Historically, state tax policy and welfare reform efforts

Transcription

1 Social Tax Policies Directed at the Working Poor Social Tax Policies Directed at the Working Poor: The New York State Experience Abstract - Major changes in federal and state welfare systems have created new opportunities for the development of innovative social policies aimed at low income individuals who desire to work. New York State, which had one of the most generous earned income tax credits and child and dependent care credits among the states, is now using federal funding through the Temporary Assistance to Needy Families program to finance enhancements in these tax credits. The authors demonstrate the impact of the combined income tax credits on low income taxpayers. The results show that over the past seven years, effective tax rates have decreased markedly and become negative for these taxpayers. In effect, New York provides direct cash rebates to working poor families, and these tax subsidies are among the largest of all the states. David Boughtwood, Arthur Friedson, & Nick Gugie New York State Department of Taxation and Finance, Office of Tax Policy Analysis, Albany, New York National Tax Journal Vol. LIII,. 3, Part 1 INTRODUCTION Historically, state tax policy and welfare reform efforts have had little in common and have developed independent of one another. New York is an exception to this rule. The state has been at the forefront of innovative policies surrounding both its personal income tax and its approach to welfare reform for many years. More recently, the relationship between state tax policy and welfare policy has become even more intertwined. This paper will explore New York s experience with social tax policies directed at working individuals with below average incomes. It will also demonstrate how new federal laws have caused New York policy makers to further utilize the tax system to promote desired social welfare outcomes. New York State Personal Income Tax New York is one of 41 states with a broad based personal income tax. The income tax is the state s largest revenue source, collecting over $23 billion in State Fiscal Year (SFY) This comprised over one half of all state tax revenues. New York s personal income tax starts with federal adjusted gross income with certain state specific modifications. Taxpayers may choose either the standard deduction or itemized deductions, whichever is larger. The standard deduction currently equals $7,500 for single individuals, 439

2 TIOL TAX JOURL $10,500 for heads of household, and $13,000 for married couples filing a joint return. Itemized deductions equal federal deductions with the main exception of the deduction of state and local income taxes paid. personal exemptions are allowed for the taxpayer or spouse, but $1,000 may be deducted for each dependent. New York has a graduated income tax schedule with current rates ranging between 4 and 6.85 percent. The tax brackets for the married filing joint tax rate schedule include full income splitting. Top tax rates apply at $20,000 of taxable income for single individuals, $30,000 for heads of household, and $40,000 for married couple filing jointly. New York provides personal income taxpayers a variety of tax credits, including a household credit (HHC), real property tax circuit breaker credit, and a series of investment tax credits. This paper will focus on two credits which are refundable, the earned income tax credit (EITC) and the child and dependent care credit (CCC). In this paper, refundable means that the credit can reduce a taxpayer s liability to a negative number such that the state rebates the negative liability to the taxpayer. This is different from the cash flow term tax refund which refers to returning to a taxpayer an amount of overpayment (e.g., withholding less tax due). Welfare Reforms TANF Recently, the federal government enacted landmark welfare reforms in the Personal Responsibility and Work Opportunity Act of This legislation created the Temporary Assistance to Needy Families (TANF) program, which converted the former Aid to Families with Dependent Children (AFDC) to a block grant. States were allocated a fixed amount of federal TANF funding over six federal fiscal years The TANF program provides flexibility for funding a variety of employment and training activities, support services, and benefits that allow individuals to find work. States fund their TANF programs with a combination of federal and state funds. If states use federal funds, recipients are subject to work and participation requirements, a time limit of the federal assistance, data reporting, and certain prohibitions. States retain broad discretion in providing a wide range of benefits and services, and to set different eligibility standards for the different types of benefits. There is also the availability of state maintenance of effort (MOE) funds. States must spend 80 percent of their historic level of spending, or 75 percent if they meet work participation requirements, on qualified state expenditures to meet the basic MOE requirement. All MOE funds must be spent on TANF eligible families. Because of the improved economic picture in New York over the past five years, unemployment is low and welfare case loads have been significantly reduced. Therefore, the fixed size of the TANF block grant has generated surplus funds that can be used in many ways. In New York, about three quarters of the TANF monies are used to fund the provision of benefits to eligible households and finance services that encourage work. The remainder of the TANF funds are used for fiscal relief for state and local governments and for contingency reserves. TANF has expanded opportunities states have to develop new policies to help people leave the welfare rolls. This has been exemplified by a multitude of welfare to work programs, especially at the state level. In addition, TANF has spurred a new partnership between these mainstream welfare policies and the state income tax structure. States, including New York, are now using the refundable portion of certain income tax credits such as 440

