The Earned Income Tax Credit in Rhode Island

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The Earned Income Tax Credit is a short term

investment with long-term benefits.

Improve Rhode Island’s Earned Income Tax Credit To Help Hard-working Rhode Islanders

March 2014

The Earned Income Tax Credit (EITC) is widely recognized as one of the most effective policies at keeping low-income working families out of poverty by supplementing wages and encouraging work.

It is estimated that the federal EITC kept 6.5 million working Americans out of poverty in 2012.

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The EITC is a short-term investment with long-term

benefits. While the majority of workers only claim the credit for one to two years, it has lasting effects.

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Beneficiaries work more, earn more, and are less likely to rely on cash assistance. Children of EITC beneficiaries also are healthier, do better academically, are more likely to go to college, and earn more as adults.

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Rhode Island is among 25 states and the District of Columbia that offer a state EITC, but unlike most states, the credit is only partially refundable.

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Just over 83,000 Rhode Island taxpayers claimed the state’s EITC in Tax Year 2012

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. The average credit was $119. Of those taxpayers receiving a credit, 73,119 received a refund, averaging $82.45.

Rhode Island should enhance the effectiveness of the state EITC for low-wage workers by making the credit fully refundable. To offset some of the cost of enacting this change, the credit could be

reduced from 25 to 20 percent. In addition to the benefits outlined above, an enhanced state EITC would help offset the impact of regressive state and local taxes, help pay for one-time expenses such as car repairs and security deposits, and help families meet basic living expenses.

Increasing the refund will help low-income workers

Making the state’s EITC fully refundable would put more money in the pockets of Rhode Island’s

lowest wage working families. The Institute on Taxation and Economic Policy analyzed the impact of

the proposal to increase the refund and reduce the credit and found that 80 percent of EITC recipients

would benefit if the credit were reduced to 20 percent and made fully refundable. The average tax cut

for those recipients would range from $309 to $530 and come mostly in the form of a tax refund.

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The remainder would see a modest tax increase averaging between $3 and $44 due to the reduction in the credit.

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The Institute analyzed the impact of the proposal on several different hypothetical families in Rhode Island (See Appendix 1). They found that a single parent with two children who earns $25,000 a year would receive $561 more through the state EITC increase, while a married couple with two children earning just above $33,000 would receive an additional $444 tax cut. A minimum wage worker with one child would get an additional $528 through a state EITC refund under the proposed change. The estimated cost to the state of enacting these changes to the EITC is $20 million.

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Background and benefits of the Earned Income Tax Credit

The federal income tax credit was created in 1975 to provide an incentive to work and offset federal payroll and income taxes for low- and modest-working households. The credit increases with earned income until it reaches a maximum amount (which depends on the income and number of children) and then phases out as income increases. When the credit exceeds the amount of taxes owed, the balance is refunded to the taxpayer.

Research suggests that the benefits of the EITC are extensive. First, the credit has been found to increase work effort, particularly among single mothers. In fact, research found that the EITC expansions in the late 1990s were as much a contributor to women going to work as welfare reform, and that the women who benefitted experienced higher wage growth and ultimately higher social security retirement benefits. In addition, as employment among female-headed households increased, their reliance on cash assistance decreased.

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Not only does the credit increase the work effort of those

receiving it, but their children appear to be healthier, do better in school, are more likely to enroll in college, and earn more as adults.

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A recent study comparing data from before and after changes to federal and state EITCs finds that children in families receiving larger EITCs tend to do better academically both in the

short and long term, as evidenced by higher test scores and high school graduation rates.

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Recent research also finds that EITC can boost college enrollment, particularly when families have access to both federal and state credits. For a high school senior whose family qualifies for the maximum EITC benefit, a $1000 increase in tax refunds received in the spring increases college enrollment rates the next fall by roughly 10 percent.

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Children in families receiving larger EITCs tend

to do better academically and have higher college

enrollment rates.

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Rhode Island is among top 10 states that impose the highest taxes on low-income

residents.

The EITC is also found to have a positive impact on health. One study found an increased EITC can decrease rates of low-birth weights,

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while another found that eligible households spend more on healthy foods during the months when most EITC refunds are disbursed.

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An increase in the state’s refund could help curb the growth in income inequality in Rhode Island.

Income gaps widened more in Rhode Island than in all but eight other states between the late 1970s and the mid-2000s.

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The richest fifth of Rhode Island households saw their income almost double, while the poorest fifth saw their income climb by just 12 percent.

Lastly, strong state EITCs can help offset regressive state sales and property taxes.

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Combining all state and local taxes, the poorest twenty percent of Rhode Island households contribute almost twice as much of their income towards taxes (12.1 percent) as the wealthiest one percent of households (6.4 percent). Rhode Island has the unfortunate distinction of being among the ten states that impose the highest taxes on the poor.

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Rhode Island is among 25 states that offer a state EITC but unlike most states, the Ocean State’s credit is only partially refundable. Under current state law, low-income taxpayers with jobs in Rhode Island can receive a credit worth 25 percent of the federal EITC.

