STUDY CONCERNING A STATE EARNED INCOME TAX CREDIT

Section 133 of Public Act 07-1, June Special Session requires the Office of Legislative Research to study certain issues concerning a state earned income tax credit (EITC). (See Appendix A for the text of the act. ) These issues can be divided into those that affect specific groups of people and those that affect the economy. The first group concerns how an EITC would affect people with incomes below the poverty line, children in low-income families, and members of the armed forces. The second group concerns how an EITC would affect labor force participation and local economies.

The law requires OLR to study the following specific questions:

1. The number of Connecticut residents whose income, as a result of a state EITC, would rise above the federal poverty level.

2. The impact of such a credit on local economies, including the amount of money received from the credit that is spent in economically distressed neighborhoods.

3. The effect of such a credit on the state's labor force participation.

4. The effect of such a credit on members of the armed forces of the United States.

5. The effect of such a credit on children in low-income families.

GENERAL ASSUMPTIONS

Because the law did not specify any particular level or type of state EITC for this study, we based our analyses on past legislative proposals for a Connecticut earned income tax credit. We assumed that a state credit would be a percentage of the federal earned income tax credit and that it would be refundable. Within these parameters, we looked at two possible credits: one set at 10% of the federal credit and one at 20%. A state EITC's parameters determine the magnitude of its effects on people and local economies.

The law did not define such terms as “economically distressed,” “neighborhood,” “local economies,” and “low-income. ” Consequently, in some cases, we made assumptions about how to define them for purposes of this study. Our assumptions about, and definitions for, these terms are described in the appropriate chapters of this report. Often our definitions have been shaped by the available data.

Other assumptions are listed in individual chapters below.

METHODOLOGY AND SOURCES

We began our study of the questions posed by the law with a wide-ranging survey of available literature on earned income tax credits. These studies highlighted the myriad factors that determine how an EITC affects people and economies and identified the type of data and statistical methods we would need to estimate the impact of a Connecticut EITC. We then inventoried the data that is currently available and determined whether it would allow us to answer the questions the law poses.

Virtually all of the many studies of such credits deal solely with the impact of the federal credit, not a state credit. In cases where specific data for Connecticut was lacking, we relied on these studies to draw analogies about the impact of a state credit. But we caution that conclusions based on federal credit impacts may not hold for a Connecticut state credit, particularly if the state credit is substantially smaller than the federal credit.

In addition, the impact of a state credit in Connecticut may differ from the experience of other states. For example, if another state has a lower threshold for liability for state income tax than Connecticut, participation in its state EITC program might be higher than it would in Connecticut, where 2007 state income tax liability starts at $ 19,050 for a head of household and $ 24,050 for joint filers. Another factor that could affect participation rates is the extent to which Connecticut publicizes its credit and encourages eligible residents to claim it.

In our study of the questions posed, we were often forced to use imperfect data or found that there was no reliable data on a particular point. Throughout this report, we attempt to identify the data shortcomings that affected our ability to answer the questions.

EXECUTIVE SUMMARY

INTRODUCTION TO THE EARNED INCOME TAX CREDIT

The federal EITC was enacted in 1975. It provides a refundable tax credit to low-income workers. A refundable credit means that if a taxpayer owes no taxes or if his or her tax liability is less than the credit, he or she receives a refund of the difference.

Federal credit amounts vary by income, tax filing status, and number of children. For 2007, the maximum qualifying income is $ 39,783 for a married couple with two or more children. The maximum credit is $ 4,716 for a single or married worker with two or more children.

A person must file an income tax return to receive the federal credit. In 2005, 165,026 Connecticut federal income tax filers claimed the federal EITC; the average credit they received was $ 1,658.

Twenty-two of the 42 states with state income taxes have state earned income tax credits. All of these state credits are percentages of the federal credit ranging from 3. 5% to 50%. Like the federal credit, 19 of the 22 state credits are refundable. Since 1998, members of the Connecticut General Assembly have introduced 21 bills to establish a state credit here, but none has become law. Most of the proposals have called for a refundable state EITC equal to 10% or 20% of the federal EITC.

STUDY DESIGN

Section 133 of Public Act 07-1, June Special Session requires the Office of Legislative Research to study and report on the effects a state earned income tax credit would have on (1) Connecticut residents living in poverty, (2) local economies, (3) labor force participation, (4) military personnel, and (5) children in low-income families. We researched available literature on the impacts of the federal earned income tax credit and those in other states and gathered available data necessary to conduct the study. Where data was lacking, we drew analogies from the literature and made certain assumptions, which are detailed throughout the report.

