The 2019-20 Budget: Analysis of Proposed Earned Income Tax Credit Expansion

The 2019-20 Budget: Analysis of Proposed Earned Income Tax Credit Expansion GABRIEL PETEK LEGISLATIVE ANALYST MARCH 6, 2019 Summary Governor Proposes $600 Million Earned Income Tax Credit (EITC) Expansion. The state adopted an EITC in 2015 and expanded it in 2017 and 2018. The Governor proposes another expansion starting in 2019. This proposal would cost roughly $600 million and would: (1) extend the income eligibility range to $30,000, (2) increase the credit amount for workers with dependents under age six, and (3) increase the credit amount for workers with earnings at the higher end of the current eligibility range. The administration also proposes exploring options for providing monthly credits. Proposal Would Modestly Affect Poverty and Work Incentives. One way to evaluate an EITC expansion is the extent to which it alleviates poverty among workers. Although the Governor’s proposal would provide benefits to a large number of Californians in poverty, it only would move roughly 50,000 workers above the poverty line and 12,000 workers above deep poverty (half of the federal poverty level). Another way to evaluate the proposal is its effects on work incentives—both for workers to enter the workforce and to work full time. The Governor’s proposal to increase the credit for families with dependents under six would strengthen the incentive for those parents to enter the workforce. Most of the proposed expansion, however, is focused on encouraging more workers to work full time. That said, evidence at the federal level suggests that the EITC does not have much of an effect on workers’ decision to work more hours if they are already working. Consequently, the increased benefit under the Governor’s proposal would be unlikely to have a large effect on work patterns. Alternative Credit Designs. We offer two alternative credit designs for Legislative consideration (both would cost roughly $600 million). The first increases the benefit most for those with the lowest earnings, providing more assistance to those in deep poverty (moving 58,000 workers above deep poverty). This credit design also would increase the incentive for people to enter the workforce relative to the Governor’s proposal. The second alternative increases the maximum eligible income and increases the benefit for those toward the higher end of the eligibility rage. Relative to the Governor’s proposal, this credit design further reduces the disincentive for moving from half-time work to full-time work (although these effects might still be relatively small). The Legislature’s ultimate design of a credit expansion will depend on how it wishes to prioritize reducing poverty, increasing workforce participation, or encouraging full-time work. Options for Monthly Payments. Assuming providing monthly credits would not affect Californians’ eligibility for federal health and human services programs; the state could take a variety of approaches for providing monthly benefits. The main considerations we discuss in this report are (1) which agency should administer the program and (2) whether payments should be made in advance or on a deferred basis. While advanced payments likely would be more helpful to the recipients, accurately estimating worker’s EITC advance would be difficult, but also important. In particular, attempts by the state to recoup over-payments could create hardships for those affected. analysis full gutter 2019-20 BUDGET INTRODUCTION The state adopted an EITC in 2015 and the credit amount for workers with earnings at expanded it in 2017 and 2018. The Governor the higher end of the current eligibility range. This proposes another expansion starting in 2019 that report evaluates the Governor’s proposal, discusses would (1) extend the income eligibility range to potential alternative approaches, and examines $30,000, (2) increase the credit amount for workers implementation issues and options for providing with dependents under age six, and (3) increase credits on a monthly basis. BACKGROUND Federal EITC people) earned a total of $7.2 billion of federal credits with an average credit amount of $2,314. Refundable Credit Based on Earned These EITC amounts moved an estimated 750,000 Income. The federal EITC is a provision of the Californians’ income above the federal poverty level U.S. income tax code that allows workers filing ($20,160 annually for a family of three in 2016, a tax return who earn less than a certain amount lower for smaller households, and higher for larger (about $46,000 for single workers with two ones). dependents) to reduce their federal tax liability. Federal EITC Generally Encourages People to The EITC is refundable. The amount of the credit Enter Workforce. The amount of the federal credit depends on the worker’s “earned income” (which initially rises with earnings, increasing the value of primarily includes wages and self-employment work. Consequently, when individuals receiving the income), filing status, and number of qualifying EITC first enter the workforce, their total after-tax dependent children. The amount of the federal earnings are greater than their initial pre-tax wages. credit initially rises with earnings, such that the This creates a stronger incentive for people to join greater the worker’s earnings, the larger the credit. the workforce. Studies have shown that the federal The federal EITC peaks and is then flat for a range EITC has resulted in significantly more people of income—between $14,250 and $18,700, for entering the workforce, particularly low-wage and example, in the case of single workers in 2018 low-skilled single parents. (See our December with two dependents. The credit then gradually 2014 report, Options for a State Earned