3 Social Tax Policies Directed at the Working Poor the EITC and the CCC towards the MOE requirement. The TANF regulations make clear that income tax credits that go beyond tax relief and are paid to the eligible family would count toward a state s basic MOE requirement if the expenditure is reasonably calculated to meet a purpose of the TANF program (U.S. Department of Health and Human Services, 1999). This means that tax credits that provide general tax relief, such as the household credit or circuit breaker credit here in New York, would not qualify under TANF. Welfare Reforms in New York State After the passage of the federal Personal Responsibility and Work Opportunity Act of 1996, New York State crafted its own counterpart. In 1997, welfare reform legislation was enacted in New York that allowed the State to spend the federal block grant in a program that was designed to put people back to work. New York s welfare system underwent broad, fundamental changes that reduced State welfare rolls by over 700,000 since Due to these reforms and a vibrant economy, welfare case loads in New York are at levels that have not been observed since the 1960s. Key provisions of the 1997 New York State welfare reforms include: Established a new Family Assistance program that provides 60 months of cash payments (replacement for AFDC). Created a new Safety Net program that replaced the cash based Home Relief general assistance program. The new safety net provides non cash benefits to welfare recipients to ensure their basic needs are met. Small cash allowances are made for personal needs. Established the NY Works program, where able bodied welfare recipients are required to work for their benefits. This includes a five year lifetime limit on cash benefits. Recipients that exhaust their NY Works benefits become eligible for non cash Safety Net services. Created Earnfare, where welfare recipients that work are allowed to keep more of what they earn before benefits are terminated. They also remain eligible for Medicaid and child care benefits for up to one year, and low income daycare subsidies. Created a new state and local food assistance program for certain noncitizens who are not eligible for federally provided food stamps. This includes the elderly, disabled, and children who are legal immigrants, but not U.S. citizens. Reduced benefits to new state residents. Welfare recipients from other states, who come to New York, have their benefits limited to the benefit level of their former state or 50 percent of New York s payment level for 12 months (whichever is greater). The next section of this paper describes New York State s two main tax credits aimed at encouraging work for those individuals with modest or low income: the EITC and the CCC. Both of these credits have been significantly increased through legislation as New York has sought to avail itself of funding through the federal TANF program. The third section provides an overview and analysis of state EITC and child and dependent care tax provisions, including a comparison of tax thresholds in the states. The fourth section illustrates how New York s income tax structure, including refundable credits, affects families at various levels of the poverty line over time, including the interaction with federal law. The fifth section is the conclusion. 441

4 TIOL TAX JOURL DESCRIPTION OF NEW YORK STATE INCOME TAX CREDITS FOR THE WORKING POOR Earned Income Tax (EITC) Chapter 170 of the Laws of 1994 made New York the seventh state to provide an EITC. Enactment of the credit enjoyed broad political support, ranging from low income advocacy groups to business organizations. The EITC took effect for tax year 1994, and is based on a percentage of the federal credit. It was originally scheduled to phase in from 7.5 percent to 20 percent of the federal credit over the four year period However, legislation enacted in 1995 accelerated the full phase in from 1997 to Table 1 shows the credit percentages and amounts since The 1995 legislation also required that claimants reduce their EITC by the amount of household credit (HHC) they use to reduce tax liability. The HHC, a nonrefundable credit averaging about $50 and available to taxpayers with federal adjusted gross incomes under $32,000, was previously scheduled to be eliminated by As a tradeoff for retaining the HHC, the 1995 legislation required its subtraction from the EITC beginning in 1996, in effect limiting the HHC to persons without earnings and/or children generally the elderly. Finally, legislation enacted in 1999 increased the credit percentages to 22.5 percent in tax year 2000 and 25 percent for tax years beginning after One factor behind the increase was the certification by the U.S. Department of Health and Human Services that increased refundability of state EITCs is eligible for federal TANF revenue. The Department of Taxation and Finance estimates that approximately 85 percent ($110 million) of the $130 fully effective cost from increasing the EITC from 20 to 25 percent of the federal amount is eligible for federal reimbursement under TANF guidelines. The 1999 increase contained statutory language, termed a reversion event, that would return the EITC to its original 20 percent if New York were not able to access the federal TANF funding through the EITC. That is, if the federal government had determined that state increases in EITCs did not qualify as welfare spending, then New York would not have increased its EITC. However, this reversion has not thus far occurred. Figure 1 illustrates the structure of New York s EITC for tax year Future Changes As part of the New York s SFY budget, the EITC was increased from 25 percent to 27.5 percent of the federal credit for tax year 2002, and to 30 percent thereafter. This will provide additional annual benefits of approximately $125 million when fully effective. The Department of Taxation and Finance estimates that about 85 percent of this amount, or $105 million, would represent additional refunds, and therefore would qualify for the TANF offset. As with the 1999 legislation, the EITC reverts back to its original 20 percent of the federal credit if TANF resources cannot be used to fund the increase in the credit. Some other key features of the EITC include: The credit is refundable to residents, nonrefundable to nonresidents, and partly refundable for part year residents based on their resident period earnings. Taxpayers claim the credit on Form IT 215, which they must file along with their regular tax return. 1 For a summary and analysis of this legislation, see New York State Department of Taxation and Finance (2000). 442

5 443 Tax Year/. of Children 1994 Families with 1 child Families with 2 or more children Workers without children* 1995 Families with 1 child Families with 2 or more children Workers without children* 1996** Families with 1 child Families with 2 or more children Workers without children* 1997** Families with 1 child Families with 2 or more children Workers without children* Rate (%) TABLE 1 NEW YORK STATE EARNED INCOME TAX CREDIT, Maximum able Earnings $7,750 8,425 4,000 $6,160 8,640 4,100 $6,330 8,890 4,220 $6,500 9,140 4,340 Max. $2,038 2, $2,094 3, $2,152 3, $2,210 3, State Rate (%) State Max. $ $ $ $ Earnings for Start of Phase Out $11,000 11,000 5,000 $11,290 11,290 5,130 $11,610 11,610 5,280 $11,930 11,930 5,430 Phase Out Rate (%) Income Cut Off $23,760 25,300 9,000 $24,396 26,673 9,230 $25,078 28,495 9,500 $25,760 29,290 9,770 Social Tax Policies Directed at the Working Poor 1998** Families with 1 child Families with 2 or more children Workers without children* $6,680 9,390 4,460 $2,271 3, $ $12,260 12,260 5, $26,473 30,095 10, ** Families with 1 child Families with 2 or more children Workers without children* $6,800 9,540 4,530 $2,312 3, $ $12,460 12,460 5, $26,928 30,580 10, ** Families with 1 child Families with 2 or more children Workers without children* $6,920 9,720 4,610 $2,353 3, *Must be over age 24 and under age 65. **The credit is reduced by the amount of household credit used. tes: is refundable to residents, nonrefundable to nonresidents. Phase out based on greater of earnings or modified FAGI. Source: Office of Tax Policy Analysis $ $12,690 12,690 5, $27,413 31,152 10,380

