Few policy topics generate as much passion, disagreement and even
some cognitive dissonance as poverty—or more accurately,
anti-poverty.
For as long as U.S. policymakers have sought to eradicate poverty,
debate has raged over the relative effectiveness of various anti-poverty
programs. Lyndon Johnson's War on Poverty was considered a mixed success
at best. Social Security, on the other hand, has clearly prevented
a great deal of poverty among the elderly.
Whatever their faults, antipoverty programs—combined with a growing
economy—have had a dramatic effect. Poverty rates have dropped
significantly in recent decades, declining by half from 1959 to 2000
for all families, according to the Bureau of the Census, and dropping
from 43 percent to 29 percent for female-headed households.
During the Clinton administration, policymakers again revisited national
welfare programs and in 1996 significantly reformed their provisions
and, by extension, the nation's approach toward poor families and
children. The debate over the 1996 reforms continues in full force
today, thanks to the fact that the 1996 measures are up for reauthorization,
and President Bush, Congress and various interest groups are debating
changes to current programs.
But amid the argumentative din, one particular program—the Earned
Income Tax Credit (EITC)—has been conspicuously absent, despite
having managed to accomplish many of the goals of both welfare advocates
and critics. It rewards work, is well targeted to low-income households
(and therefore resource-efficient) and provides string-free resources
to low-income families.
Most important, as an anti-poverty program, the EITC is demonstrably
effective: In 1999, for example, EITC payments were directly responsible
for lifting almost 5 million people—half of them children—above
the poverty threshold, according to an analysis of census data by
the Center on Budget and Policy Priorities. That's a greater impact
than any other government transfer program.
The EITC is a tax code provision, administered not by the Department
of Health and Human Services but by the Internal Revenue Service.
And while IRS code is not generally known for its straightforward
nature, it is precisely the simple and singular design of the EITC
that, say analysts, results in its success as an anti-poverty program:
If the biggest problem facing the poor is their lack of money, then
give them more money and allow them to spend it as needed.
In all, federal EITC spending tallied about $32 billion in 2002, and
supplemental state programs added another $1 billion or so onto the
paychecks of low-income workers. (See a description
of the EITC's payment design.) That compares with total state and
federal welfare spending of $30 billion in 2001, according to a report
last year by the National Council of State Legislatures.
Like its anti-poverty predecessors, the EITC's just-give-them-money
approach comes with trade-offs and unintended consequences. But a
substantial body of research suggests that no other program can claim
the anti-poverty success and administrative efficiency of the EITC
when it comes to poor families. In a paper on the political history
of the EITC, Dennis Ventry of the Brookings Institution wrote, “The
overwhelming majority of economic evidence suggests that the EITC
constitutes a uniquely effective and viable anti-poverty program.”
A winning design?
In the last several years, an armful of studies has shown that the
EITC has had a large, positive effect on reducing welfare use and
increasing employment among single parents. In a 2001 paper for the
National Bureau of Economic Research (NBER), Jeffrey Grogger of the
University of California, Los Angeles, found that the EITC was a “particularly
important contributor to both the recent decrease in welfare use and
the recent increase in employment, labor supply and earnings.”
Specifically, he found that the EITC explained as much as one-third
of the decline in welfare use from 1993 to 1999 and close to half
of the increase in employment. EITC expansions in the 1990s “have
had substantial effects on almost all dimensions of behavior. The
EITC may be the single most important policy measure for explaining
the rise in work and earnings among female-headed families in recent
years.”
Follow-up research published this year by Grogger is particularly
notable because he investigated factors behind both entries into and
exits out of welfare. While this might sound obvious, the vast majority
of research looks only at welfare exits, treating the entire welfare
pool as “lifers” as it were, rather than as a mixed, mostly
transient pool where some recipients are long term but most come and
go—all for different reasons.
