ISSUE. Evaluate several options for expanding eligibility for North Carolina s Earned Income

Transcription

1 To: Professor Gene Nichol From: Jared Elosta Re: Options for Expanding EITC Eligibility in North Carolina Date: June 11, 2010 ISSUE Evaluate several options for expanding eligibility for North Carolina s Earned Income Tax Credit (EITC), including extending the credit to noncustodial parents, seniors age 65 and over, and young workers under the age of 25. BRIEF ANSWER A Noncustodial Parent EITC (NCP EITC) would be the most effective expansion of the North Carolina EITC program since (1) a model for such an expansion already exists in New York and the District of Columbia; (2) administration of the program would be relatively simple; (3) the program would promote tax fairness; and (4) the credit would be large enough to provide incentives for low-income noncustodial parents to work more and meet all of their child support obligations. On the other hand, extensions of the state EITC to seniors age 65 and over or to young workers under age 25 would not be as effective because these extensions would (1) involve administrative complexities and (2) not result in a large enough credit to provide work incentives. AN EITC FOR NONCUSTODIAL PARENTS I. The Rationale for a Noncustodial Parent EITC Low-income noncustodial parents (NCPs) face a significant challenge escaping poverty since many are legally obligated to pay child support without gaining any of the tax breaks received by custodial parents. Custodial parents may be eligible for the head of household filing

2 status, dependency exemptions, the child tax credit, and the additional child tax credit. In addition, the EITC offers more substantial benefits to custodial parents than noncustodial parents. Nevertheless, NCPs are required to contribute a significant amount of their income to the custodial parent in the form of child support. As a result, NCPs who work and earn wages at or just above the poverty level are often driven into poverty by the combined effect of federal taxes and child support obligations. The following chart, created by Laura Wheaton and Elaine Sorenson at the Urban Institute, illustrates the effect of current tax policies on low-wage NCPs compared with custodial parents, both working full time and earning the minimum wage. 1 Table 1. Impact of Federal Taxes and Child Support on Income and Poverty Status of Custodial and Noncustodial Parents with a Full-Time Job, 2008 Earnings (full-time minimum wage job in 2008) As a Percent of Poverty Payroll Tax Federal Tax (before credits) Refundable Child Tax Credit Earned Income Tax Credit Earnings Less Taxes, Plus Credits As a Percent of Poverty Single Custodial Parent with 2 Qualifying Children $12,775 74% $977 $0 $641 $4,824 $17, % Noncustodial Parent $12, % $977 $382 $0 $8 $11, % Child Support (25% of NCP s gross wages) $3,194 ($3,194) Income after Taxes, Credits, and Child Support As a Percent of Poverty $20, % $8,229 73% 1 LAURA WHEATON AND ELAINE SORENSON, URBAN INSTITUTE, EXTENDING THE EITC TO NONCUSTODIAL PARENTS: POTENTIAL IMPACTS AND DESIGN CONSIDERATIONS 3 (2009), available at 2

3 An EITC specifically tailored to low-income NCPs could be a useful tool to boost these workers incomes. A NCP EITC would serve the following goals: (1) help low-income NCPs to escape poverty; (2) enable more NCPs to meet their child support obligations; and (3) provide an incentive for NCPs to work more. 2 II. The NCP EITC in New York and Washington, D.C. In 2006, New York State and Washington, D.C. became the first jurisdictions in the nation to implement a NCP EITC. 3 The New York and D.C. NCP EITC programs share a number of characteristics. They both require that NCPs pay all of their child support obligations from the tax year in question in order to be eligible for the NCP EITC. 4 Both programs require that NCPs have a child support order and participate in the IV-D program, which is the state and local child support enforcement service, overseen by the federal government. 5 In both, the state tax department must receive a certification from the IV-D program stating that the NCP paid all of his or her child support for the tax year. 6 Both programs do not allow NCPs to claim the NCP EITC if they are eligible for the child-based EITC (i.e., they claim qualifying children of their own). 7 Finally, both programs follow the phase-out rates the rate at which the credit decreases as income rises set by the federal EITC for workers with qualifying children. 8 These phase-out 2 Id. at 1. 3 Id. 4 Id. at 4. 5 Id. at Id. 7 See N.Y. TAX LAW 606 (d-1)(5) (Consol. 2010); WHEATON & SORENSON, supra note 1, at 13 n DISTRICT OF COLUMBIA OFFICE OF TAX AND REVENUE, SCHEDULE N, DC NON-CUSTODIAL PARENT EITC CLAIM (2009), available at [hereinafter DISTRICT OF COLUMBIA OFFICE OF TAX AND REVENUE, SCHEDULE N]; N.Y. STATE DEP T OF TAXATION AND FINANCE, CLAIM FOR NONCUSTODIAL PARENT NEW YORK STATE EARNED INCOME CREDIT, FORM IT-209 (2009), available at [hereinafter N.Y. STATE DEP T. OF TAXATION AND FINANCE, FORM IT-209]. 3