Income Tax phases out for workers with higher levels of income Credit, for more information about the design and (generally those working full time). The credit is effectiveness of the federal EITC.) “refundable,” meaning that the worker receives Federal EITC Can Discourage People Already the full amount of the credit even if it reduces their Employed From Working More Hours. The design liability below zero. of the federal EITC provides the largest benefits Federal EITC Benefit Can Be Significant. to low-wage workers who work part-time. While The average credit nationally in 2016 was $3,181 this design increases the number of participants for workers with dependent children. Workers in the formal labor market, the structure can with fewer qualifying dependents receive lesser discourage workers from pursuing full-time work. amounts. The benefit for workers with no qualifying This is because the phase out of the credit may dependent children is much smaller (the maximum offset the additional earnings associated with credit for such individuals is $519). working more hours. For example, a single person Federal EITC Reduces Poverty. The EITC with two dependents who works 20 hours per increases the after-tax income of low-income week at $15 per hour earns $15,000 over a full individuals and families. In 2016, 3.1 million year (working 50 weeks). In 2018, this worker California workers (representing nearly 10 million 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET would receive the maximum federal EITC benefit maximum credit for a worker with two dependents of $5,716. If the same worker instead worked is $2,559, corresponding to income in the narrow full time, his or her pre-tax earnings would rise range of $7,501 to $7,550. The state credit also to $30,000 and his or her EITC benefit would be has a point (the “kink”) after which the benefit $3,333. Given the roughly $2,400 decline in the phases out much more slowly. Figure 1 shows how worker’s EITC benefit, the worker’s net earnings the income levels of these peaks and kinks vary increase from working full time would be roughly in 2018 depending on the number of the workers’ $12,600 (rather than $15,000). This benefit decline dependents. Workers whose income is to the right can discourage people from moving to full-time of (higher than) the kink points generally receive work, although evidence suggests that in practice much lower benefit levels than those with income to this impact is small. (For those already working full the left of (below) the kinks. time, the phase out of the EITC does not appear to Nearly 1.5 Million Filers Claimed State EITC affect decisions about how many hours to work.) in 2017 . . . In tax year 2017, roughly 1.5 million California filers received a total of $348 million in California’s EITC credits under the state EITC. Figure 2 (see next State EITC Builds on Federal Credit. Most page) shows the number of dependents for these of the state EITC’s provisions are modeled on workers and their average and median credit federal provisions, such as that eligible filers must amounts. As seen in the figure, nearly half of these be U.S. citizens or permanent residents. Like the workers did not have dependents and received federal EITC, the state credit is refundable and much smaller EITC benefits. Moreover, for each the credit amounts are larger for filers with more category of filer, the median credit amounts are dependents, as explained below. The Franchise Tax much lower than the average credit amounts. Board (FTB) annually adjusts the income thresholds That is because most workers claiming the EITC and credit amounts for inflation, similar to the receive fairly small amounts, but a small portion adjustment made at the federal level (although the of recipients (typically those with income between state uses a California-specific inflation index). As $5,000 and $10,000) see much larger benefits. with the federal credit, the state EITC provides larger amounts for workers with more dependents (up to three). Figure 1 For example, at $10,000 of EITC Benefits Larger for Filers With More Dependents income the EITC benefit is $62 for a worker with no dependents, $3,000 $254 for one dependent, $1,740 Peak Maximum benefit level for a filer with three dependents for two dependents, and $1,958 2,500 for three or more. State EITC Structure Differs 2,000 From Federal. As with the federal 1,500 EITC, the state credit amount initially rises as workers’ earnings 1,000 rise and phases out above a Kink Point after which the benefit certain income level. The state 500 declines more slowly credit, however, lacks a broad range of income over which the 50 5,050 10,050 15,050 $20,050 credit is constant. Instead, the Income Before Calculating EITC credit amount peaks at a narrow range of incomes and declines for No Dependents One Dependent Two Dependents Three or More Dependents any amount of income past the EITC = Earned Income Tax Credit. peak. For example, in 2018 the www.lao.ca.gov 3 analysis full gutter 2019-20 BUDGET . . . Recent Changes to EITC Figure 2 Likely to Increase Use Further. Average EITC Benefits Exceed Median Benefits The Legislature expanded the state EITC for tax year 2018 in 2017 Tax Year two ways. First, the income limits EITC Benefit: Number of were raised from $22,300 to Dependents EITC Returns Average Median $24,950 for filers with dependents 0 674,111 $76 $62 and from $15,000 to $16,750 for 1 429,942 267 163 workers with no dependents. This 2 253,177 474 193 increased the number of workers 3+ 119,830 515 192 eligible for the state credit. At the EITC = Earned Income Tax Credit. time, the Department of Finance (DOF) estimated this change federal EITC. In 2016 and 2017, the state awarded would affect roughly 700,000 additional potential $2 