6 Figure 1. New York EITC Phase Out Range, Tax Year TIOL TAX JOURL

7 Social Tax Policies Directed at the Working Poor Similar to federal practice, the Department of Taxation and Finance computes the EITC for taxpayers who request so when filing the non compute Form IT 100 (the New York counterpart to the federal 1040 EZ). The 1994 legislation requires that the Department of Taxation and Finance prepare an annual report, both in preliminary and final format, which provides statistical information on the EITC based on county of residence, filing status, amount of earned income, and number of qualifying children (New York State Department of Taxation and Finance, various years). 2 Table 2 shows credit usage and amounts from 1994 through As noted above, the EITC is refundable to New York State residents, who account for over 99 percent of all claimants and amounts. In addition, approximately 85 percent of the total EITC claimed was paid as refunds to persons without tax liabilities. This is similar to the federal experience. Child & Dependent Care (CCC) Effective beginning in the 1977 tax year, New York adopted a nonrefundable CCC equal to 20 percent of the federal credit. Except for federal changes, the credit remained unchanged through A series of law changes enacted in 1996 through 2000 gradually increased the credit percentage at certain income levels, above which it continues to phase down to 20 percent. 3 Also, effective in 1996 the CCC was made refundable for New York residents, though the CCC remains nonrefundable for nonresidents. Table 3 summarizes these changes. Table 4 shows the number of credit claimants, and the value of credits claimed, in recent years. The table indicates that the increases in the credit effective for 1996 and 1997 had no impact on overall CCC usage, but the average amount of the credit claimed increased slightly from $101 to $108. In fact, the total value of the CCC remained between $35 million and $40 million annually until the more substantive changes enacted in 1998 took effect. The credit expansion effective for tax years beginning after 1998 is estimated to result in a total CCC value of approximately $150 million for the 2000 tax year. Finally, the expansion enacted and effective in 2000 partially qualifies for the TANF offset. As with the EITC, beginning in 1996, taxpayers must file a separate Form IT 216, together with their tax return, to claim the CCC. The Department of Taxation and Finance computes the credit for taxpayers who file the no compute Form IT 100, which is the New York counterpart to the federal 1040 EZ. TABLE 2 NEW YORK STATE EARNED INCOME TAX CREDIT CLAIMS, Tax Year. of Claims Amount ($ Millions) Average ($) ,523 77, ,095, , ,076, , ,114, , ,141, , Source: Office of Tax Policy Analysis. 2 In federal fiscal year , 87 percent of the federal credit will represent an outlay, or refund in excess of tax. See Estimates of Tax Expenditures for Fiscal Years , Joint Committee ontaxation, (December 22, 1999). 3 For more information, see Summary of Tax Provisions in SFY Budget, Office of Tax Policy Analysis, New York State Department of Taxation and Finance (various years). 445

8 Maximum Percentage of the TABLE 3 NEW YORK CHILD & DEPENDENT CARE CREDIT, RECENT YEARS Provision Before After Maximum Income for 100% $10,000 $10,000 $17,000 $35,000 $50,000 Maximum Amount 1 Child* $144 $216 $432 $720 $720 $ Maximum Amount 2 or more Children $288 $432 $864 $1,440 $1,440 $1,584 Minimum Amount 1 Child* $96 $144 $288 $480 $480 $480 Minimum Amount 2 or More Children* $192 $288 $576 $960 $960 $960 Income Range Over Which Phases Down to 20% $10 14,000 $10 14,000 *Assuming maximum qualifying expenses of $2,400 for 1 child and $4,800 for 2 or more children. Source: Office of Tax Policy Analysis. $17 30,000 $35 50,000 $50 65,000 TIOL TAX JOURL

