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- Tax Policy to Reduce Poverty: Changes to State EITC a Win for Hoosiers
By Andy Nielsen
In a legislative session dominated by the biennial budget and pandemic response, Indiana lawmakers took an important step to strengthen our state’s social safety net for many Hoosiers across the state. House Enrolled Act 1009 increased the state’s Earned Income Tax Credit (EITC) from nine percent to ten percent of a taxpayer’s federal EITC, which had been largely untouched since 2011. Many thanks to our lawmakers for recognizing the effectiveness of this tried and true tool to help combat poverty in Indiana.
The federal EITC was created in 1975 as a tool
to incentivize work, boost earnings, and combat poverty. Eligibility and the
amount of the credit are a function of a taxpayer’s earned income, filing status,
and the number and age of children claimed on the tax return. Simply put: the
more you (and/or your spouse) work, the higher the credit, and once you earn a
certain amount, the credit begins to phase out. Have kids? Then you may receive
a larger credit.
The federal credit phases out at a higher income for married
couples filing jointly compared to individuals filing single or head of
household. However, the maximum credit is determined by the number of children
(under age 19 or 24 if full-time student and must have a valid SSN) claimed on
the return and whether or not the filer is single or married. The table below
illustrates these differences. Income ranges provide the minimum earned income
to receive the maximum EITC and the maximum amount where credit is zero (completely
phased out).
The federal EITC has been extremely effective at combating
poverty and is quite popular. In 2018,
the credit lifted approximately 5.6 million people out of poverty – including
about three million children. Data from the Internal Revenue Service
(IRS) for tax year 2019 demonstrates the credit’s popularity with about 25
million individuals and families nationwide receiving an average EITC of around
$2,461, including 515,000 Hoosiers with an average credit of $2,424. Unfortunately,
only 78% of
eligible taxpayers (79.8% in Indiana) claimed the federal tax credit in 2017. To put
this in perspective, nearly 135,000 additional Hoosiers were eligible but did
not claim the credit – that’s over $324 million gone unclaimed.[1]
One of the more important features of the credit is that it is
fully refundable, meaning the "unused" portion of the credit is recouped through
a refund at tax time. A quick refresher on tax credits. Unlike tax deductions
that lower taxable income, tax credits offset tax liability dollar-for-dollar.
Say you owe $2,000 in taxes and have a $2,400 credit. If the credit is
refundable, your tax liability is reduced to $0 and you receive the remaining
$400 of the credit as a refund on your return. If the credit is non-refundable,
the remaining $400 is left on the table. Refundability ensures the credit is
fully realized by low-income taxpayers who may reduce their tax liability to
zero through other credits or deductions.
In 1999, Indiana followed the federal government’s lead by
creating its own EITC. While the credit was modified several times and remains
decoupled (stay tuned for future blog post) from its federal counterpart, the
state credit is still an
important tool for Hoosiers. Like the federal EITC, Indiana’s credit is
fully refundable, making it among the
most effective and targeted tax reduction strategies to help offset regressive
state taxes. According to an analysis provided by the Institute
on Taxation and Economic Policy (ITEP), recent
changes (effective tax year 2022) made to Indiana’s EITC in the 2021 Legislative Session will
provide a tax cut to 13 percent of Hoosiers (see table below). Again, this is
an important change and a moment to celebrate the legislature’s efforts towards
a stronger social safety net, but we need to keep up the momentum.
Looking ahead, Indiana needs to focus even further on using the tax code to strengthen Hoosier households and families. Given the substantial changes made to the federal EITC, Indiana lawmakers should create parity between the federal and state credits, which would be a critical step towards further improving the livelihoods of our most vulnerable fellow Hoosiers.
[1] Author’s calculations using participation rates and individual income and tax data from 2017 IRS data.