The Earned Income Tax Credit is our most significant modern anti-poverty federal program. The EITC supports low-income working families with children by topping off annual income during tax season. It’s a fully refundable credit, so families with no or minimal federal tax liability still benefit from the EITC by getting a refund check from the federal government.
The EITC provides as much as $6,000 annually to families with three or more children. It saves 9.4 million people from poverty each year, and is associated with a whole host of positive social outcomes, from improved infant health, to increase academic achievement, to long-term lifetime earnings gains by children in EITC-recipient families.
Because the EITC is a once-per-year income boost, it essentially functions like an annual bonus from the federal government. Though it’s proven highly effective, there might be ways that we could improve upon this “lumpy” structure of the EITC. For instance, we could smooth out payment of a family’s expected EITC across regular biweekly or monthly so that they receive income support year-round.
Wouldn’t a “smooth” EITC be better than a “lumpy” EITC? While the smooth EITC has begun to quietly gain support in policy circles, a prominent group of policy experts has pushed back, arguing that the lumpy EITC provides superior financial and psychic benefits to working families. However, as I explain below, this pushback rings hollow, and the smooth EITC is ultimately a program that we should seriously pursue.
Unlike our current lumpy EITC, a smooth EITC would simply provide a family’s estimated EITC value in advance through regular periodic payments throughout the year. This essentially unlocks a family’s earned tax-credit income, giving them regular access to their benefits rather than limiting access to tax season.
The most prominent plan to turn the EITC into this kind of periodic income subsidy has come from Sen. Marco Rubio. More recently, Oren Cass (former policy director for Mitt Romney’s 2012 presidential campaign) proposed a similar wage subsidy plan to replace the EITC in a policy paper from the Manhattan Institute. The Center for American Progress has proposed a different but related early refund option that would allow families to access part of the EITC to cover unexpected expenses.
There are compelling reasons to convert the EITC into a regularly paid wage subsidy. Smoothing payment out over the course of a year would have a greater positive financial impact on family budgets, economists have found. And for a government program that is explicitly meant to promote work, periodic payment similar to a worker’s paycheck cycle would strengthen the connection between the EITC and work.
Paying the EITC directly to workers throughout the year would also detach the program from our costly and complex tax code. In order to claim the EITC, two-thirds of claimants incur costs by resorting to help from commercial tax preparers. This loss is especially acute among the many families who make too little to otherwise need to file federal income tax returns and only do so for the sake of claiming EITC benefits. For these families, a portion of their EITC is given over to tax prep companies—the cost of retrieving earned benefits that are submerged in our convoluted tax code.
While there’s a strong case for this kind of reform to the EITC, recent work from researchers and policy experts has challenged this position. Defenders of the current form of the EITC make three principal arguments for preserving the status quo EITC: First, they argue that the lump-sum structure of the EITC promotes dignity and pride among its recipients. It’s an acknowledgement and reward for a year’s worth of hard work. And by baking it into a tax refund, we avoid the stigma of year-round welfare subsidization.
Second, where a periodic EITC would promote income smoothing, the lump sum EITC is said to better promote saving. Because it is paid out once a year, the current EITC acts as a de facto forced savings device, accruing over the course of the year and paying out to families during tax season.
Third (and relatedly), the lump sum EITC also protects its recipients from having a positive tax liability (i.e., owing the federal government taxes instead of receiving a refund) and thus may reduce the stress and uncertainty around tax filing for some families.
The pitfalls of these arguments become apparent when analyzing the alternative to a lump sum EITC. Consider a program that gives EITC-eligible families the option to elect to receive all or part of the EITC in periodic installments throughout the year. This option would revive and improve upon the Advance EITC — an IRS program that allowed workers to receive a portion of the EITC in every paycheck.
The Advance EITC was disbanded in 2010 because it had a low take-up rate — only 3 percent of EITC claimants elected to receive advance payments. However, eligible workers had little knowledge of the program. Those who did know about it may have been discouraged by its requirement that workers sign up for the Advance EITC through their jobs, perhaps fearing stigma from supervisors. Others may have worried about changes in income that affect EITC eligibility, understandably hesitant to risk owing the IRS money at the end of the tax year.
Each of these flaws in the original Advance EITC program, however, could be fixed through simple technocratic tweaks. The IRS could reach out directly to EITC eligible households to provide information on a smooth EITC and simplify the process for opting into the program. This would both enhance knowledge and reduce the sense of stigma by decoupling the smooth EITC from one’s place of work.
Moreover, the IRS could adopt a modest safe harbor to guard against overpayment problems. This would tolerate the potential that when individuals choose to receive the smooth EITC, they may receive higher payments than they are entitled to due to income increases over the course of a year. Such a tolerance is not unprecedented, either; we’ve embraced it before with the Advance Child Tax Credit (used in the 2003 stimulus) and the Affordable Care Act’s premium subsidies. Accepting this inefficiency is worthwhile in that it would cushion recipients from shocks at tax time, making them more comfortable to elect to receive the smooth EITC.