9 Social Tax Policies Directed at the Working Poor TABLE 4 NEW YORK STATE CHILD & DEPENDENT CARE CREDIT CLAIMS, Tax Year. of Claims Amount ($ Millions) Average ($) , , , , , Source: Office of Tax Policy Analysis. COMPARISON OF STATE LOW INCOME TAX FEATURES State Earned Income Tax s As of the 2000 tax year, 13 states have EITCs. Table 5 lists states that currently allow these credits and the respective size of the credits based on the maximum percentage of the federal credit allowed. t included in this table are State tax provisions that may be referred to as earned income credits, but that in reality are neither linked to the federal credit structure nor emulate the federal structure. New York s 22.5 percent rate is among the highest in the nation and is fully refundable. Full refundability ensures that all taxpayers benefit from the credit although they may not otherwise owe tax. The credit is currently scheduled to increase to 25 percent of the federal credit in tax year 2001, 27.5 percent in 2002, and 30 percent in State Colorado (1) Illinois (2) Iowa Kansas Maryland (3) Massachusetts (4) Minnesota (5) New Jersey (6) New York (7) Oregon Rhode Island Vermont Wisconsin (8) TABLE 5 STATE EARNED INCOME TAX CREDITS AS OF JANUARY 1, 2000 Max. Percentage of or Approx. Equivalent Link to Structure Liability Starting Point Liability Starting Point tes: (1) is only available if state revenues exceed constitutional spending limitations. The credit was 8.5% of the federal credit in tax year (2) House Bill 3939, now Public Act , was signed into law on May 11, The credit is available beginning in tax year The credit is scheduled to sunset after three years and is to be paid for by tobacco settlement funds. (3) is only partially refundable. (4) is currently scheduled to increase to 15% of the federal credit by tax year (5) is not based on the federal credit, but on earned income at the following credit rates % (no children), 6.8% 8.5% (one child), and 8% 20%(two or more children). Equivalent maximum percentage of the federal credit shown is an estimate for a taxpayer with two or more children with earned income of approximately $17,000 $18,100. (6) is currently scheduled to increase to 15.0% in tax year 2001, 17.5% in 2002, and 20.0% in tax year The credit is only available to families with gross incomes of $20,000 or less. (7) is currently scheduled to increase to 25% in tax year 2001, 27.5% in 2002, and 30% in tax year (8) Percentage of federal credit varies by number of children 4% (one child), 14% (two children), and 43% (three or more children). Source: Office of Tax Policy Analysis compilation from various sources, including CCH State Tax Guide and Johnson, N. (1999, December 27). A Hand Up: How State Earned Income Tax s Help Working Families Escape Poverty. State Tax tes, Refundable for Residents Partially Eligibility for Workers Without Children

10 In contrast, Maryland s credit has a higher rate at 50 percent of the federal credit, but the state s credit is only partly refundable. Minnesota s credit is the only state credit not explicitly linked to the federal credit. The credit is based on earned income at different rates for single taxpayers or those with one, two or more children. The equivalent maximum percentage of the federal credit is approximately 32 percent. Two other states Rhode Island and Vermont allow their residents a portion of the federal credit due to their assumption of federal tax liability as the starting point for their taxes. Rhode Island and Vermont, with credit rates of 26 percent and 25 percent, respectively (based on their linkage to federal tax liability) are also higher, but only Vermont s credit is refundable. Wisconsin s refundable credit varies with the number of children. The maximum credit rate is 43.0 percent, but workers without children may not claim a state credit. The remaining states offer relatively small EITCs. Colorado, for instance, currently offers a refundable state credit equal to 10 percent of the federal credit. Iowa offers a nonrefundable credit of 6.5 percent of the federal credit. Kansas provides a refundable credit of 10 percent of the federal credit, but the benefits are limited to those workers with dependent children. Massachusetts credit is currently 10 percent of the federal credit, but is scheduled to increase to 15 percent by tax year Oregon offers a nonrefundable credit of only 5 percent of the federal credit. As noted, the availability of the TANF offset for states adopting or increasing the refundable share of their EITCs is likely to lead to more state legislation. Indeed, legislation has been introduced in many states to this effect. Illinois will offer state residents a nonrefundable credit equal to 5 percent of the federal credit beginning in tax year TIOL TAX JOURL However, the program does not appear to be linked to the availability of TANF funds. Indeed, non refundability greatly limits the use of TANF funds. Rather, the refundable credit is scheduled to sunset in 3 years and is to be paid for with tobacco settlement funds (Giertz and McGuire, 2000). New Jersey will provide families with gross incomes of $20,000 or less a 10 percent refundable credit beginning in tax year The credit is scheduled to increase to 15 percent of the federal credit in tax year 2001, 17.5 percent in 2002, and 20 percent in tax year 2003 and thereafter. States with Child and Dependent Care Tax Provisions Table 6 provides details on current state child care provisions. Currently, some 25 states have such provisions. These provisions include both refundable and nonrefundable credits, subtractions, deductions, and itemized deductions. The vast majority of states 20 in all provide a credit for child and dependent care expenses. s are typically linked to the federal credit structure. Fifteen of the 20 states calculate their credits as a percentage of the applicable federal credit. Four states calculate their credits based on federal expense amounts. The remaining state, New Mexico, does not directly link to the federal structure, but requires that taxpayers calculate their state child day care credit as qualifying state expenses minus the portion of the federal credit actually used. Seven of the 20 states offering credits make them fully refundable. An eighth state, Nebraska, provides a partially refundable credit. In addition, Oregon allows taxpayers to carry forward unused credits for a period of up to five years. For tax year 2000, New York s CCC provisions are the highest in the nation in terms of both the credit percentage and

