Earned Income Tax Credit: Small Benefits, Large Costs
October 23, 2015
Lately the idea of expanding the earned income tax credit (EITC) to help the working poor has gained some support.
The EITC is the largest federal cash transfer program and is primarily a spending program. In 2015 it will provide about $69 billion in benefits to 28 million recipients. However, the downside is that there is a high error and fraud rate and creates a disincentive to increase earnings, additionally, it imposes a $60 billion cost on other taxpayers.
A study by the Cato Institute shows that the costs of the EITC are likely higher than the benefits, thus, the program should not be expanded. Nevertheless Congress has done the opposite, it has expanded the size and scope of the EITC over the decades.
Some unintended side effects of the EITC are:
- As labor supply increases, market wages fall and employers are more inclined to hire additional workers.
- But it ends up hurting low earners who receive no EITC or a small EITC.
- The program also acts partly as a subsidy to businesses that hire lower-skilled workers.
- Although the EITC encourages low-income workers to find a job it has a negative effect on the number of hours worked.
The best long-term solution would be to cut the EITC as well as other welfare programs and the payroll tax. Policymakers should pursue policies to boost wages and increase job growth including reducing the corporate income tax rate which would boost investment, generate higher demand for labor, and thus raise wages.
Source: Chris Edwards and Veronique de Rugy, "Earned Income Tax Credit: Small Benefits, Large Costs," Cato Institute, October 2015.
Browse more articles on Tax and Spending Issues