Methodology – Earned Income Tax Credit Versus Temporary Assistance for Needy Families

An important difference between the structure of the TANF and EITC is that EITC payments actually go up as a proportion of earned income until a certain level. Additionally, a key issue with the TANF is that it offers a strong disincentive to work. The EITC provides the answer and this paper will examine the widely held conviction that the EITC program provides a strong incentive for people to work.[1]

The conclusion will then state if it is worthwhile to pursue by comparing this benefit with the cost. The Center for Budget and Policy Priorities estimates that the total cost of EITC in 2002 was over $32 billion.[2] In contrast, the federal government spent $15 billion on the TANF in the same year.[3]

The EITC functions as an income supplement rather than a direct cash transfer program. A person must be working to qualify and there are quite a few requirements for workers to qualify for the EITC. Along with filling out a tax return even if the recipient owes no income tax, a person should make an adjusted gross income less than a given threshold amount.

So a good alternative to the “stick” approach of payment limits and work requirements in TANF is the “carrot” approach of the EITC. For example, in 2003, single taxpayers with two or more children would get a credit of 40 percent of income up to $10500. After that, between the income of $10500 and $13750, the individual would obtain the maximum credit of $4200. Then, between the earnings of $13750 and $33650, the benefit is reduced by 21.11 percent for every dollar of extra earnings after $13750. When income reaches $33650, the EITC has fully phased out and the worker is not eligible. One study has revealed that over 60 percent of EITC benefits go to individuals with pre-EITC earnings under the poverty line. Also, 95 percent of EITC payments are made to taxpayers making less than the median wage of $13.53 in 2003.[4]

The EITC then improves work incentives for the poor and in the phase-in range, the federal government adds 40 cents to each dollar of earnings.[5]

In a 1996 Wall Street Journal column, conservative Harvard economist and then Journal contributing editor Robert J. Barro stated that, “There exists a serious program in the form of the earned income tax credit that actually helps the working poor in a way that promotes work and discourages welfare.”[6]

The research is continued here.

[1] Robert A. Moffit (Summer 2003). The Negative Income Tax and the Evolution of U.S. Welfare Policy. Journal of Economic Perspectives, 17, 119-40.This shows the relationship of the EITC to its intellectual predecessor, the Negative Income Tax which is a useful concept in this paper.

[2] Center on Budget and Policy Priorities, “Estimating the Cost of a State Earned Income Tax Credit,” (28 April 2003), http://www.cbpp.org/cms/index.cfm?fa=view&id=1373

[3] U.S. Department of Health and Human Services, Administration for Children and Families, “TANF Financial Data,” http://www.acf.dhhs.gov/programs/ofs/data/overview_2002.html

[4] Dickert, Stacy, Scott Houser and John Karl Scholz, 1995, “The Earned Income Tax Credit and Transfer Programs: A Study of Labor Market and Program Participation,” Tax Policy and the Economy, James M. Poterba (ed.), National Bureau of Economic Research and the MIT Press, 9, 1-50

[5] Gayer, Ted and Harvey Rosen. Public Finance Ninth Edition. McGraw Hill/Irwin. 2007

[6] Robert J. Barro, “Workfare Still Beats Welfare,” Wall Street Journal, May 21, 1996.