11 449 State Arkansas California Colorado (3) Delaware Hawaii (4) Idaho (5) Iowa Kansas Kentucky Maine (6) Maryland (5) Massachusetts (5) Minnesota Montana (7) Nebraska (8) New Mexico (9) New York rth Carolina (4)(10) Ohio Oklahoma Oregon (4)(11) Rhode Island South Carolina (4) Vermont Virginia Maximum Percentage of Subtraction Subtraction Deduction 100 Itemized Deduction Deduction TABLE 6 STATE CHILD AND DEPENDENT CARE TAX PROVISIONS AS OF JANUARY 1, 2000 Link to Structure Expense Expense Expense Expense Expense Expense Expense Expense Refundable for Residents / State Income Measure California AGI FAGI Hawaii AGI Iowa Net Income Household Income Montana AGI FAGI NM Modified Gross Income New York AGI FAGI Ohio AGI Taxable Income Max. Benefit Income Range (1) $ 10 $40,000 $ 0 $ 0 $22,000 $20,001 and over $ 0 $9,999 $3,000 and over $ 0 $17,720 $ 0 $18,000 $ 0 $22,000 $ 0 $21,424 $ 0 $25,000 $ 0 $25,000 $ 0 $19,999 $ 0 $5,000 Max. Eff. State Benefit Rate (%) (2) Min. Benefit Income Range (1) $100,001 and over $60,001 and over $40,001 and over $ 0 $1,000 $40,000 and over $ 0 $1,000 $31,371 and over $18,001 and over $29,001 and over $21,425 and over $65,000 and over $40,001 and over $40,001 and over $45,000 and over tes: (1) The maximum is 30% of qualifying expenses in the Adjusted Gross Income (FAGI) range $0 $10,000. The minimum percentage is 20% of qualifying expenses for taxpayers with FAGI over $28,000. Qualifying expenses must exceed earned income. Maximum qualifying expenses are $2,400 for one child and $4,800 for two or more children. (2) Maximum or minimum effective state benefit rates are calculated for comparison with federal benefit rates. (3) Taxpayers with FAGI of $60,000 or less claim the larger of the of 50% of their federal child care credit or their Colorado Child Tax ($200 per qualifying child under age 5). (4) The state credit is calculated as a percentage of the federal calculated expense. (5) State allows a subtraction from FAGI or deduction for federal expense amounts. Benefit rates are minimum and maximum state tax rates. (6) H.B. 454 of the Laws of 1999 doubles the credit for tax years after 2000 if the taxpayer utilizes quality child care. A maximum $500 of the credit is refundable. (7) Montana allows an itemized deduction for child and dependent care expenses. (8) is nonrefundable for residents with FAGI over $29,000 and refundable for residents with FAGI of $29,000 or less. (9) New Mexico s child day care credit is calculated as qualifying (non federal) expenses minus the portion of the federal credit actually used. Qualifying expenses are the lesser of $1,200 or $8.00 per child per day times 40% (but not exceeding $480 per child). (10) FAGI ranges for state credit vary by filing status. percentages also vary based on age of children. (11) Unused state credit may be carried forward for 5 years. Source: Office of Tax Policy Analysis compilation from various sources including Commerce Clearing House State Tax Guide Min. Eff. State Benefit Rate (%) (2) Social Tax Policies Directed at the Working Poor

12 income ranges at which specific credit rates apply. Moreover, New York s credit is fully refundable. The credit equals 110 percent of the federal for taxpayers with New York Adjusted Gross Income (NYAGI) of up to $25,000. The credit percentage then phases down to 100 percent at $40,000 and remains at that percentage until NYAGI exceeds $50,000. The credit percentage then phases down to 20 percent of the federal credit when NYAGI exceeds $65,000. In all, 11 of the 19 states with credits vary the size of their credits based on state defined income measures. Colorado and rth Carolina both vary their respective credits based on FAGI. California, Hawaii, Iowa, New York and Ohio s credits vary based on respective state AGI. Iowa s credit varies based on Iowa net income and New Mexico s credit by state modified gross income. Minnesota s credit varies based on household income. Oregon s credit varies based on federal taxable income. One way to compare the relative value of state child and dependent care tax provisions and the federal credit is to calculate maximum and minimum benefit rates. Benefit rates are the percentage of federal expenses multiplied by the maximum or minimum percent of the federal credit allowed. For example, New York s highest benefit of 110 percent of the federal credit equals a maximum benefit rate of 33 percent versus the federal benefit rate of 30 percent. The minimum benefit rate is 4 percent, or 20 percent of the minimum federal credit allowed (20 percent of expenses). Several other states have credits with maximum benefit rates that equal the federal maximum at specified income levels. The maximum benefit rate for Minnesota s refundable credit, for instance, is 30 percent, but only where household incomes do not exceed $17,720. Benefit rates then decrease until the credit is no longer permitted when household income exceeds $31,370. Nebraska s maximum benefit rate 450 TIOL TAX JOURL also equals the federal when FAGI does not exceed $22,000, and this credit is refundable. The minimum benefit rate is 5 percent when FAGI exceeds $29,000, but the credit is thereafter nonrefundable. Five states do not offer credits, but nonetheless offer tax benefits based on child and dependent care expenses. Idaho and Maryland permit taxpayers to subtract federal expense amounts from their respective state adjusted gross incomes (AGI). Massachusetts and Virginia offer similar deductions for the same purposes to determine taxable income. Montana allows taxpayers itemizing their deductions to deduct child and dependent care expenses ranging from $2,400 for one person to $4,800 for three or more persons. For federal purposes, a maximum of $4,800 in expenses are permitted for two or more children. The benefit for taxpayers in each of these states equals the amount of expenses multiplied by the applicable marginal tax rate. States with EITCs and Child & Dependent Care Tax Provisions Table 7 shows the maximum dollar value of EITCs and child and dependent care tax provisions in states that provide both tax law features. Only three states offer both forms of low income taxpayer benefits on a fully refundable basis. New York is one of these states. Because of varying income limitations these maximum dollar values are not additive, but the maximum dollar values show the relative size of the benefits. New York offers the third highest fully refundable EITC after Minnesota and Vermont. Moreover, New York provides taxpayers with the single largest refundable CCC. State Tax Free Thresholds Another way for states to ease the tax burden on lower income taxpayers is to have a high tax free threshold. These