4 rates extend to significantly higher incomes than the phase-out rates for the childless EITC. 9 For example, for tax year 2009, the most a single worker with no qualifying children could earn and still be eligible for either state s EITC in 2009 was the federal cap of $13,400; however, the cap for the NCP EITC in New York was $35,463; for D.C. it was $43, This means that in New York and D.C., many workers who are ineligible to receive the standard earned income credit due to income limitations on childless filers may be eligible for the NCP credit. Despite these similarities, the NCP EITC programs in D.C. and New York have important distinctions. D.C. s NCP EITC targets younger parents exclusively only NCPs between the ages of 18 and 30 are eligible but it is more generous to those who qualify. 11 NCPs receive the same amount as similarly situated custodial parents: 40 percent of the federal earned income credit owed custodial parents. 12 For example, for tax year 2009, a single NCP paying child support for one child and earning $15,500 receives a $1,214 credit from D.C. the maximum amount allowed this category of filer and the same amount earned by a custodial parent. 13 The credit plateaus at this amount and then starts to diminish as the worker earns more than $16,500. At $35,000, the same NCP receives $ ELAINE SORENSON, URBAN INSTITUTE, NEW YORK NONCUSTODIAL PARENT EITC: IMPLEMENTATION AND FIRST- YEAR FINDINGS 2-3 (2010), available at 10 See DEP T OF THE TREASURY, INTERNAL REVENUE SERVICE, PUBLICATION 596: EARNED INCOME CREDIT, Earned Income Credit Table 49 (2009) available at [hereinafter IRS PUBLICATION 596]; N.Y. STATE DEP T. OF TAXATION AND FINANCE, FORM IT-209, supra note 8; DISTRICT OF COLUMBIA OFFICE OF TAX AND REVENUE, SCHEDULE N, supra note 8. The maximum income a filer can earn and still receive an earned income credit is determined by filing status (single or married filing jointly, for instance) and the number of children claimed. 11 DISTRICT OF COLUMBIA OFFICE OF TAX AND REVENUE, SCHEDULE N, supra note Id. 13 A custodial parent with one qualifying child earning $15,500 would be eligible for a federal earned income credit of $3,043. Moreover, that custodial parent would receive $1,214 from the D.C. EITC program (40 percent of $3,043). While the NCP with one qualifying child who earns $15,500 is not eligible for the federal earned income credit, he or she is eligible for a $1,214 credit from the D.C. EITC. For information on the amount of credit per income level, see IRS PUBLICATION 596, supra note IRS PUBLICATION 596, supra note 10. 4

