. For lower-income families, the inability to find high quality, affordable childcare can be devastating to employability and self-sufficiency. Appropriately crafted childcare credits can provide an extremely effective approach for dealing with this problem.
 
 
 
 

Childcare

While North Carolina already provides a refundable tax credit for child and dependent care, the credit is limited by several federal and state provisions which may warrant review:

1. Benefits may not be claimed for more than two children,

2. The maximum credit is 13 percent of allowable expenses,

3. The maximum credit of 13 percent is available only for children under the age of seven and dependent(s) who were physically or mentally incapable of caring for themselves, and

4. The remaining allowable expenses for children seven to twelve years of age may be claimed at a maximum rate of 9 percent.

Medical Coverage

The cost of adequate health care coverage for workers and families constitutes a significant portion of the basic needs budget. Current federal policy allows for a deduction for qualified medical costs that exceed 7.5 percent of adjusted gross income. This deduction also is allowed under state law for those filing itemized deductions. North Carolina could enact legislation to provide an income-based credit for those claiming a standard deduction. Such a provision likely will have greater impact on lower-income families who are less likely to itemize deductions.

Rental Cost Credit

The single largest item in the monthly budget of most low-to-moderate income families is housing. Currently, both North Carolina and federal income tax laws allow deductions for interest paid on home mortgage loans and property taxes. Neither allows credits for rental costs regardless of income level. Lower-income families are less likely to be able to purchase a home and thus, benefit from such provisions. The state could examine a graduated rental cost credit for lower-income families

Transportation Credit

Transportation problems are probably the single most frequently cited employment-related issue for low-wage workers; however, absent a statewide system of public transportation, a credit in this area is unlikely to produce an impact equivalent to an investment in one of the other credit provisions. Some benefit may be gained by a credit for "creative transportation solutions" such as employer sponsored vans pools. Such activities can alleviate individual transportation problems, provide workers from labor surplus areas to labor shortage areas, and assist in reducing environmental and traffic congestion problems.

Conclusion

The federal government and many of the states have taken the position that it is counterproductive to encourage low-income families to attain self-sufficiency through employment while maintaining an income tax structure which eliminates the financial incentive for work. As shown in this report, a significant number of states have modified their income tax codes to assist low-income workers and working families in meeting a basic needs budget. These provisions have included tax floors, increased deductions and increased personal exemptions, as well as earned income and other related tax credits. As a part of its own efforts, North Carolina already has raised the tax liability threshold for a family of four to above the poverty level, has incorporated a child and dependent care credit, and has instituted a credit for children. All of these provisions have achieved some success in assisting working families. However, it should be noted that without additional modification of the state tax liability for two-parent families of four, the state’s threshold is projected to equal that of the poverty level in 1999.

A careful review of the state and federal earned income tax credit provisions described in this study demonstrates that such methods do indeed provide viable options for assisting North Carolinians in maintaining a basic needs budget. If desired, targeting of specific barriers to employment may be accomplished through use of a SEITC in combination with one or more of the other tax credit options.

Additional research will be required to assess the potential numbers of eligible individuals and families, the recommended credit levels, and the costs associated with implementation of each alternative.

End Notes

1/This document updates and revises the report issued on May 1, 1998

2/ "State Income Tax Burdens on Low-Income Families in 1998: Assessing the Burden and Opportunities for Relief," Center on Budget and Policy Priorities, March 1999.

3/ For the purposes of this report, the District of Columbia is counted as a state.

4/ A total of 44 states have a state income tax; however, two states (New Hampshire and Tennessee) tax only interest and dividends and are not included in this analysis.

5/ BTC Reports, "Working for a Living in North Carolina: Time for Another Look," Vol. 3, NO. 16, October 1997.