million in grants to these groups to help expand workers. Second, workers with no dependents these education and outreach efforts. These who are under age 25 or over age 65 were made efforts include advertising and media outreach, eligible. No filing data is available yet on how this distribution of printed materials, and canvassing— change has affected the number of filers claiming direct contact with individuals in targeted residential the credit or the credit’s total cost. Under the neighborhoods. In 2018, the state increased administration’s current estimates, however, the the amount of grants it awarded to $10 million state EITC (including this expansion) is expected to and allowed grant recipients to fund tax filing cost $410 million in 2018-19. assistance. In addition, FTB receives $900,000 State Provides Funding for Outreach. Many annually for additional EITC outreach activities community-based organizations and other state and to fund the grant making process. State and local government agencies (such as school EITC grants are currently administered through districts and county social services offices) engage an interagency agreement with the Department of in efforts to raise awareness about the state and Community Services and Development (CSD). GOVERNOR’S PROPOSAL Proposal Would Expand EITC in Three Ways. renaming the credit the “Working Families Tax The administration proposes expanding the state Credit”). We describe each of the three major EITC in three ways: (1) providing an additional aspects of the Governor’s proposal in more detail $500 credit for all EITC-eligible workers that have at below. least one child under the age of six, (2) increasing Additional Credits for Families With a Child the maximum qualifying income to $30,000, and Under Age Six. First, the Governor’s proposal (3) increasing the credit for individuals and families would increase the EITC for every eligible worker with earnings at the higher end of the eligibility with at least one dependent child under the age range. The administration estimates these changes of six. This increase would be a flat $500 for every would increase the amount of credits received worker with income under $28,000, then phase out by $600 million—bringing the total cost of all between $28,000 and $30,000 of income at a rate EITC credits to around $1 billion—and increase of $1 of credit for each $4 of income. (This phase the number of taxpayers receiving the credit out range would be fixed until 2022 and would be by 400,000. The administration also proposes adjusted for inflation thereafter.) DOF estimates that renaming the credit to the “Cost of Living Refund” this change would affect 400,000 workers and cost (previously, the Governor’s budget proposed $240 million annually if implemented alone. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Maximum Eligible Earned Income Amount DOF Estimates Entire Proposal Would Would Increase. Second, the Governor proposes Cost $600 Million. DOF estimates the cost increasing the maximum eligible income to $30,000 of all three components of the proposal to be for all workers regardless of their number of about $600 million. This is more than the sum dependents. The current maximum income for of the estimates for the components because eligibility is $24,950 for workers with dependents some components interact with one another. For and $16,750 for workers with no dependents. DOF example, the additional $500 for workers with estimates that this will make the credit available dependents under age six would cost more if the to up to 1 million new workers and would cost maximum income were increased to $30,000 than $70 million in 2019-20 if implemented alone. Of if it remained at $25,000. The Governor proposes these new workers, about 70 percent would have paying for this proposal with some conforming no dependents. The administration also proposes changes to state tax law to reflect major changes to holding the income limit at $30,000 until 2022, after federal tax law passed in 2017. The administration’s which it would be automatically adjusted annually intent is to raise enough revenue through these for inflation. changes to cover the entire cost of the EITC Credit Would Phase Out More Slowly. Finally, (roughly $1 billion annually), not just the proposed the Governor proposes increasing the credit for expansion. individuals and families with earnings at the higher Governor Proposes Providing $5 Million end of the eligibility range. Under current law, a for Outreach. The Governor’s proposal includes worker’s EITC benefit starts to decline once it $5 million for EITC outreach and education grants exceeds the peak level. Initially, the benefit declines to community-based organizations and other state rapidly, as shown by the steep line after the peak and local government agencies. In a departure and before the kink in Figure 3. Within this income from recent state practice, in which outreach range (to the left of the kink) EITC benefits decrease funding was provided to FTB and administered by at the same rates they increase before the peak (for CSD, these grants would be administered through example, 34 cents for each additional $1 earned the Office of Planning and Research (OPR). The for a worker with two dependents). After the kink, the benefit declines Figure 3 more slowly, decreasing the benefit Proposal Would Raise EITC Benefit for by less than 2 cents for each Workers With Relatively Higher Income additional $1 earned for workers with any number of dependents. $3,000 Figure 3 shows the differing benefit amounts (Governor’s proposal 2,500 compared to current law) for 2,000 workers with no dependents and those with two dependents. As 1,500 seen in the figure, the Governor’s proposal would eliminate the kink 1,000 for