13 Social Tax Policies Directed at the Working Poor State Colorado Iowa Kansas Maryland Massachusetts Minnesota New York Oregon Rhode Island Vermont TABLE 7 MAXIMUM DOLLAR VALUE AND REFUNDABILITY OF BENEFITS IN STATES WITH BOTH CHILD AND DEPENDENT CARE TAX PROVISIONS AND EARNED INCOME TAX CREDITS AS OF JANUARY 1, 2000 Max. EITC Dollar Value (1) Refundable , , , Partially Max. Child and Dependent Care Dollar Value (2) Refundable 720 1, ,440 1, tes: (1) Maximum EITC dollar values are calculated applying maximum percentages of the federal credit or approximate equivalents from Table 5 to the maximum federal credit for taxpayer with two or more children, or $3,888. (2) Maximum child and dependent care dollar values are calculated by applying maximum effective state benefit rates from Table 6 to maximum federal expense for two or more children, or $4,800. Source: Office of Tax Policy Analysis. thresholds are the relative income level at which a specified type of taxpayer owes no state tax. Thresholds are typically calculated as the sum of standard deductions, personal or dependent exemptions, and generally allowable tax credits. Table 8 shows state tax free thresholds for two parent families of four for tax year New York s tax free threshold was tenth highest in the nation for tax year Married taxpayers filing jointly benefit from a standard deduction of $13,000. Moreover, taxpayers may claim exemptions of $1,000 per dependent. A household credit of $80 is also claimed by such taxpayers, as is a refundable EITC of $240. The addition of the refundable CCC to this taxpayer scenario raises the tax free threshold far higher still. For example, if the family were to incur child and dependent care expenses of a maximum $2,400 for one child, the tax free threshold would rise from the $23,000 shown by about 25 percent to approximately $28,830. Moreover, if the family claimed the maximum $4,800 in child care expenses for two children, the threshold would rise to approximately $36,410, or almost 60 percent above the level shown. New York s tax free threshold has increased markedly over time. In 1994, the threshold for the same family of four was approximately $16,905 versus $23,000 in The standard deduction increased from $9,500 to $13,000 over the period. The State EITC increased from 7.5 percent to 20 percent of the federal credit. Although not included in these threshold numbers, the CCC also increased from a nonrefundable 20 percent of the federal credit to a refundable credit equal to 100 percent of the federal credit from tax years 1994 to Moreover, New York s standard deduction for married taxpayers filing jointly is currently scheduled to increase further to $14,600 by tax year Another way of assessing comparative state tax treatment of low income taxpayers is to look at the relative tax burdens faced by taxpayers with incomes at the federal poverty line or other defined income levels. A recent study, for example, found that New York taxpayers had the third lowest tax burden in fact the third highest negative tax liability rebated to taxpayers at both the federal poverty line and for taxpayers earning the minimum wage (Johnson, Zahradnik, and McNichol, 2000). 451

14 TIOL TAX JOURL Rank TABLE 8 STATE TAX FREE THRESHOLDS, TWO PARENT FAMILY OF FOUR (TAX YEAR 1999) State California Minnesota Pennsylvania Rhode Island Vermont Maryland Colorado Connecticut Arizona New York Kansas New Mexico Massachusetts Maine Wisconsin rth Dakota Mississippi Nebraska Idaho South Carolina Iowa rth Carolina Delaware Arkansas Utah Georgia Oregon Missouri Louisiana Oklahoma Ohio Michigan Hawaii New Jersey West Virginia Indiana Montana Virginia Illinois Kentucky Alabama A REPRESENTATIVE LOW INCOME NEW YORK STATE TAXPAYER Description of the Representative Taxpayer Model Tax-Free Income Level (1) 35,500 26,000 26,000 25,400 25,400 24,800 24,600 24,100 23,600 23,000 20,900 20,600 20,500 20,200 18,800 18,700 18,600 18,600 18,400 18,200 17,300 17,000 16,100 15,600 15,500 15,300 14,400 13,900 12,700 12,700 12,300 11,800 11,000 10,000 10,000 9,500 9,100 8,200 6,600 5,200 4,600 tes: (1) Estimated 1999 poverty line for a family of four is $17,028. Source: Adapted from Johnson, N., R. Zahradnik, and E. C. McNichol (2000). The Office of Tax Policy Analysis has developed a model that computes income tax liabilities for individual taxpayers. To allow for a full consideration of relative taxpayer burdens, the model simultaneously calculates both the New York 452 Amount Above/Below Poverty Line 18,472 8,972 8,972 8,372 8,372 7,772 7,572 7,072 6,572 5,972 3,872 3,572 3,472 3,172 1,772 1,672 1,572 1,572 1,372 1, (28) (928) (1,428) (1,528) (1,728) (2,628) (3,128) (4,328) (4,328) (4,728) (5,228) (6,028) (7,028) (7,028) (7,528) (7,928) (8,828) (10,428) (11,828) (12,428) Pct of Poverty State and federal tax liabilities for representative taxpayers. The model incorporates all major provisions of both the New York and federal tax laws. Briefly, the representative taxpayer model operates by summing items of income, including applicable exclusions, subtracting federal adjustments, such as contributions to IRAs, adding state additions (e.g., bond interest from other states) and subtracting state subtractions (e.g.,