By disaggregating the welfare population, Grogger found that much
of the decline in welfare caseloads was driven by a reduction in welfare
entries and reentries, which were heavily influenced by the EITC,
the economy and the decline in welfare benefits. Exits, on the other
hand, were affected most by the economy and welfare reform (like time
limits and lower benefit levels), though the EITC appears to have
had a small influence here as well.
Other recent research reinforces the particular influence of the EITC-among
a crowd of potential factors-on moving welfare recipients into the
workforce. Bruce Meyer of Northwestern University and Dan Rosenbaum
of the University of North Carolina at Greensboro, writing in The
Quarterly Journal of Economics in 2001, stated that “financial
incentives have powerful effects on single mothers' employment decisions.”
They attributed about 60 percent of the increase in work by single
mothers from 1984 to 1996 “to the EITC and other tax changes,
with smaller shares for welfare benefits cuts, welfare waivers, training
programs and child care programs.”
Looking at an anti-poverty demonstration project in four California
counties for the Joint Center for Poverty Research, V. Joseph Hotz,
Charles Mullin and John Karl Scholz (2001) found “striking, positive
effects of the EITC on employment.” Evidence suggested that the
EITC “has played an important role in increasing the employment
rates among low-skilled workers,” particularly those that are
current or past welfare recipients. From 1993 to 1998, the researchers
calculated, the EITC was responsible for 21 percent of the increase
in labor force participation among one-child, single-parent welfare
recipients, and 45 percent of the increase among single-parent households
with two or more children.
That doesn't mean that the EITC has a proportional effect on the amount
of work. In fact, for those already in the labor force, economic theory
suggests that the EITC should have a slightly negative effect on the
number of hours worked, because the phase-out portion of the program
reduces the financial premium for working longer hours.
In a 1996 paper, Nada Eissa of the University of California, Berkeley,
and Jeffrey Liebman at Harvard University stated that while theory
predicts an expansion of EITC benefits should increase labor force
participation and reduce hours worked by those already working, their
empirical analysis found that only the first prediction held true
when the EITC was expanded in 1987: Labor force participation did
increase, but there was no reduction in hours worked. The authors
noted, “compared with other elements of the welfare system, the
EITC appears to produce little distortion of work incentives.”
A March 2003 study by Eissa and Hilary Williamson Hoynes of the University
of California, Davis, put a finer point on it: The EITC had a modest
disincentive for married women to work, “effectively subsidizing
married mothers to stay at home,” while single women with children
have been shown “to substantially increase labor supply in response
to the EITC.”
Indeed, it appears that the EITC's most important lever is inducing
nonworkers into the labor force, which has important lasting implications.
For one, it limits long-term unemployment, which has significant consequences
for the job skills and other human capital of workers that determine
ultimate earnings. More immediately, poor families today retain access
to numerous support programs if they decide to work—a major shift
from the old welfare system that reduced assistance as work earnings
increased.
Rebecca Blank of the University of Michigan and the NBER pointed out
in a December 2002 paper, “The evidence on income and poverty
suggests that most single mothers had higher incomes by the end of
the 1990s, despite a loss in [direct] government assistance.”
Research over the last decade "unambiguously" showed that
“steady work, even at a relatively low wage, when combined with
EITC, with child care assistance, with access to Medicaid, with Food
Stamp and Child Support assistance, would leave a woman substantially
better off.”
Keep it simple
Much of the success of the EITC can be traced to its simple, tax-based
design. It achieves its unique objective—getting more resources
directly into the pockets of poor families, no strings attached—with
great efficiency.
High participation. As many as 85 percent of qualified individuals
are believed to claim the EITC; in contrast, the Urban Institute estimated
that participation among eligible families for Temporary Aid to Needy
Families (the main federal welfare assistance program created in the
1996 welfare reform law) ran about 55 percent in 1998, possibly because
of the bureaucratic headache of applying and receiving benefits, and
partially because of the stigma associated with welfare—both
of which are avoided by the EITC.