workers with no dependents entirely. For workers with 500 dependents, the Governor’s plan would move the kink point further to the left. DOF estimates this 50 5,050 10,050 15,050 20,050 $25,050 change would cost $300 million Income Before Calculating EITC annually if implemented alone. No Dependents, No Dependents, Two Dependents, Two Dependents, Current Law Proposed Current Law Proposed EITC = Earned Income Tax Credit. www.lao.ca.gov 5 analysis full gutter 2019-20 BUDGET proposal also indicates that the state will require generally occurs several months following the end grantees to provide a funding match as part of their of the year. The administration has committed to applications. The administration has not provided exploring ways to provide the EITC, or a portion any details on how OPR would administer these of the EITC, to qualified workers during the year grants or the criteria for distributing them. in monthly payments rather than later in a lump Governor Proposes Examining Options sum. The administration does not have a specific to Provide Monthly Credit. As it is currently monthly payment proposal for us to evaluate, structured, workers eligible for the EITC receive but we discuss possible options for legislative a tax refund after they file their annual taxes. This consideration later in this report. ASSESSMENT This section first assesses the Governor’s participation, we think an expansion merits serious proposal to link the EITC expansion with state consideration. tax law changes. We then lay out criteria the Criteria to Evaluate EITC Proposals. There Legislature can use to evaluate an EITC proposal are three basic criteria that can be used to evaluate or expansion and then evaluate the Governor’s proposals to modify the EITC. First, how does proposal using these criteria. We conclude this the proposal affect poverty in the state? Does section with a summary of our assessment of the the proposal target those in deep poverty (those Governor’s proposal. with income less than half of the poverty level)? Conformity Changes and EITC Expansion Second, how does it affect work incentives, both Should Be Considered Separately. While the for people who have to decide whether to enter the Governor proposes them together, we suggest formal labor market and for people who are already the Legislature consider the merits of the EITC working but are considering switching from part expansion separately from the proposed conformity time to full time or vice versa? Third, what does changes to state tax law. Attempting to offset the proposal cost, in terms of both revenue and revenue losses from an expanded EITC with additional compliance and administration? conformity actions is problematic. Estimates Poverty Impact of the revenue impacts of expanding the state EITC and possible conformity actions are subject One major policy goal of the EITC is to reduce to considerable uncertainty. Considering these poverty. In this section, we evaluate the extent to proposals separately would mean the state would which the Governor’s proposal would help reduce need to use ongoing General Fund resources for poverty in California and among which groups. We an EITC expansion. Both our November Outlook estimate that roughly 1.2 million workers receiving and the administration’s January estimates (without the EITC in 2017 were below the poverty line and the Governor’s proposed conformity changes) 420,000 were in deep poverty. (Roughly 5.2 million suggest that an additional roughly $3 billion in Californians overall are in poverty and 2.5 million ongoing General Fund resources might be available are in deep poverty. These numbers are larger for additional budget commitments in 2019-20. because they represent all Californians—including Excluding the EITC, the Governor proposes children—not just those filing taxes.) Here, we $2.7 billion in new ongoing spending in 2019-20, refer to the official poverty measure as opposed to growing to $3.5 billion over time. We suggest the the Supplemental Poverty Measure (SPM) which Legislature consider an EITC expansion relative accounts for differences in living costs and for the to the ongoing spending proposals introduced by effects of other means-tested programs such as the Governor. Given the effectiveness of the EITC California Work Opportunity and Responsibility to at reducing poverty and increasing labor market Kids (CalWORKS) and CalFresh. While the SPM 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET is usually a more relevant measure, tax filing data • Workers With Income Just Beyond does not provide sufficient information for us to Kink Points Would See Largest Benefit evaluate the effects of the proposal using SPM. Increases. Figure 4 shows the increase Under the SPM, the poverty and deep poverty in benefit under the Governor’s proposal thresholds are significantly higher than they are compared to current law for workers with no under the official measure (likely above $30,000 dependents and workers with two dependents for many larger households). Measured against the (similar to Figure 3). The shaded portions SPM, the Governor’s proposal would benefit more of the figure show the increase in benefit workers with income below that threshold, but to workers at each income level relative move fewer of them out of poverty. to current law. As seen in the figure, the Proposal’s Impact Would Be Broad, but Not largest increase in benefit goes to those who Deep. Like the 2017 expansion, the Governor’s under current law are at or close to the kink. proposal would provide a broad but modest benefit Workers “at or close to the kink” are those increase. We estimate that it would benefit roughly who earn around $5,000 annually if they have 1 million workers (slightly less than half of whom no dependents, $10,000 