5 Because D.C. s NCP EITC is based on the federal EITC, which provides a larger credit for custodial parents claiming two or more children, NCPs in D.C. claiming more than one child also receive a larger credit. Thus, a NCP paying child support for two children and earning $15,500 would receive $2,011 from the D.C. program 40 percent of the federal credit s $5,028 value. 15 In contrast, New York s NCP EITC makes the credit available to all NCPs who are 18 and older, but offers a smaller, though still potentially hefty, credit. New York s program allows NCPs to claim the greater of either 2.5 times the federal EITC for a worker without qualifying children or 20 percent of the federal EITC for a single taxpayer with one qualifying child. 16 For tax year 2009, a NCP earning $6,000 receives the maximum amount of $1,142 from the New York EITC, regardless of the number of children he or she has. 17 The credit continues to decline as a NCP earns more; at $33,000, the NCP receives a credit of $ III. Evaluation and Application to North Carolina 1. Evaluation of the NCP EITC Because NCP EITC programs are so new, there is little research available on the success of the programs in New York and D.C. Nonetheless, several issues present themselves when evaluating whether New York and D.C. s NCP EITC programs would be effective strategies to provide tax relief to low-income NCPs and encourage child support payments. 15 For tax year 2009, the federal credit for a filer earning $15,500 with two qualifying children is $5,028. The D.C. credit equals 40 percent of $5,028 or $2, NEW YORK OFFICE OF TEMPORARY AND DISABILITY ASSISTANCE, Noncustodial Parent New York State Earned Income Tax Credit (EITC) available at 17 See IRS PUBLICATION 596, supra note 10. The federal credit for a worker with no children earning $6,000 in tax year 2009 is $457. Two hundred and fifty percent of $457 is $1, This is larger than the alternate calculation, which produces a credit of $410 (20 percent of $2,049). 18 See IRS PUBLICATION 596, supra note 10. The federal credit for workers with one qualifying child earning between $33,000 and $33,050 was $390 for Twenty percent of $390 is $78. In this situation, the NCP has earned too much to be eligible for the childless credit so this is the only option available. 5

6 First, both New York and D.C. have shown that the administration of a NCP EITC is possible without creating an overly complicated program. Because child support enforcement agencies in both jurisdictions certify whether NCPs have paid the entire amount of child support due, the burden placed on the tax agency is minimized and the risk of significant errors is reduced. A second issue is whether a NCP EITC should require that NCPs pay 100 percent of the child support due during the tax year in order to be eligible for the credit. In its first year in 2006, only 5,100 NCPs received the credit in New York. 19 Besides the novelty of the program, one reason proffered for the low participation rate is that the percentage of low-income NCPs who pay all of their child support in any given year is relatively small. One study estimates only 16 percent of NCPs who earn $10,000 to $20,000 a year, and only 25 percent for NCPs earning $20,000 to $30,000 a year, pay all of their child support. 20 As the program becomes increasingly well-known, a greater number of NCPs who have not paid all of their child support in the past may be motivated to do so. It would be worth reviewing more recent data to determine if more NCPs have claimed the NCP EITC since It would also be useful to examine whether the percentage of NCPs in New York who paid all of their child support in a tax year increased after the creation of the NCP EITC. Analysts have leveled several criticisms at the NCP EITC. First, some have argued that a federal NCP EITC is impractical because of the complexity of coordinating 50 different child 19 SERENA KLEMPIN, CENTER FOR RES. ON FATHERS, CHILDREN AND FAMILY WELL-BEING, POLICY BRIEF: A RESEARCH AND DISSEMINATION PROJECT ON TAX-BASED WORK INCENTIVES FOR NON CUSTODIAL FATHERS (2008) 2, available at 20 WHEATON & SORENSON, supra note 1, at 6. 6

7 support enforcement systems with the IRS. 21 While this criticism of the NCP EITC has force as regards a federal version, it does not apply to state NCP EITCs. Moreover, the implementation of state NCP EITCs would supplement federal efforts to expand the EITC to a broader range of recipients. Another criticism of the NCP EITC is that it may be unfair or unwise to single out non-custodial fathers for special rewards. 22 The idea here is that a broader group of childless workers needs additional income support, and that access to the EITC and an increase in the amount of the credit should apply to all, not just NCPs. However, the creation of a NCP EITC at the state level provides a targeted incentive for NCPs to pay all of the child support they owe. This program would not exclude efforts at the federal level to increase the EITC for childless workers, which is a goal that may be worth pursuing for different reasons. 2. Creating a NCP EITC in North Carolina Since two jurisdictions in the U.S. have already created a NCP EITC, it is possible to follow their lead in North Carolina. First, North Carolina should require NCPs to be in the IV-D program in order to be eligible for the NCP EITC, as New York and D.C. do. North Carolina should also require that the Division of Social Services Child Enforcement Services provide a certification to the North Carolina Department of Revenue (DOR) showing proof of child support payments for NCPs claiming the credit. Second, North Carolina should adopt D.C. s, rather than New York s, approach for determining the amount of the NCP earned income credit. As stated above, D.C. s EITC simply gives NCPs the same amount that custodial parents receive under the program, while the New York credit is set at the greater of 2.5 times the federal EITC for childless workers or 20 percent 21 See DANIEL P. GITTERMAN, ET AL., UNC CENTER ON POVERTY, WORK AND OPPORTUNITY POLICY BRIEF, EXPANDING THE EITC FOR SINGLE WORKERS AND COUPLES WITHOUT CHILDREN 26 (2007). 22 PETER EDELMAN, ET AL., GEORGETOWN CENTER ON POVERTY, INEQUALITY AND PUBLIC POLICY, EXPANDING THE EITC TO HELP MORE LOW-WAGE WORKERS 11 (2009). 7

