This content is provided by the Americans for Tax Reform Foundation.

Current Law

The Earned Income Tax Credit is a refundable tax credit for low- and middle-income individuals and households. It was enacted as an assistance program that “rewarded work” by increasing in value as earned income increased. The credit begins to phase in with the first dollar of earned income, plateaus at the maximum credit value at a certain income level (depending on the filer’s number of dependents), and phases out slowly as more income is earned.

The current iteration of the EITC features a top rate of 45% of earned income (for couples with three or more dependents), for a maximum credit value of $5,891; for this group, the credit begins phase-out at $22,300 of earned income, and is completely phased out after $45,060 of earned income.

Scheduled Changes

In 2013, a number of provisions enacted in 2009 to change the EITC will expire. Most significantly,  families with three or more dependents will see the top rate for their credit decline from 45% to 40% of earned income. Additionally, the beginning point of the phase-out range for joint filers will be reduced by $3,000 (to $19,300), a “marriage penalty” will reemerge in the phase-out range, and filers with liability from the Alternative Minimum Tax (AMT) will be limited in their ability to claim EITC benefits.

ATRF Analysis

The EITC was designed in 1975 to cover the FICA taxes of lower-income people. It was created as an alternative to Milton Friedman’s Negative Income Tax, a proposal to replace the welfare state with a simple system of cash assistance for the poor (Friedman, for his part, opposed the EITC, because it supplemented the existing welfare bureaucracy instead of replacing it). Within ten years of the credit’s creation, its tax-relieving intent was swamped by a new purpose: to provide welfare through the tax code by empowering the IRS to cut checks to workers with negative tax liabilities.

That said, much of the EITC’s benefits cannot be accurately characterized as tax relief — rather, it is social spending. According to 2009 data from the IRS, $54 billion of EITC benefits were cash supplements (“refunds,” according to the IRS, although it’s unclear what is being refunded), while only $5.3 billion served as tax relief, or an offset to existing tax liability.

The changes set to occur in 2013 will reduce tax relief in the EITC substantially — by $26.5 billion over ten years. This amounts to an effective tax increase of $2.65 billion per year, whittling away the EITC’s actual tax relief by roughly half. A special burden will be placed on AMT filers (many of them middle-income, due to bracket creep), who will no longer be able to claim the EITC against their AMT liability.

To contrast, the 2013 changes will only reduce EITC social spending (outlays) by $14.0 billion in ten years — a positive step towards lower government spending, but a drop in the bucket compared to the EITC’s outlays over that same period.

Scheduled changes to the EITC will reduce legitimate tax relief, while making only a small dent in government spending through the tax code. On net, this is a major loss for taxpayers.

10 Year Cost to Taxpayers

Department of the Treasury: $40.5 billion (of that amount, $14.0 billion are outlays, or “refunds”)

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