with one dependent would have no dependents) who have incomes (not shown), or $15,000 annually with two or below the federal poverty line. Despite the fact more dependents. that the proposal would provide benefits to a large • Up to 400,000 Workers With Dependents number of Californians in poverty, it would only Under Age Six Could Benefit. We estimate move roughly 50,000 workers above the poverty that about 385,000 workers with $30,000 or level (excluding federal EITC benefits and other less of income in 2017 had at least one federal and state supports) and roughly 12,000 dependent under the age of six. Under the above the deep poverty level. In large part, this is Governor’s proposal, these workers would because the Governor’s proposal does not raise receive an additional $500 benefit regardless the maximum benefit amount. (These figures do of other changes to the EITC. not account for any change in EITC participation or in current Figure 4 workers’ number of hours worked. Workers Close to the Kink Would See Largest Benefits The proposal’s impact on poverty likely would be greater to the $3,000 extent that it encourages more people to enter the workforce.) 2,500 The proposal also would modestly 2,000 increase EITC benefits for an estimated 1.2 million workers 1,500 (about 60 percent of whom would have no dependents) who have Proposed Benefit 1,000 relatively low income but are $726 Current Law Benefit nonetheless above the poverty $255 500 line. Largest Benefits Would Be to Two Groups of Workers. While 50 5,050 10,050 15,050 20,050 $25,050 the Governor’s proposal generally Income Before Calculating EITC provides a relatively small benefit No Dependents, No Dependents, Two Dependents, Two Dependents, Current Law Proposed Current Law Proposed increase to many workers, two Shading indicates groups of workers would see the EITC = Earned Income Tax Credit. benefit increases largest benefits: www.lao.ca.gov 7 analysis full gutter 2019-20 BUDGET Work Incentives wage increase is unlikely to have a large effect on work patterns. Every EITC program faces an inherent tension. Minimum Wage Increases Would Affect On one hand, by increasing the value of initial Future Work Incentives. The state’s minimum earnings, an EITC encourages people to enter the wage is scheduled to rise by $1 per hour at the workforce. On the other hand, the EITC reduces start of each of the next four years, reaching the incentive to work for those with income within $15 per hour by 2023 for all employees. As such, the “phase out” range (where the credit amount is the effect of an EITC expansion on work incentives declining). This can discourage people from moving will be very different in 2023 from what they are from part-time to full-time work in some cases. In in 2019. This table shows how the benefits for this section, we consider how well the Governor’s working part time and full time would change for proposal encourages people to join the workforce a worker with two dependents (both over age six) while reducing the disincentive to work full time. who works a full year at the minimum wage from Proposal Would Increase Incentive to 2019 to 2023. (We assume inflation adjustments Enter Workforce, Mainly for Workers With would increase EITC income thresholds and benefit One Dependent Under the Age of Six. The amounts by 10 percent by 2023.) As Figure 5 Governor’s proposal would strengthen the incentive shows, EITC benefits for both types of workers will to enter the workforce somewhat, but mostly decline as the minimum wage increases. for certain groups. In particular, the Governor’s proposal to provide a $500 credit to workers with Costs and Administrative Issues dependents under age six could encourage those Estimates Are Always Uncertain. Estimating not currently working to work at least part of the the costs to create and expand the state EITC year. The structure of the Governor’s proposal was tricky when the program was first established. also would increase the benefit for a worker with This largely was due to the fact that many state one dependent working 20 hours a week at the EITC filers had not previously filed state tax returns minimum wage (income of $11,000) from $236 to (because most of them did not owe state taxes). $691 (or to $1,191 if the dependent is under age There is less uncertainty in estimating the cost of six). As such, this proposal creates a somewhat the Governor’s proposal for two reasons. First, the larger incentive for that individual to work part state has had some years of experience operating time. (This increased benefit is specific to a worker its own EITC. Second, the Governor’s proposal with one dependent earning roughly $11,000 per targets somewhat higher income groups, most year.) The proposal would not create a similar work of whom already file state taxes. That said, there incentive for individuals with similar earnings and is always some uncertainty in projecting costs either no dependents or multiple dependents (none associated with a new program and the actual of whom are under the age of six). costs associated with an expanded EITC could be Proposal Would Slightly Reduce Disincentive higher or lower than the Governor suggests. for Full-Time Work. As described earlier, the largest component of the Governor’s proposed expansion Figure 5 benefits those with relatively higher Benefits May Decline as Minimum Wage Rises earnings. Increasing the benefit to these workers by changing Full Year Earnings Based on 50 Weeks the phase out of the credit could Full Year Earnings reduce the disincentive to move to at Minimum Wage: EITC Benefit: Minimum full-time work. That said, evidence Wagea, $/hr 20 hr/Week 40 hr/Week 20 hr/Week 40 hr/Week at the federal level suggests that 2019 $11 $11,000 $22,000 $1,384 $375 the phase out of the EITC has very 2023 15 15,000 30,000 766 39 limited impact on current workers’ EITC = Earned Income Tax Credit. hours, and such a small effective aFor employers with 25 or fewer employees. 