Though Advance EITC take-up rate was low, the financial straits of EITC recipients indicate a pressing need for a revamped periodic income subsidy. According to a 2012 study of EITC recipients in Boston and Chicago, nearly 40 percent of EITC refund dollars were spent paying down bills and debt. While nearly 90 percent of the families surveyed used EITC funds to pay off debt, less than 40 percent used the EITC for savings, tucking away about $637 on average, about 15 percent of their total refund.
Families receiving the EITC are simply too cash-strapped for the tax credit to significantly build savings. And given the demand for costly private sector tax refund advances like refund anticipation checks, it seems clear that creating an option for earlier EITC payments would provide relief to many financially-strained Americans.
So while defenders of a lump sum EITC claim it promotes savings, it might actually be doing the opposite: forcing many recipients into short-term debt. The families that the EITC benefits largely live paycheck to paycheck, or close to it, and their most pressing need is to avoid debt before creating savings. Thus, we could avoid these financial losses and boost the real impact of the EITC by advancing it to families throughout the year.
If the current EITC isn’t actually promoting savings, and if a periodic EITC can be structured to guard against repayment liability, then the current EITC’s defenders are left to depend on a single argument for their case: that a lump-sum, tax code-based EITC better preserves the dignity of its beneficiaries. Professors and authors Laura Tach and Kathryn Edin argue: “The dignity-building nature of [the EITC] is reinforced by the way it is administered, through tax preparation offices. Here, low-wage workers are customers served with a smile, not supplicants seeking a handout.”
Edin and co-authors make this argument more explicitly in a 2012 paper: “At H&R Block and its competitors, one is no longer a ‘recipient’ but a customer. The facilities are pleasant, well lit, and clean. This stands in stark contrast to the often run-down welfare office, the long wait to be seen, and the caseworker who may be more concerned with detecting misuse of funds than with client service.”
Perhaps the early spring ritual of trudging to the local tax preparer binds low-income families to a unifying national slog. Nonetheless, this argument hinges on the assumption that there is a special dignity in private, typically for-profit interactions. That is, claiming a lump sum tax benefit at a tax prep center is a respectable and well-earned benefit, whereas receiving a government check smacks of welfarism.
The problem is that the “dignity” of the ubiquitous private tax prep offices in low-income neighborhoods is all too often a deeply manipulative, predatory kind of faux dignity. In 2011, Mother Jones published an important investigation into how tax prep centers were pushing loan products on EITC claimants and other low-income filers expecting tax refunds. These centers advanced the refunds owed to cash-strapped filers so they wouldn’t have to wait for the IRS — doing so at annualized interest rates climbing over 100 percent.
One tax prep agent explained how he relied on the indignities of the other financial options in low-income communities to help draw in these customers. “At the check-cashing place, they’re talking to someone behind bulletproof glass[.] . . . The welfare building—you can imagine what that’s like. Here, we treat them well, and they want to come back.” Once in the center, customers who were due refunds were then urged to take on high-interest refund loans.
Though banks have largely discontinued financing usurious advances of their customers’ own money, tax prep centers have simply replaced the refund anticipation loan with the only slightly less egregious refund anticipation check. And recently, the tax prep industry was caught lobbying Congress to increase the complexity of the form used to claim the EITC, hoping that the added confusion would drum up business and fees among low-income families.
True, Edin and her co-authors studied EITC recipients utilizing free community tax preparation centers. Maybe these individuals did find an authentic dignity during the EITC claiming process that was unsullied by exploitative money grabbing. But some two-thirds of all EITC claimants rely on commercial tax preparation companies. For these families, some substantial but regrettable part of the dignity that Edin and others praise is the dignity of a fleecing by businesses looking to take a cut of families’ hard-earned benefits.
So the case for a lumpy EITC — that it promotes savings, guards against positive tax liability, and preserves dignity — ultimately falls short. Providing families with the option for a smooth EITC would seem to be eminently sensible policy. But given the disappointment of the Advance EITC, how do we know what a retooled smooth EITC would look like in practice?
Over the past two years, the city of Chicago (backed by the Center for Economic Progress) has been conducting a pilot program that makes half of the EITC available to certain eligible families in quarterly payments spread throughout the year. The smooth EITC pilot proved overwhelming appealing, with nearly all families who were given the option and presented with an explanation of the program electing to sign up.
The Center for Economic Progress recently released its final report analyzing the results of the pilot program, and their findings were encouraging. The participating families gained disposable income and had higher savings rates in comparison to a control group of families receiving the lumpy EITC. This was because families receiving a smooth EITC were able to avoid taking on debt throughout the year. Not surprisingly, the smooth EITC also decreased financial stress and improved mental health.
We should move toward taking these reforms national and adopting a smooth EITC option for eligible families across the country. The EITC is already our most successful anti-poverty effort. Its effect would only be amplified if it were paid out several times per year, providing financial support year-round and saving families from needless debt.