State Earned Income Tax Credit Expansion

Background

State Earned Income Tax Credit (EITC) Boosts Low-Income Households’ Earnings. The California EITC is a state personal income tax provision that benefits individuals and families who earn less than $22,300. The amount of the credit depends on taxpayers “earned income” (which primarily includes wages and self-employment income), filing status, and the number of qualifying dependent children. The tax credit is fully refundable. This means that if the amount of a taxpayer’s EITC is greater than his or her liability before applying the credit, then the state pays the taxpayer that difference.

After Maximum Credit, Amount Declines as Income Rises. The amount of the EITC initially rises with earnings, such that the greater the filer’s earnings, the larger the credit. The credit peaks at a certain income and then gradually phases out for higher levels of earnings. For the 2017 tax year, the maximum credit was $2,775 for single filers with three or more dependents who earned roughly $7,300. (The maximum credit was lower for filers with fewer dependents.) The credit phases out completely at about $22,300 for filers with at least one qualifying dependent child and at about $15,000 for filers with no dependents. The Franchise Tax Board (FTB) annually adjusts the income thresholds and credit amounts for inflation.

California Expanded EITC Last Year. The 2017 budget package expanded the state EITC to include self-employment income (which was previously excluded) and increased the income level at which the credit phases out completely (previously around $14,000). Due primarily to this expansion, the number of filers has increased from 386,000 last year, to about 1.3 million through April of this year. (The administration expects that more than 1.5 million filers will claim the EITC by the end of the year.) The average credit amount has decreased with the expansion, however—from about $840 to about $350 for filers with qualified dependent children and from about $120 to about $70 for filers without dependents—because there are many more filers with higher incomes, who receive smaller credits.

State EITC Structured on Federal EITC. The U.S. tax code has long included an EITC. In 2015, when California created the state EITC, it was designed to supplement the federal EITC for those working individuals and families whose incomes were relatively low. As the state EITC is based on the federal EITC, it also shares certain restrictions on eligibility. Specifically, eligible filers must be a U.S. citizen or resident alien. In addition, if they do not have a qualifying child, eligible filers must be at least age 25 and younger than age 65.

Governor’s Proposal

Expand EITC to Close Age Gaps and Compensate for Rising Minimum Wage. The administration proposes to expand the state EITC to working individuals without children who are between the ages of 18 and 25, as well as to those over age 65. In addition, the administration proposes to increase the income level at which the credit phases out completely to $24,960 (the earnings of one person working fulltime at the 2019 minimum wage of $12 per hour) for filers with one or more dependents and to $16,800 for filers with no dependents. These changes to the EITC would be in effect for the 2018 tax year. The administration estimates that this proposal would allow 700,000 more tax filers to claim the credit each year, increasing the EITC annual cost by about $60 million.

Expansion Would Increase Amount of Credit for Some Filers. The expanded credit would leave most features of the existing credit, such as the maximum amount, unchanged. By increasing the maximum qualifying income, however, the proposal would increase the amount of the credit—by tens of dollars—for those filers with earned incomes that fall near the high end of current qualifying range. For example, a single filer with two dependents and earned income of $18,000 would receive about $30 more under the expansion.

LAO Comments

Cost Estimate Reasonable, But Uncertain. The proposed expansion of the EITC affects four groups of people who are currently ineligible:

Filers aged 18‑24 with earned incomes of up to $16,800, who have no dependent children, and cannot be claimed as a dependent by another filer.
Filers over age 65 with earned incomes of up to $16,800 and who have no dependent children.
Filers with qualified dependent children and earned incomes between $22,300 and $24,960.
Filers with no dependent child and earned incomes between $15,000 and $16,800.

While demographic statistics suggest the administration’s cost estimates are reasonable, they are highly uncertain. The cost of the expansion will depend on various factors, including awareness of the credit, the “take-up” rate—that is, the share of eligible individuals who file a tax return claiming the credit—for each group, and filers’ income. Consequently, the actual cost of the proposed EITC expansion may be tens of millions of dollars higher or lower than $60 million.

Some Newly State Eligible Individuals Not Eligible for the Federal EITC. Those filers who would be able to claim the expanded state EITC because of the changes on age restrictions will still not be able to claim the federal EITC. Many of these individuals—those with incomes below about $14,000—are not required to file state tax returns. As a result, these newly eligible individuals may not know about the state EITC and may not file a state return.

Consider Whether Additional Outreach Is Needed. The FTB receives $900,000 annually for EITC education and outreach. FTB uses these resources to educate taxpayers and tax preparers broadly about the state EITC and free tax preparation services. As we describe in our earlier analysis, the Legislature augmented FTB’s budget in 2016‑17 and 2017‑18 by $2 million for grants to other organizations to expand awareness of the EITC. The administration is not proposing any spending on EITC education and outreach—beyond the $900,000 typically allocated to FTB—this year. Many of the individuals who would become eligible for the EITC under the administration’s proposal are not required to file state income taxes, will be ineligible for the federal EITC, and would receive relatively small credit amounts. Thus, should the Legislature approve this proposal, additional one-time spending on targeted education and outreach to those who are newly eligible because of their age may be justified.