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Administration’s Cost Estimates Appear Outreach Funding Lacks Clear Plan. FTB Reasonable. We estimate that the Governor’s and CSD are currently working on a report that proposal would cost about $550 million if there evaluates the effectiveness of the state’s EITC is no increased participation for currently eligible education and outreach grant program. The households. The proposed benefit increases— administration expects that OPR will work with FTB particularly for those with dependents under and CSD to determine the most effective outreach age six—likely will increase participation among strategies, based in part on the findings of that those already eligible, however. DOF’s estimate of report. More broadly, however, the administration $600 million is therefore reasonable assuming some has not provided a clear rationale for shifting additional participation by those eligible under outreach funding from FTB to OPR. In particular, current law. why the administration expects OPR would improve FTB May Be Able to Validate Dependents’ education and outreach is unclear. Ages in Coming Years. FTB does not have a way Summary of Assessment of to validate dependents’ ages. Currently, FTB relies Governor’s Proposal on voluntary taxpayer compliance, subject to audit. For example, if the FTB believes that a worker The Governor’s proposal provides the largest has claimed an ineligible dependent as a child in benefit to those working more than part time. error, it may request additional information from This reduces the disincentive for full-time work the worker—including documentation of the age associated with the EITC. Research suggests, of any dependents—before processing a refund. however, that the phase out of the EITC has very The administration’s proposal to provide additional limited impact on current workers’ hours. Moreover, benefits for workers with at least one dependent the Governor’s proposed effective wage increase under age six increases the advantages of having likely is too small to have a large effect on work a method to validate the age of a dependent patterns. child prior to approving a refundable tax credit. The Governor’s proposal also aims to reduce We understand that FTB is looking into ways to poverty and somewhat increase the incentive to exchange worker data—including full names, dates join the labor market, especially among those who of birth, and social security numbers—with the have children under the age of six. While roughly Social Security Administration (SSA), but that may 400,000 workers with young children could benefit not be available for a couple of years. Implementing significantly, we estimate the proposal would raise a new age validation system with the SSA will only about 50,000 workers above the federal require additional one-time and ongoing costs. poverty line and roughly 12,000 above the deep poverty level. ALTERNATIVE CREDIT DESIGNS In this section, we provide a few different Alternatives to Mitigate Poverty and alternative credit design options for legislative Promote Workforce Participation consideration. Each of the EITC alternatives outlined would carry the same costs as the Target Benefits to Those in Deep Poverty and Governor’s proposal. The first set of options Encourage More People to Enter Workforce. focuses more on the goals of addressing poverty Rather than focusing on encouraging those and increasing work incentives. The second option already in the labor force to work more hours, focuses more on reducing the disincentive for the Legislature may wish to expand the EITC to full-time work. create a stronger incentive for people to enter the workforce and provide larger benefits to those in www.lao.ca.gov 9 analysis full gutter 2019-20 BUDGET deep poverty. The Legislature could do this by the state credit is modeled on the federal credit, extending the credit’s phase-in range at the current which reduces workers’ taxes up to a certain credit percentages. This would both (1) increase amount based on child care costs. Prior to 2010, the maximum benefit and (2) increase the income the state credit was refundable. At the time, the at which workers qualify for the maximum benefit. average credit amount for filers making less than For example, assuming the Legislature wanted $40,000 a year was $368. Today, workers with less to expand the EITC by $600 million—as in the than $40,000 of income receive very little benefit Governor’s proposal—it could increase both because these workers typically do not owe state the peak EITC benefit and the income at which taxes and the credit is not refundable. the maximum benefit is reached by 42 percent. Making the Credit Refundable Could Almost the entire benefit of this proposal would Target Assistance to Lower-Income Families. go to workers currently below the poverty line We estimate that making the state child credit and provide larger benefits to those near deep refundable and increasing the amount of the poverty. In particular, we estimate this alternative credit to be more similar to the federal credit would move roughly 1,000 workers’ income would cost approximately $125 million annually. above the federal poverty line, but would move Generally, making this credit refundable would 58,000 workers out of deep poverty. As with the benefit a broader income range—up to $60,000 in Governor’s proposal, these figures would be higher income—than under the Governor’s EITC expansion to the extent that the EITC benefit encouraged proposal. Extending the credit to relatively higher more labor