by Nemesio Cabral
There is strong evidence that current state and federal social safety net programs are effective at combating poverty. However, rates of inequality and poverty among working- and middle-class Californians are rising. These trends suggest that social policy reform, or expansion of current programs, is necessary to prevent material deprivation and the continuation of current trends in the state. Below, I propose various reforms to the CalEITC, including an increase of the maximum credit amount and elimination of the phase-in period, to better support low-income Californians.
California has a larger GDP than every other U.S. state and most European countries, making it the fifth largest economy in the world. Nonetheless, income inequality and wage stagnation are major drivers of poverty and economic insecurity in the state. Despite a decline over the past 19 years, California currently has the eighth highest income inequality among all fifty U.S. states and Washington, D.C., which is forcing many working households into poverty. Figures 1 and 2 below further illustrate the United State’s income inequality.
According to the official poverty measure, the poverty rate for California was 14.3 percent in 2016. However, the California Poverty Measure (CPM) – a more comprehensive, robust measure – estimates that 19.4 percent of California households lived in poverty in 2016. Counterintuitively, the unemployment rate in California was only 4.1 percent in 2018. In fact, the vast majority (79.5%) of poor households had at least one working adult in 2016, and almost half (46%) of poor households contained at least one full-time worker. High employment rates among households below the poverty line make it clear that a growing number of working households in California are struggling economically, particularly low-wage workers.
Wage growth is concentrated among those with higher educational attainment, with lower levels experiencing no growth or in some cases, a reduction in real wages. An analysis of median weekly real earnings for full-time wage and salary workers in California found that wages have remained relatively unchanged between 1980 and 2018, especially for low-wage workers (see Figure 3 below). While those with a Bachelor’s degree or higher have higher earnings relative to the 1960s, real earnings for those with some college education or less have either remained constant or declined since 1963.
While those with a Bachelor’s degree or higher have higher earnings relative to the 1960s, real earnings for those with some college education or less have either remained constant or declined since 1963.
These trends create strong justification for boosting earnings among low-income working households through redistribution. In contrast to popular proposals for new safety net programs, such as Universal Basic Income, building on current state and federal safety net programs, will yield similar benefits at a much lower cost considering the high administrative burden of building new infrastructures. Various state and federal social safety net programs accomplish this objective, but there is one program in particular that effectively targets low-income working households and has strong bipartisan support – the Earned Income Tax Credit.
Federal Program: EITC
The federal Earned Income Tax Credit (EITC) is a fully refundable tax credit awarded to low-income tax-filers. It was created in 1975 to provide more in-work support to poor working households and has been highly praised for its ability to reduce poverty and incentivize work. The cash benefit is slowly phased in based on earnings to incentivize work and boost income, is capped at the maximum credit amounts, and is slowly reduced or phased out as earnings rise. EITC has a work-requirement – individuals must earn income to be eligible. Tax-filers who have dependent children qualify for larger credit amounts and those who are married have higher income eligibility limits. The maximum credit amount ranges from $529 to $6,557 depending on the number of qualifying children. Single tax-filers with zero, one, two and three or more dependent children are ineligible for the credit at pre-transfer incomes of $15,570, $41,094, $46,703, and $50,162 respectively (see Figure 4).
As Sara Kimberlin, Senior Policy Analyst at the California Budget & Policy Center, describes in her interview with The Basic Income Podcast, the EITC is one of the most effective tools or policies for addressing poverty. The federal program has a wide range of benefits: poverty reduction, work incentives, and improved life outcomes. Nothing reduces poverty more than cash income. The EITC is refundable and technically an in-kind “cash back” transfer; it is designed to help people keep more of their earnings. As a result, EITC can boost (cash) earnings by over one-third to almost one-half.
In addition, due to its conditioning on earnings, the EITC has strong work incentives that increase employment and labor supply, especially among single mothers. It lifts more children out of poverty than any other social safety net program, improves infant health – a key predictor of economic well-being – and is linked to positive life outcomes associated with education and earnings. Over 90 percent of EITC dollars have gone to households with children, and one in five, or about 20 percent, of tax-filers in the U.S. claim the EITC. Therefore, in addition to having major benefits, EITC is also one of the most utilized safety net programs in the country.
State Program: CalEITC
Most states have designed their own state EITC programs to reinforce the benefits of the federal EITC. As of 2018, twenty-eight states, including California, and Washington, D.C. have their own EITC. California’s EITC (CalEITC), created in 2015, is far more robust and targeted than other states’ programs. Whereas most states provide tax credits that are 30 percent or less than that of the federal EITC, CalEITC provides 85 percent of the federal credit amount for the lowest earners. In addition, CalEITC was redesigned to target households with the lowest earnings – those with the highest economic need. In 2017, it was expanded by extending the annual income eligibility limit to $22,300 for those with qualifying children (see Figure 5) The robust, targeted design and expansion of CalEITC have significantly reduced poverty in California.