15 Social Tax Policies Directed at the Working Poor federal bond interest, and in New York, certain retirement income). The model also deducts appropriate exemptions for taxpayers and their dependents as well as the respective New York state and federal standard or itemized deductions. Taxpayer liability before credits is then calculated using the appropriate tax rate schedules. Next, nonrefundable credits are subtracted to further reduce actual taxpayer liability. Finally, refundable credits are subtracted to determine ultimate taxpayer liability and the amount of the cash rebate the taxpayer may be entitled to receive. The Head of Household Taxpayer Example The following example is that of a head of household taxpayer with one dependent. Child care expenses are the maximum $2,400 allowed for one child under the federal child and dependent care credit. The taxpayer has solely wage income. FAGI and NYAGI are equal as the taxpayer has no federal adjustments to income, New York additions or subtractions, or income modifications. Taxpayer liability is calculated in three separate ways for each tax year from These are the tax liability before the EITC and CCC, liability after the EITC, and liability after both the EITC and CCC. The head of household taxpayer example above was chosen so as not to vastly overstate the realistic benefits of the credits. As previously noted in Table 7, in tax year 2000 the maximum possible values of New York s EITC and CCC, respectively, are $875 and $1,584, or a combined $2,459. However, because of different income phase out ranges, typical taxpayers would likely receive lower credit amounts. For example, for a head of household taxpayer to claim the maximum benefits, he or she must have two children in day care with the maximum qualifying federal expenses $4,800 and have wage (earned) income of as little as $9,717. At most, married taxpayers with two children and maximum child care expenses can get a combined maximum benefit of $2,304 with income as $13, In the former case total child care expenses approach 50 percent of income and, in the latter, 35 percent. In the example presented hereafter, child care expenses represent, at most, slightly under 25 percent of earned income. In Table 9, the taxpayer has income equal to 100 percent of the federal poverty line. In 1994, this income level was TABLE 9 NEW YORK STATE TAX LIABILITY, HEAD OF HOUSEHOLD FILER, 1 DEPENDENT, 100 PERCENT OF POVERTY LINE, Tax Liability/Eff. Tax Rates Before EITC/Child Care s Tax Liability ($) Eff. Tax Rate (%) After EITC Tax Liability ($) (149) (209) (430) (442) (454) (462) (527) Eff. Tax Rate (%) After EITC/Child Care s Tax Liability ($) (153) (209) (629) (807) (1,150) (1,158) (1,293) Eff. Tax Rate (%) tes: Poverty threshold data are from U.S. Census Bureau Historical Poverty Tables. Source: Office of Tax Policy Analysis. 4 This result is largely due to the fact that the model assumes two earner couple incomes are divided on a 65/35 percent basis rather than a 50/50 percent basis. 453

16 TIOL TAX JOURL $9,978. The level increases each year until it reaches $11,550 in tax year At this low income level, the taxpayer has little or no liability before the EITC or CCC in each tax year. As a result, very low income taxpayers basically receive no benefit from standard deduction increases. However, when a refundable EITC is added, the taxpayer has a negative tax liability and receives a cash rebate. This rebate was $149 in 1994; increases in the State EITC credit rate increased the cash rebate to $527 by tax year The taxpayer s effective tax rate decreases from 1.49 percent to 4.57 percent by tax year The addition of a refundable CCC reduces taxpayer liability even further. New York s credit was nonrefundable through 1995, but became fully refundable in Moreover, the credit percentage has increased over time. The addition of the CCC means that this taxpayer with income equal to the federal poverty line can receive a cash rebate of almost $1,300 by tax year Under this scenario, the taxpayer s effective tax rate decreases further to percent by tax year Table 10 presents the same taxpayer liability data when the taxpayer s income increases to 150 percent of the federal poverty level. In contrast to the very low income taxpayer, this taxpayer receives some benefit from the changes in the standard deduction. However, as New York s tax brackets are not indexed for inflation, the increase in the standard deduction is somewhat offset as income increases over time. Tax liability before the two refundable credits decreases by only $46 from $204 in tax year 1994 to $158 in tax year The effective tax rate only declines from 1.36 percent to 0.91 percent. Again, the EITC changes this situation to a very obvious extent. Tax liability decreases by $228 from $98 to $130 over the same period. The effective tax rate drops from 0.66 percent to 0.75 percent. The subsequent addition of the refundable CCC further decreases liability. The 1994 tax liability is $31. By tax year 2000, liability has dropped by $785 to $816. The effective tax rate falls from 0.21 percent to 4.71 percent. Table 11 presents the same taxpayer liability data when the taxpayer s income increases to 185 percent of the federal poverty level. This taxpayer sees a larger benefit from the increase in the standard deduction, but as income increases over time and New York s tax brackets are not indexed, liability begins to increase by tax years The refundable EITC reduces liability in every year except tax year Liability decreases from $309 in tax year 1994 to $177 in tax year The effective tax rate declines from TABLE 10 NEW YORK STATE TAX LIABILITY, HEAD OF HOUSEHOLD FILER, 1 DEPENDENT, 150 PERCENT OF POVERTY LINE, Tax Liability/Eff. Tax Rates Before EITC/Child Care s Tax Liability ($) Eff. Tax Rate (%) After EITC Tax Liability ($) Eff. Tax Rate (%) (102) 0.65 (123) 0.76 (128) 0.79 (110) 0.65 (130) 0.75 After EITC/Child Care s Tax Liability ($) Eff. Tax Rate (%) (31) 0.21 (63) 0.41 tes: Poverty threshold data are from U.S. Census Bureau Historical Poverty Tables. Source: Office of Tax Policy Analysis. 454 (232) 1.47 (248) 1.54 (752) 4.60 (734) 4.36 (816) 4.71