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The credit is applied against taxable income and similar to the federal policy, when the credit exceeds the amount of taxes owed, the balance is refunded to the taxpayer. In Rhode Island, however, only 15 percent of the unused amount can be refunded. This means that the maximum state refund is only 3.75 percent of the federal EITC, or $221 for a family with three children.

Neighboring states Massachusetts and Connecticut currently offer larger EITCs than Rhode Island.

Connecticut offers a fully refundable 25 percent state credit which is scheduled to rise to 30 percent by 2015, while Massachusetts fully refunds a 15 percent credit.

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Conclusion

Rhode Island households continue to suffer the effects of the Great Recession. Since the start of the

economic downturn, the median wage has been stagnant, twice as many individuals are seeking

emergency food assistance and the amount of payday loans being taken out has doubled. Increasing

the refund offered through the state’s Earned Income Tax Credit would boost the income of low-wage

households, improve a child’s ability to succeed in school and work, enhance tax equity, and curb

growing income inequality in the Ocean State.

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Appendix: Impact of Fully Refundable 20% EITC on RI Households, TY 2013

Single Parent with Two Children Annual Earnings $25,000 Adjusted Gross Income $25,000 Standard Deduction $12,000 Personal Exemptions $11,250

Taxable Income $1,750

Taxable Income × 3.75%

Tax Rate

$66

Federal EITC $3,799

Impact of Current RI EITC

Impact of 20%

Refundable EITC RI 25%

EITC $950 RI 20%

EITC $760 Smaller

of Tax or RI EITC

- $66

Smaller of Tax

or RI EITC

- $66

= $884 = $694

Partial Refund (15%)

$133 100%

Refund $694

$561

Difference between current EITC and 20% fully refundable EITC

Married Parents with Two Children Annual Earnings $33,280 Adjusted Gross Income $33,280 Standard Deduction $16,000 Personal Exemptions $15,000

Taxable Income $2,280

Tax Rate

$86

Federal EITC $3,179

Impact of 20%

EITC $795 RI 20%

EITC $636 Smaller

of Tax or RI EITC

- $86

Smaller of Tax

or RI EITC

- $86

= $709 = $550

Partial Refund (15%)

$106 100%

Refund $550

$444

Difference between current EITC and 20% fully refundable EITC

Single Parent with One Child Annual Earnings $16,640 (min wage) Adjusted Gross Income $16,640 Standard Deduction $12,000 Personal Exemptions $7,500

Taxable Income $0

Tax Rate

$0

Federal EITC $3,250

Impact of 20%

EITC $813 RI 20%

EITC $650 Smaller

of Tax or RI EITC

- $0

Smaller of Tax

or RI EITC

- $0

= 813 = $650

Partial Refund (15%)

$122 100%

Refund $650

$528

Difference between current EITC

and 20% fully refundable EITC

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i Center on Budget and Policy Priorities. Policy Basics: The Earned Income Tax Credit. January, 2014.

ii Tim Dowd and John Horowitz. Income Mobility and the Earned Income Tax Credit: Short-Term Safety Net or Long-Term Income Support. Public Finance Review, 2011.

iii Chuck Marr and Chye-Ching Huang. Earned Income Tax Credit Promotes Work, Encourages Children’s Success at School. Center on Budget and Policy Priorities. March 5, 2013.

iv Institute on Taxation and Economic Policy. Reward work through Earned Income Tax Credits. November 15, 2013.

v 2012 Statistics of Income. RI Division of Taxation, 2014.

vi Institute on Taxation and Economic Policy analysis of RI tax data, 2013

vii Ibid.

viii Chuck Marr and Chye-Ching Huang. Earned Income Tax Credit Promotes Work, Encourages Children’s Success at School. Center on Budget and Policy Priorities. March 5, 2013.

ix Ibid

x Michelle Maxfield, “The Effects of the Earned Income Tax Credit on Child Achievement and Long Term Educational Attainment,”

November, 2013.

xi Dayanand S. Manoli and Nicholas Turner, “Cash-on-Hand & College Enrollment: Evidence from Population Tax Data and Policy Nonlinearities”, January, 2014

xii Hilary W. Hoynes, Douglas L. Miller, and David Simon, UC Davis. The EITC: Linking Income to Real Health Outcomes.

xiiiLeslie McGranahan and Diane W. Schanzenbach. The Earned Income Tax Credit and Food Consumption Patterns. Federal Reserve Bank of Chicago. November, 2013.

xiv Elizabeth McNichol, Douglas Hall, David Cooper, and Vincent Palacios. Pulling Apart: A State-by-State Analysis of Income Trends.

Center on Budget and Policy Priorities and Economic Policy Institute. November 15, 2012.

xv Institute on Taxation and Economic Policy. Who Pays? A distributional analysis of the tax systems in all 50 states. January 2013.

xvi Ibid.

xvii R.I.G.L. 44-30-2.6

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Institute on Taxation and Economic Policy. Reward work through Earned Income Tax Credits. November 15, 2013.