By Ed Murphy
Among several new economic proposals in his State of the Union address on January 20th, President Obama issued a call to substantially expand the federal Earned Income Tax Credit (EITC) for childless workers. This proposal builds on momentum for an expansion that has been developing over the last year as Republicans have increasingly signaled support for the EITC—or something like it—over other anti-poverty measures. But while the payment for such an expansion has been hotly debated, there has been less attention to the critical role states can play in ensuring the EITC’s effectiveness as an anti-poverty tool.
The EITC is a federal income tax credit used to alleviate poverty among low- and moderate-income working families. It is widely considered to be the most effective anti-poverty policy in the country. According to the Center on Budget and Policy Priorities the federal EITC lifted 6.5 million people out of poverty in 2012, of which 3.3 million were children. And because the EITC is structured to reward families that work, it enjoys a rare level of bipartisan support, with public statements of support over the last year coming from the Heritage Foundation, the American Enterprise Institute, former Bush administration economic advisers, and—with some reservations—Senator Marco Rubio and Representative Rand Paul.
The basic way in which the EITC supplements earnings is fairly simple. Up to a certain income threshold, the EITC benefit increases as a person’s income rises. At a certain threshold, the benefit remains flat through a range of incomes. Finally, the value of the EITC begins to decrease until, at a certain income level, the EITC benefit is $0. The income levels defining these phases of the EITC vary based on two family characteristics: number of children and marital status.
Notably though, these income limits do not vary based on cost of living. This creates a situation in which families living in high-cost states phase-out of EITC eligibility before they have sufficient earnings to pay basic costs of living in their city or state. If the EITC is to be a truly effective tool in moving families out of poverty, it is important that states supplement the federal EITC to ensure that its income limits are tailored to the particular needs of the state.
Twenty-five state governments and the District of Columbia do this, offering their own EITCs as a supplement to the federal program. Most of these are offered as a simple flat percentage of the federal EITC. Unfortunately though, much as the federal EITC does not take cost of living into account, these supplemental programs don’t either, creating a situation in which many working families in high cost of living states are ineligible for their own state EITCs before they have earned enough to meet basic costs of living. New Jersey is a state that falls into this group and offers a good illustration.
In 2011, Legal Services of New Jersey defined the cost of living for a two-parent-two-child family in the State as $64,238 per year. However, the New Jersey EITC fully phased out at $46,044 per year for a family of this structure. This meant that there was an income range of $18,194 ($46,044 through $64,238) in which families made too much for the New Jersey EITC but still did not meet the cost of living in the State. This is because New Jersey offers its EITC based on the federal EITC definition, which does not take cost of living into account.
While the cost of living will also fluctuate at the local level within a given state, looking at New Jersey shows that these fluctuations are not large enough to undermine the basic premise here. The aforementioned Legal Services of New Jersey report also presents cost of living data for all 21 counties. Only Atlantic County has a cost of living that would fall within EITC eligibility.
It is true that families earn higher incomes in New Jersey than they would in almost every other state. However, higher incomes do not necessarily translate to a higher standard of living. For example, the cost of living in New Jersey also happens to be one of the highest in the nation. The Bureau of Economic Analysis defines Regional Price Parity (RPP) for each state. RPP compares the price level in a state to the price level in the nation. The District of Columbia, Hawaii, New York, New Jersey, California, Maryland, and Connecticut have very high RPPs. This means that families in these states might make more money, but they also must meet very high living costs. They experience no net benefit due to their relatively high incomes.
If the purpose of the EITC is to help struggling working families make ends meet, those states with higher costs of living must consider those costs in structuring their supplemental tax credits. As in low costs states such as Iowa, Georgia, or Louisiana, a working class New Jersey family struggles to make ends meet. The New Jersey working class family might make a higher salary, but their cost of living is also much higher. And yet they lose eligibility for the EITCs from their federal and state governments because of an unnecessarily rigid income definition.
The New Jersey state legislature cannot do anything to change the Federal EITC definition. Without policy change in Washington, many working class families in New Jersey will still miss out on the Federal EITC. However, the state can change the definition it uses for its own EITC offering. It can end its reliance on the federal definition and adopt income limits more appropriate for a high cost of living state.
A good starting place would be to make sure that working class families are eligible for the state EITC until they meet the cost of living in the State. Working class families in New Jersey and other high-cost states are earning higher incomes than the national average, and yet they are forced to also pay a higher cost of living. As the program currently exists, these families are left with little to show for their higher incomes but ineligibility for EITC offerings and an enduring inability to afford basic necessities. States can, and should, adopt their own unique EITC to offer meaningful support for these struggling families.
Ed Murphy is a public policy student at Rutgers University