17 Social Tax Policies Directed at the Working Poor TABLE 11 NEW YORK STATE TAX LIABILITY, HEAD OF HOUSEHOLD FILER, 1 DEPENDENT, 185 PERCENT OF POVERTY LINE, Tax Liability/Eff. Tax Rates Before EITC/Child Care s Tax Liability ($) Eff. Tax Rate (%) After EITC Tax Liability ($) Eff. Tax Rate (%) After EITC/Child Care s Tax Liability ($) Eff. Tax Rate (%) (318) 1.58 tes: Poverty threshold data are from U.S. Census Bureau Historical Poverty Tables. Source: Office of Tax Policy Analysis. (404) 1.95 (456) percent to 0.83 percent over the period. When the refundable CCC is included, taxpayer liability declines from $189 in tax year 1994 to $456 in tax year The effective tax rate drops from 1.02 percent to 2.13 percent over these tax years. Interaction of the New York State EITC and CCC Figure 2 shows the phase out ranges for both the EITC and CCC for the head of household example as income increases. The EITC range shown is that for a worker with one child. The phase out is based on the maximum of earnings or modified FAGI. In contrast, the CCC phases out based on NYAGI. However, remember that the federal credit on which New York s credit is based phases out on FAGI. This makes little difference in this example where FAGI and NYAGI are the same, but the two income measures can often differ. The CCC is obviously much larger than EITC. Also, the credit phases out over a much broader range. In fact, like its federal counterpart, the CCC does not entirely phase out. For tax year 2000, the minimum credit is 20 percent of the federal credit for taxpayers with NYAGI over $65,000. However, both of these credits offer the maximum benefit to taxpayers with lower incomes. Taxpayers with one child only receive an EITC of any real size when their income is less than $25,000. These taxpayers also receive the highest CCC (110 percent of the federal credit). A Comparison of New York State and Tax Liability Another way to demonstrate the potential significance of the New York State refundable EITC and CCC is to compare the State benefits to the federal benefits. The example is for the same taxpayer with income at the poverty line. Figure 3 shows that the relative value of New York State cash rebates has steadily increased compared to the federal benefits. In tax year 1994, the New York State EITC was 7.5 percent of the federal credit. The State CCC was nonrefundable. Accordingly, the state rebate was only 7.51 percent of the federal rebate. However, the State EITC was enlarged several times from tax year 1994 to tax year The CCC was also made fully refundable in 1996 and it was increased to an ultimate 110 percent of the federal credit. Accordingly, the New York State rebate for this representative taxpayer increased to over 29 percent in tax year 1996, almost 37 percent in tax year 1997, and reaches almost 55 percent of the federal rebate in the final tax year shown (tax year 2000). 455

18 Figure 2. New York State s EITC and CCC Phase Out Ranges, Tax Year TIOL TAX JOURL

19 Social Tax Policies Directed at the Working Poor Figure 3. New York Rebate as a Percent of, Poverty Level:

20 TIOL TAX JOURL CONCLUSION The federal government has instituted personal income tax credits that encourage low and moderate income taxpayers to enter the labor force. States have followed the federal lead by instituting similar provisions into their own tax laws. Twelve of the 41 states with a broad based income tax have an EITC and 24 states have child care expense deductions or credits. New York State has one of the most generous low income tax structures in the nation. The EITC has been raised twice in the last two years from 20 percent of the federal credit to 30 percent by The CCC has also been enhanced several times in the last few years, most recently so that it provides 110 percent of the federal credit to taxpayers with low incomes. The combination of these credits plus other features of the State s income tax structure consistently place New York as one of the top states in terms of tax free thresholds. As a result of federal and state reforms of welfare delivery systems, states have discovered new opportunities for using monies from federal TANF sources. In 1999, New York enacted a two year increase in the EITC to be paid for by TANF. The interesting provision in the new law was that the EITC would revert back to its original 20 percent of the federal credit should the TANF resources no longer apply. In 2000, additional enhancements to the EITC and to the CCC were enacted, also with the reversion language. In total, nearly $500 million in refundable credits will flow to lower income New York families that work, with some $200 million of this amount constituting qualifying expenditures as defined by the 1996 federal welfare reforms. These tax welfare reforms have allowed states like New York to develop new and innovative social tax policies that can effectively assist less fortunate families in their efforts to earn meaningful returns to work. Acknowledgments The views in this paper are those of the authors and do not necessarily represent the views of, and do not constitute any official statement by, the New York State Department of Taxation and Finance. REFERENCES Giertz, J.F., and T.J. McGuire. Lawmakers OK Property Tax, Earned Income. State Tax tes (April 24, 2000): Johnson, N., R. Zahradnik, and E.C. McNichol. State Income Tax Burdens on Low Income Families in Washington, D.C.: Center for Budget and Policy Priorities, March Joint Committee on Taxation. Estimates of Tax Expenditures for Fiscal Years (JCS 13 99), December 22, New York State Department of Taxation and Finance. Income Tax Reduction Act of 1995: Benefits to New Yorkers, June, New York State Department of Taxation and Finance. Earned Income Tax : Analysis of Claims, various years. New York State Department of Taxation and Finance. Summary of Tax Provisions in SFY Budget, various years. U.S. Department of Health and Human Services. Register (April 12, 1999). 458