8 of the federal EITC for single workers with one qualifying child. A major problem with following New York s approach is that it may be complex for the DOR to administer and difficult for taxpayers and tax preparers to understand. Tax filers and the DOR would have to calculate both the childless EITC and the EITC for a worker with one qualifying children and compare them to see which is greater. This has the potential to discourage its use and produce errors. 23 Further, when advocating to create a NCP EITC in North Carolina, the simpler explanation of how the credit would work is likely to produce the best results. For these reasons, eligible NCPs in North Carolina should receive the same state earned income credit as custodial parents. Applying the current North Carolina formula, a single NCP earning $15,500 a year who pays child support for one child would receive a credit of $152 (5 percent of the federal credit of $3,043). 24 If this NCP paid child support for two children, the credit would be $251 (5 percent of the federal credit of $5,028). 25 Without a NCP EITC in North Carolina, this same NCP would receive no earned income credit nothing from the federal EITC, and thus nothing from the state because as a childless worker his or her income would be too high to be eligible. A couple hundred dollars may not be a windfall, but it can pay for a car repair or fuel, groceries, utility bills, medical prescriptions, other day-to-day necessities or it can be saved for future emergencies all expenditures that can keep the NCP working and paying child support. Assuming that the effort to increase North Carolina s EITC to 10 or 15 percent is successful, the NCP EITC should increase accordingly. The following chart illustrates the effect of a NCP EITC, taking into account potential increases in the state s EITC. 23 Follow-up research with data from New York State s Department of Taxation and Finance would be useful to determine if the credit calculus used by the state s NCP EITC leads to a greater rate of error or non-participation. 24 See IRS PUBLICATION 596, supra note Id. 8

9 Table 2. A North Carolina NCP EITC Adjusted for Potential Increases of North Carolina s EITC 26 Annual Income Poverty Level (1 person) 27 Current Federal EITC Current State EITC (5%) NCP EITC at 5% of Federal EITC for Single Custodial Parent (1 child/2 children) NCP EITC at 10% of Federal EITC for Single Custodial Parent (1 child/2 children) NCP EITC at 15% of Federal EITC for Single Custodial Parent (1 child/2 children) $7,000 63% $457* $23 $119/$139 $237/$279 $356/$418 $11, % $173 $9 $152/$223 $304/$447 $456/$670 $13, % $0 $0 $152/$251 $304/$503 $456/$754 $22, % $0 $0 $105/$189 $210/$378 $315/$568 $33, % $0 $0 $16/$72 $32/$144 $48/$215 * Maximum amount that can be claimed by a worker without qualifying children. This chart shows that a NCP EITC in North Carolina would significantly increase the amount of the credit, and would allow more low- and moderate-income NCPs to claim it. North Carolina ought to adopt New York s more inclusive age range. The D.C. program s restriction to NCPs between the ages of 18 and 30 is likely an effort to keep costs down. D.C. s 40 percent match of the federal EITC is the highest in the nation; therefore, the cost of expanding eligibility for its program may be prohibitive. North Carolina, in contrast, currently matches the federal EITC at 5 percent, so cost is not as problematic. During its first year, New York s program cost $2 million. 28 That figure comprises.01 percent of the proposed 26 This chart does not include the temporary expansion of the EITC under the American Recovery and Reinvestment Act, which extends the EITC to families with up to three qualifying children. This extension of the EITC is temporary for tax years 2009 and 2010, unless it is renewed or made permanent. The NCP EITC was determined by multiplying 5%, 10%, and 15% by the EITC for each level of income for tax filers who do not file jointly. The two figures in each NCP EITC column reflect the EITC for one qualifying child on the left and the EITC for two qualifying children on the right. For the EITC amounts listed here, see IRS PUBLICATION 596, supra note U.S. CENSUS BUREAU, POVERTY THRESHOLDS 2009, available at 28 KLEMPIN, supra note 19 at 2. At 19.5 million, New York s population is over twice the size of North Carolina s (9.3 million). See, U.S. CENSUS BUREAU POPULATION FINDER, available at 9

