New Research Highlights Importance of EITC for Working Families

October 19, 2011 at 2:49 pm

New research shows that a larger share of families than we might think turn to a key federal work support — the Earned Income Tax Credit (EITC) — but that most of them receive the credit for only a year or two at a time.

Taken together with other research, the new study suggests that while the EITC helps some workers who are persistently paid low wages, for most families who use it, the credit provides effective but temporary help during hard times.

Most Earned Income Tax Credit Recipients Get the Credit for Two Consecutive Years or Less

The study, from Tim Dowd of the Joint Committee on Taxation and John Horowitz of Ball State University, examined EITC use from 1989 to 2006 and found:

  • Approximately half of all taxpayers with children used the EITC at least once during this 18-year period.
  • A large majority (61 percent) of those using the EITC did so for only one or two years at a time — only 20 percent used it for more than five straight years (see graph).

The EITC goes to working people — the overwhelming majority of them families with children — with incomes up to roughly $49,000.  Earlier unpublished research from Dowd and Horowitz found that EITC users pay much more in federal income taxes over time than they receive in EITC benefits.  Taxpayers who claimed the EITC at least once during the 18-year period from 1989 through 2006 paid several hundred billion dollars in net federal income tax over this period, after subtracting the EITC and any other refunds.

Dowd and Horowitz’s new study also found that EITC use is highest when children are youngest — which is also when parents’ wages are lowest.  (Working parents’ wages rise, on average, as their children grow up.)  This finding is particularly important given the importance of income for young children’s learning and the evidence that poverty in early childhood may reduce children’s earnings as adults.

Is Government Spending Really 41 Percent of GDP?

October 18, 2011 at 4:38 pm

Chris Edwards from the Cato Institute generated some buzz recently by stating at a Joint Economic Committee hearing that government spending in the United States is 41 percent of gross domestic product (GDP).  Although that’s right — by one yardstick for one year — it exaggerates the situation.  Edwards used data from the Organisation for Economic Co-operation and Development (OECD), which makes several adjustments to the U.S. data that pump up the government’s percentage from levels we’re used to seeing.  And Edwards picked a year when that figure is unusually high because of a weak economy.

Here’s what you need to know to put the numbers in context:

  • The OECD numbers reflect spending by all levels of government.  In the United States, that means federal, state, and local.  (State and local governments’ spending — not counting what they get from federal grants for things like Medicaid and highways — is about a third of the total.)
  • The OECD uses the United Nations’ System of National Accounts (SNA), which measures the government sector differently than we do in our national statistics.  Most importantly, the SNAs count as government spending the gross cost of many public services that users help pay for, like state universities and public hospitals.  (For example, the SNAs count the entire cost of running the public-university system, not just what legislators appropriate to supplement students’ tuition payments.)  Those adjustments push up the SNAs’ measure of both spending and receipts by roughly 4 percent of GDP compared with the standard  measure tallied by the Bureau of Economic Analysis (BEA) in the U.S. National Income and Product Accounts (see figure).
  • Whether using the BEA or OECD measures, government spending jumped as a percent of GDP during the economic downturn.  That’s not surprising.  Automatic increases in safety-net programs like unemployment insurance and food stamps, plus recovery measures that Congress enacted, pushed up the numerator (spending), even as a slumping economy squeezed the denominator (GDP).  This happened in other countries, too.

U.S. Government Spends Less than Most Other Developed Countries

By the OECD’s measure, U.S. government spending topped 42 percent of GDP in 2009 and 2010 — when the economy hit bottom — and has slipped to 41 percent this year.   The OECD forecast, made before the Budget Control Act took a deep bite out of spending, has this figure dropping to 40 percent in 2012.   While the OECD forecast ends then, the Congressional Budget Office projects that federal spending will continue to decline through mid-decade as a percent of GDP.

Two other points are worth noting.  First, this doesn’t mean that government controls about 40 percent of the U.S. economy.  The bulk of government spending goes for payments to individuals through transfer programs such as Social Security, and most of the goods and services that people buy with these payments are privately produced.

Second, government spending in the United States — by the OECD’s broad measure—remains about 2 ½ percent of GDP below the OECD average, and about 8 percent below the average level among countries that have adopted the euro.  While the United States faces plenty of long-run fiscal challenges, out-of-control spending today isn’t one of them.

Why the Supercommittee Should Reject “Dynamic Scoring”

October 18, 2011 at 2:41 pm

Senate Finance Committee Republicans have recommended that the Joint Select Committee on Deficit Reduction use “dynamic scoring” to estimate the budgetary effects of tax proposals.  In a paper released today, we explain why that’s a bad idea.

Contrary to widespread misunderstanding among policymakers and others, the standard estimates of tax and spending proposals that the Congressional Budget Office (CBO) and other federal agencies prepare are not “static.”  They incorporate many changes in individual and business behavior that occur in response to changes in tax rates and other policies.