force participation. Moreover, we expect incomes would benefit households with a second this effect to be bigger under this alternative, as the earner and could encourage a second parent benefit increase for most part-time workers would to work. (See our April 2016 report, Options for be much higher. Modifying the State Child Care Tax Credit, for more Figure 6 shows how the maximum benefit and information about this credit.) If the Legislature income levels would change under this alternative for workers with Figure 6 zero and two dependents. (All Extending Phase-In Range Would other elements of the EITC—like Boost Credit for Many Low Earners the phase out—would remain the same as under current law.) $4,000 Peak Income and Peak EITC Income $10,670 For single workers with two 3,500 Peak EITC Amount Under LAO Alternative Both Increase dependents, the maximum benefit 3,000 would be reached at an income of Benefit Increase $2,135 $10,670 which is equal to working 2,500 Under LAO Alternative about 19 hours per week for a 2,000 full year at the minimum wage of 1,500 $11 per hour (the minimum wage for employers with 25 or fewer 1,000 employees). 500 Expanded Child Care Tax Credit Could Be an Alternative 50 5,050 10,050 15,050 $20,050 to Proposed $500 Credit. Rather Deep Poverty Level Poverty Level than providing a $500 credit (Household of 3) (Household of 3) for workers with at least one Income Before Calculating EITC dependent under the age of six, No Dependents, No Dependents, Two Dependents, Two Dependents, the Legislature could consider Current Law LAO Alternative Current Law LAO Alternative expanding the existing tax credit EITC = Earned Income Tax Credit. for child care expenses. Currently, 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET wished to make this change in addition to of $22,000) would be $463 for workers with one extending the credit’s phase-in range, it could either dependent, $531 for two dependents, and $537 for somewhat reduce the maximum benefit expansion three or more. (Workers with dependents under six or increase the costs of an EITC expansion relative years old would not receive an additional benefit to the Governor’s proposal somewhat. under this example. Workers with no dependents working full time at minimum wage would receive Alternatives for Promoting an increase of $70, as under the Governor’s Full-Time Work proposal.) Compared to the Governor’s proposal, this would reduce the disincentive for moving from Larger Benefits for Workers With More half-time to full-time work by $226. Earned Income Could Encourage Full-Time Work. As Figure 7 discussed earlier, EITC benefits can discourage people from Alternative Would Provide Larger Benefit for All Eligible Full-Time Workers moving to full-time work in some cases. One way to address $3,000 this obstacle is to (1) increase the maximum eligible income 2,500 and (2) increase the benefit for 2,000 those toward the higher end of the eligible income range, so 1,500 Benefit at Kink (Under LAO Alternative 2) that the increased benefit for $925 full-time workers phases out 1,000 more slowly. Figure 7 shows a second alternative for this type of 500 expansion. Under this alternative, the maximum eligible income would be $40,000 for workers 50 5,050 10,050 15,050 20,050 25,050 30,050 $35,050 Income Before Calculating EITC with at least one dependent, and the increased benefit (relative Two Dependents, Two Dependents, Two Dependents, Current Law Governor’s Proposal LAO Alternative 2 to current law) for working full time at minimum wage (income EITC = Earned Income Tax Credit. OPTIONS FOR PROVIDING MONTHLY CREDITS The administration indicates it would like to Monthly EITC Payments May Interact provide the EITC in monthly payments but does With Federal Eligibility Rules not have a specific proposal. This section first discusses the potential interaction between Eligibility for Many Human Services Programs providing monthly credits and health and human Based on Federal Rules. The state and federal services programs. Options for providing monthly governments operate various programs that credits and the trade-offs associated with those provide assistance to low-income individuals and options are then discussed. families, including food benefits through CalFresh, monthly cash assistance through CalWORKs, and health insurance through Medi-Cal. Eligibility for these programs largely is set by federal law and www.lao.ca.gov 11 analysis full gutter 2019-20 BUDGET predominantly is based on household income. In • The Department of Social Services (DSS). addition to eligibility, benefit levels also are set By administering existing programs that according to income—lower-income households provide assistance to low-income individuals typically receive larger benefit amounts than eligible and families, DSS may be well situated to households with more income. Household income administer monthly EITC payments. DSS generally is based on earned and unearned income also operates the federal electronic benefits received on a “recurring basis” like weekly or transfer (EBT) system in the state. The EBT monthly wages. Lump-sum tax refunds, however, system allows the state to provide food are not included in the determination of household benefits and county welfare departments to income for health and human services programs. issue cash assistance to eligible recipients. Monthly EITC Payments Probably Would Not The existing programs are tightly integrated Affect Benefits. Providing the EITC on a monthly with other federal and county government basis could be considered income received on a agencies, however, which may make adding recurring basis. An increase in income could reduce a new benefit administratively and technically the amount of assistance individuals and