10 state budget for , 29 and given New York s much larger population, would likely be less. Furthermore, since a significant number of NCPs are over the age of 30, 30 following D.C. s age restriction would severely limit eligibility for the NCP EITC in North Carolina. Adopting New York s rule of allowing all eligible NCP s over 18 to claim the credit would be more effective. Finally, North Carolina should follow New York and D.C. in requiring that NCPs must pay 100 percent of the child support due during the prior tax year in order to claim the NCP EITC. This strategy has the best chance of winning over legislators, it rewards NCPs who meet their child support obligations, and it will provide the strongest possible incentive for NCPs to work more in order to pay their child support in full. Another benefit of requiring NCPs to meet their child support obligations in full to qualify for the NCP EITC is that it would be less costly than lowering the minimum amount of child support that a NCP must pay to qualify. Moreover, this approach would be easier for the relevant agencies to administer. REMOVING AGE RESTRICTIONS The federal EITC allows low- and moderate-income workers under the age of 25 and over the age of 65 to claim the credit only if they have qualifying children. 31 While some analysts have suggested that the age range for workers without qualifying children should be expanded, none of the 24 states that have a state EITC has done so. 32 The AARP has argued that the federal EITC should be extended to low-income seniors without qualifying children in order to encourage them to continue working as long as they are 29 NORTH CAROLINA OFFICE OF STATE BUDGET AND MANAGEMENT, NORTH CAROLINA STATE BUDGET: GOVERNOR S RECOMMENDED ADJUSTMENTS 35 (April, 2010), available at 30 WHEATON & SORENSON, supra note 1, at U.S. DEP T OF THE TREASURY, INTERNAL REVENUE SERVICE, Earned Income Tax Credit Rules for Everyone, available at 32 ERICA WILLIAMS, ET AL., CENTER ON BUDGET AND POLICY PRIORITIES, STATE EARNED INCOME TAX CREDITS: 2009 LEGISLATIVE UPDATE 5 (2009), available at The one exception is Minnesota, which uses different income levels for the phase-in and phase-out points. Id. 10

11 able and to assist those who must remain in the workforce. 33 The AARP estimates that 300,000 seniors over age 65 in the United States would be eligible to claim the childless EITC. 34 Labor force participation among seniors is on the rise, increasing from 2.7 million in 1977 to 6.1 million in 2009, an increase of 126 percent. 35 Furthermore, the full retirement age for seniors continues to inch upwards it is currently 66 for people born after 1942 and 67 for people born after The ravages of the current recession and the tidal wave of baby boomers approaching 65 suggest that these numbers will only increase. Although a compelling argument exists for expanding the federal and/or certain state EITCs to include childless seniors, it does not make much sense in North Carolina. First, a relatively small number of seniors in North Carolina would be eligible. According to the U.S. Census Bureau, there are approximately 117,655 seniors in North Carolina living below the poverty line. 37 An additional 70,878 seniors are fall between 100% and 124% of the poverty threshold, for a total of 188, This range roughly approximates the income eligibility for the EITC (the poverty threshold for a single person over 65 is $10,289; 125% of that is $12,861; the cut-off point for the federal credit for childless workers is $13,400). Since the EITC requires income from wages, and only 7.5 percent of poor seniors received any income from 33 See JANET MCCUBBIN, AARP PUBLIC POLICY INSTITUTE, THE EITC AND OLDER WORKERS (Jan., 2009), available at 34 Id. at U.S. DEP T OF LABOR, BUR. OF LABOR STATISTICS, CURRENT POPULATION SURVEY, EMPLOYMENT LEVEL 65 YEARS AND OVER: See BUR. OF LABOR STATISTICS, SPOTLIGHT ON STATISTICS, OLDER WORKERS (July, 2008), available at 36 U.S. SOCIAL SECURITY ADMINISTRATION, The Full Retirement Age is Increasing, available at 37 U.S. CENSUS BUREAU, AMERICAN COMMUNITY SURVEY, TBL. B AGE BY RATIO OF INCOME TO POVERTY LEVEL IN THE PAST 12 MONTHS. 38 Id. 39 U.S. CENSUS BUREAU, POVERTY THRESHOLDS 2009, supra note See IRS PUBLICATION 596, supra note