Well targeted to low-income populations. Because it subsidizes
only welfare recipients who are working, the EITC could be viewed
as poorly targeted to welfare populations. But in the larger view
of an anti-poverty program, the EITC is well targeted because the
vast majority of resources go to those with low incomes. In 1999,
almost 20 million people received more than $30 billion in EITC payments.
According to Hotz, Mullin and Scholz, 40 percent of payments go to
workers making $6.25 or less; 80 percent go to workers with wages
below $9.78.
Low administrative costs. The General Accounting Office estimates
that EITC administrative costs are about 1 percent of payments. In
contrast, administrative costs for traditional cash assistance programs
and food stamps run as high as 15 percent, according to several sources.
Administrative costs for the EITC do go up, however, if one includes
the cost of tax preparation to claim the credit. It's estimated that
about $2 billion in EITC payments were diverted for tax preparation,
electronic filing and high-cost loans (which put the money in filers'
hands about eight to 10 days earlier than a standard tax return, but
for an elevated fee). That's about 6 percent of the EITC's final payout
to eligible families, according to a 2003 Brookings Institution report.
But even when such costs are included—bringing total administrative
costs to about 7 percent—the EITC is still more administratively
efficient than traditional welfare programs.
Still not perfect
The design of the EITC involves some important tradeoffs Most importantly,
as an anti-poverty program it misses those most in need—namely,
those families without a working adult. But then again, other welfare
programs remain in place for such families, and the inclusion of nonworking
families in the EITC would likely undermine the work-oriented utility
of the program. But the EITC has other drawbacks as well.
Higher cost. As noted earlier, total spending for the EITC
is more than for traditional welfare programs because so many meet
its eligibility requirements. Whereas about 2.5 million people are
on welfare, about 20 million claim the EITC. As such, the EITC's design
creates “windfall benefits” for those workers who would
have been in the labor force anyway, absent the program—probably
about 90 percent of all EITC recipients. But from a policy standpoint,
the design is intentional: to provide incentives to help welfare recipients
into the workforce; to help low-income workers avoid going on or returning
to welfare; and to increase the living standards of the working poor
regardless of whether they were ever on welfare.
Noncompliance. Another Achilles' heel of the EITC is compliance,
making sure that only those eligible receive payment. As a tax credit,
the program receives significantly less government oversight than
a traditional anti-poverty program, which leaves the door wide open
to fraud and other noncompliance issues. A 2002 report by the Treasury
Department found that about 27 percent to 32 percent of the $31 billion
paid out in 2000 “should not have been paid.” (Interestingly,
two-thirds of all tax returns claiming the EITC were prepared by professional
tax preparers, but the IRS has found their error rates to be similar
to those returns that are self-prepared.)
This isn't a new problem. The Balanced Budget Act of 1997 gave the
IRS more than $700 million over five years solely to improve EITC
compliance through expanded customer service and public outreach programs,
better research and stronger enforcement. The IRS claims that efforts
over the five-year budget period generated $5 billion in credits that
were either protected (did not have to pay) or collected (from incorrect
or fraudulent returns).
In its latest effort, the IRS announced in late April that it would
require more conclusive proof of parental or guardian relationships
(which determine EITC eligibility) from certain subgroups known to
have high error rates—like fathers, grandparents and foster parents
who do not meet child custody requirements but still claim the credit.
The move is expected to affect as many as one in five recipients and
was criticized by sources in a New York Times article as an unfair
burden of proof and “wasteful allocation” of scarce IRS
compliance funding, given the scale of the problem in context with
other tax fraud.
By comparison
What about its anti-poverty policy competitors? Does the EITC have
any advantage over other programs or strategies? The two most prevalent
strategies are the minimum wage and narrowly focused, end-use subsidy
programs, like those for child care, transportation and job training.