families challenging. receive from other programs. However, federal • Employment Development Department law provides for a specific exclusion of the federal (EDD). EDD collects wage withholding EITC when calculating a household’s income for payments from workers who receive wages health and human service programs. This exclusion and administers the unemployment insurance, would more likely than not allow the state to make disability insurance, and paid family leave monthly EITC payments without affecting these programs in the state. In addition to having a benefit programs. There is some uncertainty, close existing administrative relationship with however, because no state currently provides FTB, EDD also pays cash benefits to those monthly EITC payments and the provision has not recently unemployed. been tested previously. Should Payments Be Advanced or Deferred? Options for Providing Providing the payments in advance compared to a deferred payment likely would be more helpful Monthly Payments to the recipients. Advance payments would create The state could take a variety of approaches some challenges, however. In particular, workers to provide monthly EITC payments. The main receiving the EITC have incomes that often vary considerations are (1) which agency would from one year to another. Accurately estimating administer the program and (2) whether the the amount of the EITC in advance is difficult and payments should be made in advance or on in many instances, the state may either under- or a deferred basis. Each of these choices has overestimate the correct amount to provide workers advantages and disadvantages. We summarize in a given year. Consequently, a method to each of these approaches in Figure 8. true-up the difference—potentially by adjusting Which Agency Should Administer Monthly the following year’s credit—could be necessary. Payments? Three state agencies could administer Attempts by the state to recoup over payments a new program to provide the EITC in monthly could create hardships for those affected. Program payments: design should balance the benefit amounts with avoiding inaccuracies and large overpayments. • FTB. As we describe in Figure 8, FTB currently administers the EITC and is responsible for processing tax refunds. FTB authorizes the State Controller to mail a check to the worker (or make a direct deposit) when he or she is owed a tax refund. 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET Figure 8 Options for Providing Monthly Payments Approach Advantages Disadvantages Franchise Tax FTB authorizes the State Controller to mail a Board (FTB) check to the worker (or make a direct deposit) when a worker is owed a tax refund. Advance FTB estimates credit amount for current year Could be provided to all eligible Administering monthly EITC may based on wage information and previous tax EITC recipients. create institutional challenges returns. for tax collection agency. Less complicated to administer Over payments difficult to recover. than other options. Defer FTB would authorize refund in monthly Could be provided to all eligible Unclear why worker would elect installments instead of a lump sum. EITC recipients. monthly payments over lump sum refund. Least risk of over payments. Department DSS administers the federal electronic benefits of Social transfer (EBT) system that allows the state Services to provide food benefits and county welfare (DSS) departments to issue cash assistance. Advance FTB or DSS estimates current credit amount. DSS Could provide benefits to workers Administratively and technically monthly adds payments to worker’s EBT card. already enrolled in other human complicated. DSS reports credit amount advanced to worker services programs. and FTB at end of year. Uses existing systems. Not all EITC recipients may Familiar to benefit recipients. receive benefits administered by DSS. Over payments difficult to recover. Defer FTB authorizes DSS or county welfare Avoids overpayments. Administratively complicated. department to issue monthly refund to worker. Uses existing systems. Not all EITC recipients may Familiar to benefit recipients. receive benefits administered by DSS. Employment EDD administers the state unemployment Development insurance, disability insurance, and paid family Department leave programs—which provide cash benefits to (EDD) eligible workers who are unable to work. Advance FTB or EDD estimates current credit amount. EDD best able to validate Administratively complicated. EDD makes monthly payments to worker. EDD workers’ current wages. reports credit amount advanced to worker and Depending on program design, Minimal overlap between EITC FTB at end of year. could provide monthly and EDD program recipients. payments to many EITC recipients. FTB and EDD already exchange Over payments difficult to recover. tax data. Defer FTB authorizes EDD to monthly issue refund to Administratively complicated. worker. Minimal overlap between EITC and EDD program recipients. EITC = Earned Income Tax Credit. www.lao.ca.gov 13 analysis full gutter 2019-20 BUDGET CONCLUSION Expanding the EITC would provide benefits Legislature wishes to prioritize reducing poverty, to low-income workers. There are a variety of increasing workforce participation, or encouraging approaches to helping these workers beyond full-time work should drive the ultimate design of those proposed by the Governor depending on the expansion. the Legislature’s priorities. The extent to which the 14 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET www.lao.ca.gov 15 analysis full gutter 2019-20 BUDGET LAO PUBLICATIONS This report was prepared by Justin Garosi and Brian Weatherford, and reviewed by Ann Hollingshead and Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 16 LEGISLATIVE ANALYST’S OFFICE