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Wednesday, September 21, 2011

The Impact of Refundable Tax Credits on Poverty Rates

Margot L. Crandall-Hollick
Analyst in Public Finance

On September 13, 2011, the U.S. Census Bureau released national estimates of the number and percentage of Americans in poverty in 2010. The number and percentage of Americans living in poverty (this percentage is sometimes called the “poverty rate”) is calculated by comparing an individual’s or family’s resources, measured as pre-tax cash income, to a poverty threshold, roughly equal to three times the cost of spending on the U.S. Department of Agriculture’s Economy Food Plan. If an individual’s or family’s resources are less than their applicable threshold, the individual or family is counted as poor.

The current calculation of poverty excludes non-cash benefits and tax credits when determining an individual’s or family’s resources. Yet, these government programs increase the resources families and individuals have to purchase basic goods. As a result of this omission, policymakers cannot use the official poverty rate to assess the antipoverty impacts of refundable tax credits, and in fact may erroneously conclude that these credits have no effect on poverty. The Census Bureau is developing a Supplemental Poverty Measure (SPM) which would include the impact of noncash benefits (like food stamps) and tax credits on poverty rates. However, the development of this new measure has been delayed due to budget constraints. Using an alternative poverty measure similar to the SPM, this report analyzes 2009 Census data (the most recent data available) to estimate the impact of three refundable tax credits, the Earned Income Tax Credit (EITC), the child tax credit, and the Making Work Pay (MWP) credit, on poverty rates.

The results of this analysis suggest that refundable tax credits have a significant antipoverty impact among children and families with children. The poverty rate for families with children when all three tax credits are included as part of income (the “comprehensive income measure”) is 16.1%. This rate is 29% lower than the poverty rate calculated when all three credits are excluded from income (“the baseline”), and 8% lower than the official poverty rate. Similarly, poverty rates among children fall by 30% compared with the baseline when refundable credits are included as part of income (25.0% to 17.5%). In contrast, since the value of the credits depends not only on earnings, but, in the case of the EITC and the child tax credit, the number of children a taxpayer has, these credits have a negligible impact on poverty rates among childless families, seniors, and singles.

This analysis also indicates that while refundable tax credits contribute to poverty reductions among eligible recipients, they do not raise a majority of their recipients out of poverty. Specifically, on its own the EITC lifts 22% of its eligible recipients out of poverty. The other tax credits have smaller effects on reducing poverty rates among eligible recipients. The child tax credit reduces poverty among eligible recipients by 13.9%, whereas the MWP credit reduces poverty among MWP recipients by 5.4%. However, taken as a whole, these credits reduce poverty among those who are eligible for all three by nearly 47%.

Finally, in light of the President’s Fiscal Commission and Domenici-Rivlin Deficit proposal that respectively retain or enhance these credits and potential congressional action to reform the tax code, this report highlights certain limitations of using refundable credits to reduce poverty. Specifically, this report examines how the EITC’s policy goal of incentivizing work may reduce its efficiency at reducing poverty and how administrative complexity can lessen both the size and scope of the antipoverty benefits of refundable tax credits.

Date of Report: September 1
4, 2011
Number of Pages: 1
Order Number: R
Price: $29.95

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