The research suggests that while each of these other programs has
positive attributes, none appears to offer the net results or benefits—the
reduction of poverty, the targeted and flexible use of resources and
the efficiency of delivery—of the EITC. Child-care subsidy programs,
for example, are widely (and accurately) lauded for helping welfare
recipients find and hold jobs (though the full magnitude of their
contribution is still a matter of debate). But success from this narrowly
defined program comes at a considerable cost.
About $9 billion per year is spent on child care through federally
funded, means-tested programs with a work requirement, according to
a variety of research sources. (Close to half of that total is spent
by states, but the funding comes mostly through federal block grants.)
Recent estimates by several government and academic studies show that
about 1.7 million children receive subsidized care. That translates
to better than $5,000 per child and includes administrative costs
and care services rendered. Actual reimbursement rates (as of 1999)
vary widely by state, ranging from $13 a day in Louisiana (equivalent
to about $3,000 annually) to $711 monthly in Maryland ($8,500 annually),
according to a 2001 study by the Joint Center for Poverty Research.
Because of limited resources, only one in seven eligible children
receives the childcare subsidy. By contrast, the EITC casts a broad
net, and the credit is available to any eligible worker for the small
price of filling out the necessary tax form. Somewhat ironically,
as many as 20 percent of those believed to be eligible for the EITC
fail to claim the credit.
But the EITC's real advantage comes in its flexibility and the absence
of any requirements about how benefits can be used. With limited resources,
poor working people face a multitude of financial challenges, including
(but hardly limited to) day care, transportation, nutritional needs
and health care. If child care is the most urgent need, then the EITC
can help pay for such needs; if not, the money can be spent on other
needs, like fixing a car.
Many policymakers and others are uncomfortable with cash subsidies,
particularly the large, lump-sum payments of the EITC, where the entire
credit is paid out at one time rather than tacked on weekly or monthly
to a paycheck. Often the perception is that EITC recipients buy stereos
or other non-necessities when they “should” be buying better
day care for children, or a safer car or more nutritional meals at
home.
What recipients actually do with EITC payments has not been studied
much, but a 2000 analysis by Timothy Smeeding of Syracuse University,
Katherine Ross Phillips of the Urban Institute and Michael O'Connor
of Loyola University found that the highest priority for EITC money
was bill paying, followed by larger purchases. Recipients can receive
EITC payments either as a single refund check or as (limited) advance
payments, and almost all choose to receive a lump sum. Both Smeeding
et al. and a 2000 study by Jennifer Romich of Northwestern University
and Thomas Weisner from UCLA found that recipients use the EITC as
something of a forced-savings plan, used later to buy goods like furniture
and entertainment but also items like cars and education that can
improve economic and social mobility.
Cash payments also encourage recipients to find spending alternatives,
which can help poor households retain precious dollars where possible.
For example, subsidizing child care penalizes those low-income workers
who have arranged informal child care. A 2001 study for the National
Center for Children in Poverty found that unpaid, informal care accounts
for almost half of all child care used by families with an employed
mother and preschool child.
Substantial increases in childcare subsidies might convince low-income
mothers using informal caregivers (like grandmothers) to seek program
subsidies for formal day care. This would increase a program's use
and cost, without necessarily creating any reciprocal benefits: The
child is better off only if placed in a better care environment (itself
a matter of some interpretation), and the subsidies do not increase
the employment of a mother already in the workforce. Day care can
also be difficult to find for nontraditional work schedules (like
third shift or weekend shifts), which precludes such families from
receiving the subsidy because it typically goes to the licensed care
provider.
Minimal challenger
Available evidence on the effect of the minimum wage on poverty
suggests that it can't compete with the EITC as an anti-poverty program
on several fronts. For starters, at its maximum credit for a family
with at least two children, the EITC acts as a wage subsidy of $2
an hour for a full-time worker, and even more for those working part
time—well above any minimum wage increases being proposed.
(In fact, one would suspect that employers and their associations
would be champions of the EITC, given their disdain for minimum wage
increases; but calls to several business associations indicated that
the EITC has little visibility among employers.)