They do not, however, include estimates of “macroeconomic feedbacks.” That is, they do not attempt to estimate whether, and by how much, a change in tax or spending policy would affect the overall economy.  They do not, for instance, include estimates of how a proposal would affect GDP growth and, therefore, do not include an estimate of how any change in GDP would affect revenues.

There are very good reasons that federal agencies do not use dynamic scoring:

  • Estimates of the macroeconomic effects of tax changes are highly uncertain.  Economists do not agree on the size of macroeconomic feedbacks from reducing marginal income tax rates or other tax changes.  According to most studies, however, they would likely be small and not have large enough effects on revenue estimates to justify the problems that dynamic scoring would create.
  • Dynamic scoring would impair the credibility of the budget process. Because the estimates of macroeconomic feedbacks are so uncertain, including them in revenue estimates would be highly controversial and inevitably viewed as biased and politically motivated.  A Joint Committee decision to include macroeconomic feedbacks for the first and only time in its estimate of any bill that it reports would appear arbitrary and would seem like a budgetary gimmick.

Finally, if the Joint Committee can craft a package of tax changes that would expand the income tax base by eliminating various tax preferences, the economy would benefit more from using the additional revenues to reduce budget deficits rather than to cut marginal tax rates.  When economic resources are fully employed, deficits reduce saving, investment, and economic growth and, according to most estimates, reducing deficits will have a larger effect in spurring economic growth than using budget savings to cut marginal tax rates.

State Tax Breaks a Costly, Ineffective Way to Attract Wealthy Seniors

October 17, 2011 at 4:42 pm

Can a state get an economic boost by giving senior citizens special tax breaks?  Maine’s governor, Paul LePage, claims so.  Last week he renewed his proposal to exempt all pension income from the state’s income tax.  (Maine already exempts Social Security income and some pension income.)  He argues that this tax cut would encourage wealthy retirees to move to Maine.  Other states have considered similar proposals.

Such tax breaks are costly and will grow much more costly as the senior population rises, as we pointed out in a major study a few years back.  Given the continued budget problems that Maine and other states face, such tax breaks inevitably come at the expense of schools, health care, roads, and other public services — all of which a state needs to compete economically.

With little evidence, LePage and others have argued that increased economic activity generated by seniors who move to (or remain in) the state because of the tax break would offset some of the revenue lost to the tax cut.  This is farfetched.

For one thing, a host of studies show that seniors choose where they live based on a variety of factors, including closeness to family, the weather, jobs, and the availability of services like health care.  Taxes matter very little.

In fact, a recent study by professors Karen Conway of the University of New Hampshire and Jonathan Rork of Reed College finds that state tax breaks for seniors enacted over the last four decades have had zero impact on senior migration patterns.  “Our results are overwhelming in their failure to reveal any consistent effect of state income tax breaks on elderly interstate migration,” they report.

As Conway and Rork’s report concludes, “Our results, as well as the consistently low rate of elderly interstate migration, should give pause to those who justify offering state tax breaks to the elderly as an effective way to attract and retain the elderly.”  Even if a few seniors were to move to Maine or stay there because of the added exemption, the cost of giving virtually every retiree in the state a tax break would far exceed the benefit to the state.

In this era of limited resources, every tax dollar is needed to maintain the services that contribute to a quality of life that actually attracts residents.  States should steer clear of tax breaks that have already proven ineffective.

Kleinbard on the Flawed Case for a Corporate “Repatriation” Tax Holiday

October 17, 2011 at 1:27 pm

On a conference call we hosted for journalists recently, Edward Kleinbard, a USC law professor and former staff director for Congress’ Joint Committee on Taxation, explained why the proposed tax holiday for overseas corporate profits “repatriated” to the United States would be a serious mistake.

Contrary to claims that corporations are cash-constrained and would significantly boost their domestic investments if they could repatriate foreign earnings at a much lower tax rate, Kleinbard explained:

I find it very difficult to come up with a list of cash-constrained American firms that nonetheless have large offshore pots of unrepatriated earnings.  [Northwestern University law professor] Tom Brennan in his academic analysis of [a similar tax holiday enacted in 2004] concluded that 73 firms accounted for 79 percent of all of the repatriations that came back. . . .  [W]ithout exception, those firms have tremendous financial resources in the United States in the form of cash in the United States and in borrowing capacity at the lowest rates in decades in the capital market.  So a cash-constrained story is a very, very difficult one to actually construct. . . .

Click on the button below for the audio of the presentation portion of the call.

 Download as mp3

Click here for the Center’s new report on this issue, which explains why a repatriation holiday would cost tens of billions of dollars in federal revenue.  Click here for our report explaining why the first holiday failed to produce the promised economic benefits and a second one would create even bigger problems.