Another Reason State EITCs Matter: They May Help States Reap the Benefits of the Federal EITC

State Earned Income Tax Credits (EITCs), like California’s CalEITC, are important tools for boosting economic security for working families. By piggybacking on the federal EITC, these state credits help families with low and moderate incomes to keep more of their earnings so they can better afford the basics. A new working paper by University of California (UC), Irvine researcher David Neumark and a former UC Irvine PhD student provides another reason why these state credits matter. State EITCs significantly boost federal EITC claims, suggesting that they may help states reap the well-documented benefits of this federal credit, which include cutting poverty, boosting employment, and supporting children’s health and development (read a summary of this research). This means that the CalEITC could help California maximize the benefits of the federal EITC. This is important because around 1 in 4 eligible California households — about 1 million in total — do not claim the federal EITC each year, depriving California of nearly $2 billion in federal funds annually. This is a huge missed opportunity, not only for the working families who would directly benefit from these dollars, but also for the California-based businesses that would gain from the purchases these additional dollars would make possible.

State EITCs May Significantly Boost Federal EITC Participation

This new study finds that state EITCs significantly increase federal EITC participation among single tax filers with children, who make up the majority of federal EITC claims. This effect is greater in states that 1) have larger state EITCs (currently, state EITCs provide credits that range from 3.5 percent to 85 percent of the federal EITC) and 2) have larger shares of residents who are likely eligible for the federal EITC, as estimated by the percentage of adults with no more than a high school degree.

Brace yourself because fully explaining the study’s results require us to get a bit wonky. The study’s key finding is that the federal EITC participation rate increases by nearly 9 percentage points for every 10-percentage-point increase in the size of a state EITC and 10-percentage-point increase in the share of state residents who are likely eligible for the federal EITC. For instance, in the hypothetical example in the table below, State A has a “20 percent” state EITC, while State B has a “10 percent” state EITC (a 10-percentage-point difference). Additionally, 35 percent of State A’s residents likely qualify for the federal EITC, compared to 25 percent of State B’s residents (also a 10-percentage-point difference). Based on these factors, the federal EITC participation rate in State A would be expected to be nearly 9 percentage points higher than that in State B – perhaps almost 89 percent compared to 80 percent. This substantial difference in participation means that State A would reap much greater benefits from the federal EITC. The additional federal EITC dollars drawn into State A would not only help more working families make ends meet, but also provide a greater boost to the state’s economy.

 


State A State B
State EITC as a Percentage of Federal EITC 20% 10%
Percentage of State Residents Likely Eligible for Federal EITC 35% 25%
Expected Federal EITC Participation Rate 88.9% 80.0%

Importantly, the study’s authors express some doubts about size of the effect they found. However, they are “quite confident that there is a positive effect.”

The CalEITC May Boost Federal EITC Participation Even More Than Other State EITCs

What might these findings mean for California? Since the study covered a period that predated the creation of the CalEITC, and because California’s state credit is structured very differently from the state EITCs included in this research, the paper’s lead author, David Neumark, can only speculate. But his informed supposition is that the CalEITC may boost federal EITC participation more than other state EITCs. That’s because the CalEITC is available only to extremely low-earning households, who are probably less likely to be aware of and currently claiming the federal EITC. In other words, there may be much room for improvement in federal EITC participation among the very workers who are eligible for the CalEITC. Also, because the CalEITC provides the largest state EITC in the nation — generally 85 percent of the federal EITC — it may be more effective than other state EITCs at encouraging people who are not currently working to join the workforce. If so, then the CalEITC would increase the number of Californians claiming the federal EITC.

Promoting the CalEITC Is Key to Its Success

Although the CalEITC has great potential to improve federal EITC participation, it is unlikely to do so without a robust and sustained promotional effort. That’s because unlike other state ETICs, the CalEITC is targeted to workers with such low incomes that most are not required to file state income taxes. In other words, many workers who stand to benefit from the new credit may not realize that they are eligible for it, or they may find the prospect of filing their taxes for the first time too daunting. As a result, California may need to work harder than other states to promote the state EITC and to connect eligible workers to free tax preparation services to make filing more feasible.

That’s why California policymakers should once again invest in community-based efforts to raise awareness of the state and federal EITCs. California’s 2016-17 budget agreement included $2 million for this purpose, but the Governor’s proposed 2017-18 budget does not maintain this funding. An additional year of funds to support EITC promotional efforts could help California make even greater headway in boosting CalEITC and federal EITC claims. With California’s families and communities facing significant threats from expected federal policy changes, it’s more important than ever to use the new CalEITC as an opportunity to maximize the federal dollars flowing to low-earning families in our state.

— Alissa Anderson