12 wages in 2008, 41 we arrive at an estimate of 14,166 seniors statewide that would qualify for the childless EITC. While this number by itself is not insignificant, the amount of money eligible seniors would receive from such a credit would be trivial. North Carolina s current EITC formula ensures that the maximum amount a senior without qualifying children could receive is $ If the North Carolina EITC grows to 10 percent or 15 percent, the maximum state credit for seniors would still be relatively meager: $46 and $69, respectively. Finally, the state would assume new administrative responsibilities if it extends its EITC program to childless workers over age 65. The federal EITC does not count social security benefits as income, 43 so in calculating a state EITC for seniors the Department of Revenue (DOR) would have to separate the wages a senior earns from the income he or she receives in social security. Since seniors are not eligible for the federal EITC, the DOR would have to verify income itself. This would create an administrative burden for the agency and potentially increase the cost of the program. Unlike the case of a NCP EITC, where DSS would simply send a letter to DOR certifying that a NCP has paid his or her child support in full for the year, extending the EITC to seniors would require the DOR to create new rules and verification processes to check each senior s income for eligibility. Similar shortcomings would occur if the state extended its EITC to non-student workers under 25 without qualifying children. Here, as with working seniors, an expansion of the state EITC to include these workers would result in a fairly inconsequential credit. Barring an 41 ELLEN O BRIEN, ET AL. AARP PUBLIC POLICY INSTITUTE, OLDER AMERICANS IN POVERTY: A SNAPSHOT 25 (2010), available at 42 The most a person without qualifying children can receive from the federal EITC is $457. Five percent of $457 is $ U.S. DEP T OF THE TREASURY, INTERNAL REVENUE SERVICE, What Is Earned Income?, available at 12

13 increase in the amount of the childless credit at the federal level or in the state matching percentage, the most a young, childless worker could claim is $23. Creating a state EITC for young workers would also create administrative headaches. The EITC was originally crafted to reach poor families rather than all low-income workers, since some low-income workers are college students or from wealthy families. 44 Thus, a way to separate college students from the working poor would be needed in order to create a targeted EITC for those between the age of 21 and 25. While this could be done at the federal level using Form 1098-T, which shows whether a student is part-time or full-time, it would be burdensome and costly to require the North Carolina DOR to verify that young taxpayers who are eligible for the state s EITC are not also students. CONCLUSION The most effective expansion of the North Carolina EITC would be to create an EITC for noncustodial parents. Since New York and D.C. have already created a NCP EITC that is relatively simple to administer, North Carolina can use them as models in creating its own program. A NCP earned income credit in North Carolina would be a large enough to meaningfully promote tax fairness, increase the payment of child support obligations, and provide work incentives for low-income workers without qualifying children. On the other hand, extending the state s EITC to workers without qualifying children under the age of 25 or over the age of 65 would result in a very small credit that would be complicated to administer. 44 See GITTERMAN, ET AL., supra note 21 at 8. The problem of separating the working poor from college students would be even more difficult, of course, if the EITC was extended to all low-income workers age 18 and up. 13