Over 900,000 tax-filers have benefited from the program, the majority of whom are working single moms, so the program overwhelmingly benefits children. When combined, the federal EITC and CalEITC significantly boost earnings and lift about 800,000 Californians out of poverty each year, most of whom are children. Families with three or more children can see their earnings increase by as much as 92 percent if the state and federal EITC are combined with the Child Tax Credit (CTC). However, the biggest challenge with both state and federal EITC is take-up rate among households at the bottom end of the income distribution – those with the highest need – because they are not required to file taxes.
The state and federal EITC are effective at addressing poverty and inequality because they are targeted towards the poorest working households – they both redistribute funds towards households with the lowest earnings. Therefore, expansion of the CalEITC has the potential to reduce the number of Californians living in poverty or deep poverty.
In order to reduce poverty and inequality, boost earnings for working households, and reduce child poverty, California should increase the maximum credit amounts and remove the phase-in period of the CalEITC.
Increasing the CalEITC maximum credit amounts and extending income eligibility limits even further will amplify the program’s ability to reduce poverty and will also extend the program’s benefits to more households. Although costly, this expansion will ensure that CalEITC credit amounts keep up with inflation and cost-of-living in California. Increasing credits and eligibility for CalEITC will not likely result in any reduction in labor supply or work since the maximum credits are modest and phased out at a slow rate. In fact, this expansion will likely increase work incentives.
Removing the phase-in or subsidy rate for the CalEITC – providing the maximum amount to anyone who has earned income – will boost the state program’s ability to reduce income inequality and deep poverty by increasing take-up and the amount of income-support provided to those with the highest economic need. Current CalEITC recipients with earnings below the phase-out range will receive larger tax credits – the maximum credit amount. Eligible non-recipients of CalEITC, most of whom currently do not file taxes, will be incentivized to file to receive the max credit. This expansion is not likely to reduce labor supply or work considering that work incentives for the federal EITC, significantly stronger as a result of higher credit amounts, will still be in place.
In addition, although CalEITC provides cash to households that can significantly reduce poverty, most workers receive modest credits that are phased out gradually. Thus the program is not likely to create behavioral distortions when dispersed annually. Furthermore, any increase in take-up rate for CalEITC resulting from this expansion will also increase federal EITC take-up and federal safety net dollars targeted towards the lowest income households in the state. Therefore, removing the phase-in for the CalEITC can potentially increase income-support by more than the CalEITC credit amounts for households that currently do not receive it, as they will receive both CalEITC and federal EITC dollars. This expansion has the potential to reduce deep poverty by further targeting those with the highest economic need and increasing EITC take-up among the lowest income households.
Income inequality, a growing population of working poor, and wage stagnation in California create strong justification for boosting income-support for working households struggling to meet basic needs. Increasing maximum credit amounts, extending income eligibility limits, and removing the phase-in rate for the CalEITC will have strong positive impacts on poverty in the state. Raising the maximum credit amounts will preserve or enhance CalEITC’s ability to reduce poverty by allowing it to grow in proportion with other rising costs. Expanding eligibility will extend those benefits to households with higher annual earnings who are also struggling economically. Removing the phase-in for CalEITC will increase the targeting of funds towards those at the bottom of the income distribution, and also has the potential to increase state and federal EITC take-up among households with the highest economic need.
The effects of removing the work requirement for CalEITC, so that those with no earnings can receive the maximum credit as well, should be further investigated. Although the credits (direct cash) provided significantly reduce poverty, there is little evidence that removing the work-requirement for CalEITC will reduce labor supply. Work incentives for the federal EITC, which have much larger income effects and behavioral responses, will still be in place. Providing more income-support for those not working will also extend to working households since some out-of-work recipients may live with working adults. The CalEITC can be renamed as a basic income tax credit (BITC), a cost-of-living credit, or a child allowance for low-income households since it will no longer be tied to earned income. Though, the child allowance label would not be applicable to tax-filers with no dependent children. Further research is needed to better understand how removing the work-requirement for CalEITC will impact labor supply and poverty in California.
Nemesio Cabral is a second-year Master of Public Policy candidate at the Goldman School of Public Policy.
The views expressed in this article do not necessarily represent those of the Berkeley Public Policy Journal, the Goldman School of Public Policy, or UC Berkeley.