Probably more important, from a design standpoint, the minimum wage
is fraught with flaws. For example, minimum wage advocates tout its
cost savings to government. But those costs ultimately are borne by
employers as an implicit tax, which has other negative repercussions.
Research has repeatedly shown that increases in the minimum wage lead
to overall employment losses. The minimum wage is also poorly targeted,
with benefits reaped by teenage workers, second-income earners and
other workers in households that might be far from poor.
A 2001 report for the Employment Policies Institute looked at the
effect of minimum wage increases on full-time workers—who would
see the largest financial gain—and found no poverty-reducing
effect, probably because many workers are already in the upper part
of the affected wage range. Said EPI, “[M]inimum wages, because
of inefficient targeting of the poor and unintended consequences on
employment and earnings, are ineffective as an anti-poverty device.
... There is virtually no meaningful evidence that higher minimum
wages reduce poverty in the United States.”
Research in 1999 by David Neumark of Michigan State University and
William Wascher of the Federal Reserve Board of Governors indicated
that minimum wages increase the net number of poor families because
employment loss “tends to exceed the number lifted out of poverty
by the higher minimum [wage].” They concluded that the EITC “is
much more likely to raise the earnings of poor families than is the
minimum wage.” The EITC's influence on poverty was stronger mostly
because of its ability to induce nonworkers into the workforce and
reduce the negative economic consequences of long-term unemployment.
A political mutt, and that's good
The development and expansion of the EITC stem largely from the
fact that it has been adapted to conform to changing political breezes.
Most important, its underlying make-work-pay philosophy embodies both
anti-poverty and anti-welfare characteristics. Even some of the strongest
criticisms of the make-work-pay movement are being questioned.
For example, many critics have argued that pushing single parents
into the workplace can compromise a child's development. But a March
2003 study funded by the National Institutes of Health found that
mothers' transition from welfare to work “did not seem to have
any negative effects on preschoolers or young adolescents.” In
general, the research found that preschoolers were unaffected by whether
their mothers went on welfare, left welfare or entered or left the
workplace. In fact, young adolescents showed slightly reduced levels
of anxiety when their moms went to work. In general, the study suggested
that each path had positive and negative aspects—like increased
income, but less family time—that might ultimately cancel each
other out.
Others have predicted that opinions about the work-first model might
change when the economy headed south. In fact, Grogger's research
indicates that the EITC's effectiveness in reducing initial entry
and reentry into welfare, along with other factors, “might explain
why caseloads have remained roughly constant despite the increase
in unemployment” since the recession that started in March 2001.
What may be most surprising about the current welfare reform debate
is that none of the proposals in play makes any mention of the EITC,
despite the fact that research has shown it has a significant effect
not only on getting welfare recipients into work and keeping them
there, but also on helping poor families out of poverty. That's not
to say the EITC is the end of poverty, but its track record—particularly
compared with other anti-poverty programs—is undeniably strong.
It's one of the few programs that puts significant resources directly
into the hands of poor families—and a lot of them—and does
so at a small administrative cost.
To evaluate alternative strategies for achieving similar policy objectives,
one has to compare their benefits and costs. As a tax-based program,
the EITC can claim high participation, good targeting to low-income
families, low bureaucracy and unique flexibility when it comes to
how the resources are actually used by recipients. Traditional welfare
programs, on the other hand, can boast pinpoint targeting with few
windfall beneficiaries and little fraud, but they carry bureaucratic
baggage in their delivery and eligibility, and have significantly
higher average costs per recipient.
Judgments about the success of various anti-poverty programs depend
on the relative weights policymakers place on the benefits and costs
of each strategy, and the debate over the best means of reducing poverty
is therefore a difficult and contentious one.
But as Eissa and Liebman stated, “If policymakers want to redistribute
income to the working poor and are comfortable with the tradeoffs
involved in using the tax system rather than the welfare system to
administer transfers, the EITC seems to be a way to do so with minimal
efficiency costs.”
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