The Oddities of the EITC and Why We Should Think Twice About Its Further Expansion

Congressman Ro Khanna has adopted the idea of expanding the size of the Earned Income Tax Credit recently and attracted some media attention as a result (Lowrey at Atlantic; Ferenstein at Quartz and at Medium). The idea comes from a Neil Irwin piece at the New York Times, which the CBPP and Tax Policy Center helped prepare the background figures for.

The precise content of Khanna’s proposal is, according to Ferenstein, still forming. But in general the point is to increase EITC benefit levels substantially in order to counteract the effects of decades of wage stagnation.

Since his election last year, Khanna has quickly established himself as one of the most ambitious and progressive members of Congress. His interest in substantially expanding the EITC is clearly part of a genuine desire to do something big to fix our country’s festering inequality problem. But there are good reasons to believe that an expanded EITC is not the best approach.

The EITC gets a lot of unqualified praise because it helps to increase the disposable incomes of many low-earning families. Perhaps because it has these positive benefits, little attention is paid to the problems and downright strangeness of the program. But if we are going to start considering making it an even bigger part of the US welfare state, we really should consider these defects, both with the EITC in general and Khanna’s EITC.

  1. High improper payment rates. The IRS estimates that more than 1 in 5 EITC payments are improper. If this is going to be the centerpiece of a new distributive agenda, we probably should figure out how to actually administer it correctly.
  2. Employers capture some of the benefit. It is impossible to say how much, but an oft-cited Jesse Rothstein model concludes that employers could capture as much as 27 percent of the EITC benefits through reduced wages.
  3. Pegging child benefits to earnings is absurd. The truly bizarre thing about the EITC is that it combines a wage subsidy with earnings-related child benefits. The reason this is weird is that it does not make sense to say that parents who earn more money should get more benefits for their children. A child of a $5,000-earner is no less needy than a child of a $10,000-earner. In fact, it’s the opposite. Yet the EITC gives far more child benefits to the richer child than the poorer child. Any major EITC reform we embark upon should go ahead and sever the child benefit element from the EITC and move it into its own program (see here). Then, the EITC could act as a pure wage subsidy that pays the same benefits to all adults with the same earnings.
  4. The EITC is not a basic income or negative income tax. Khanna has mentioned in various interviews that his plan is a kind of basic income proposal, but it is not. Any plan where the benefits phase in based on earnings cannot be a basic income program or a negative income tax. This is because a phase-in design deprives those with lower earnings (or no earnings) of the full benefit. Additionally, it’s worth noting that the phase-in design is what allows employers to capture some of the benefit through reduced wages. A true negative income tax, which lacks a phase-in, has the opposite effect in that it should actually increase the wages employers pay people (see again Rothstein).
  5. It does not really address wage stagnation. This may or may not be an issue depending on how important you think wages are, but it is worth pointing out that this proposal does not increase people’s wages to bring them up to where they would be without stagnation. In fact, since the employer captures some of the benefit through reduced wages, the proposal actually does the opposite: it pushes wages down some. More generally, this is a transfer income strategy, not a labor income strategy. That distinction may be normatively meaningless and transfers may be the best we can do in a poorly organized labor market with very little coordinated wage-setting, but it is nonetheless worth noting that an EITC expansion does not directly fix the wage inequality problem that motivates its proponents.
  6. The $1 trillion price tag for an expanded EITC is really not that much. This is more a criticism of the coverage of the idea than the idea itself. Irwin describes it as “serious money” and Lowrey as “a lot of dollars.” But in reality, $1 trillion means $100 billion per year. Against a $19 trillion GDP, that’s a touch over 0.5% of GDP. Talking about sums like this as if they are astronomical is both misleading and unhelpful. The US has plenty of room in its tax level for an extra 0.5% of GDP.
  7. These and other problems are good reasons to think twice about making a substantial EITC expansion the next big thing in US welfare development. There is clearly some room for an earnings-related wage subsidy type program, but it probably should not be the centerpiece of an expansion agenda.

    Things like free child care, free health care, universal child allowances, and other similar benefits could achieve the same or similar net distributive result (provided you do the right stuff on the tax side) and are far better ways to expand the welfare state than trying to use it to (somewhat counterproductively) patch up our labor market’s wage-setting problems.

  • Dan Lynch

    Well said, and to the final paragraph’s suggestions I would add raise the minimum wage, a lot.

  • The Amerikaner

    Nobody is starving to death in America. That’s the extent of our obligations to each other. Everything else is a luxury good. You want something? Hustle for it.

  • Chris Meyer

    All important points. The employer capture problem is less severe when the EITC is paired with a decent minimum wage, but that’s currently only possible at the state level.

  • Robert William Sperry

    The fact that employers can capture some of the benefit is a feature not a bug of the EITC system. This acts as a subsidy of employers that employ people on the low side of the wage scale! This will result in an increase in the quantity of workers demanded, and thus an expansion of employment opportunities for low skilled workers. One of the most important thing for people is getting that first job and the associated experience as it gives them something to build off of. Contrast this with the minimum wage that acts as a tax on low skill workers and shrinks employment demand and is terribly cruel to the lowest skill workers. Hopefully an overhaul of the system could solve the EITC’s dependence on children that you rightfully point out.

  • Point #4 is important (that this is not a BI or a NIT). In efforts to popularize the UBI, we should help people appreciate the difference between conditional and unconditional payments. (Or relatively less conditional anyway — even many UBI proponents insist that recipients be citizens and maybe even adult citizens).