In assessing the impact of a state EITC, we modeled credits based on past legislative proposals. Thus, we assumed a state credit that piggybacks on the federal credit. If a taxpayer is eligible for the federal credit, he or she would be eligible for the assumed state credit. We also assumed the credit would be refundable and would be set at 10% or 20% of the federal credit.

FISCAL IMPACT OF STATE EITC

For this report, the Office of Fiscal Analysis estimated that a 10% state EITC would result in revenue losses of $ 29. 4 million in FY 09 and $ 32. 4 million in FY 10. A 20% EITC would have a revenue impact of $ 58. 8 million in FY 09 and $ 64. 8 million in FY 10.

FINDINGS AND CONCLUSIONS

Poverty Level Incomes

Because the assumed Connecticut state credits are small compared to the federal credit and other available income support, it appears that a state credit would raise relatively few of the 52,378 Connecticut families with below-poverty incomes in 2006 above the federal poverty level (FPL). Those whose incomes would be increased above FPL fall into narrow income ranges that are already quite close to the FPLs for their family sizes.

Available data on incomes by family size is not precise enough to allow us to estimate with certainty the number of state families whose incomes would rise above the FPL if the state enacted a 10% or 20% credit. It appears that approximately 17,000 families have incomes within ranges for which a state credit could have that effect, but the number for whom it actually would is likely to be smaller.

A look at families receiving cash assistance from the Temporary Family Assistance (TFA) program and subject to the program's work requirements shows that, with a federal EITC and a TFA benefit, a state EITC of 10% or 20% would raise the income of a family of three above poverty if the family breadwinner works between 17 and 17. 5 hours per week. If such a person worked the program average of 28 hours per week, it would be the TFA benefit rather than either the federal or state EITC that pushes his or her income above poverty. Likewise, a family whose breadwinner works full-time for the state's $ 7. 65 per hour minimum wage would be pushed over the FPL by his or her wages or by wages plus the federal EITC, not by a state EITC. The only such worker whose income does not exceed poverty even with a federal and state credit is one with a larger family (five or more).

Economic Effects

The economic effects of a state EITC depend on many factors, including how many eligible taxpayers claim the credit and how and where they decide to spend the money they receive. Studies of the economic effects of EITCs have looked at (1) how EITC recipients use their credits and (2) the economic outputs, such as spending and job creation, that can be attributed to the credits.

Taxpayers receiving federal EITCs can choose to receive their credits as a lump sum or spread out over the year. Research suggests that the lump sum generates greater economic effects as recipients use the money to make larger purchases or pay off debt. But policymakers have recently instituted programs to encourage recipients to save the money for future needs. One example is Connecticut's Individual Development Account (IDA) program.

Whether EITCs affect the local more than the regional or state economy depends on the number of times the money circulates in the economy. Research from other states suggests that the EITC's economic impact on an area depends partly on the area's size and the number of EITC claimants who live there. Internal Revenue Service (IRS) data from the 2005 tax year shows the highest concentrations of federal EITC recipients live in Connecticut's largest cities, however a lack of data on the locations of different types of businesses prevents our gauging the impact of a credit on local and neighborhood economies.

Labor Force Participation Rates (LFPR)

Connecticut's labor force participation rate was 69. 2% in November 2007 and has remained stable through periods of economic growth or recession. The EITC may influence several of the many factors that influence labor force participation, such as the wages a person will need to accept a given job and the negative effect a credit has on other types of benefits, such as Food Stamps.

Relatively few studies have addressed the impact of state or federal earned income tax credits on labor force participation. Some studies found the credit had a modest effect and some found no effect. Researchers have determined that the federal EITC has had a prominent role in bringing single mothers into the workforce. We assume that the impact of a state credit increases with the size of the credit (though the relationship is not necessarily linear) and that a refundable credit has a bigger effect than a nonrefundable one. But based on studies in other states, the assumed size of a Connecticut EITC, and the historic stability of Connecticut's LFPR, we believe a state credit would have at best a marginal effect on the state's LFPR.

Armed Forces Members

Basic military pay scales for 2007 show that pay for many enlisted ranks and some entry-level officer ranks would allow the active duty military personnel in those ranks who have children to qualify for the federal EITC in 2007, if their spouses are either not working or working but not earning significant wages.

Using Department of Defense demographic data, we estimate that 1,066 or about 15% of the military families stationed in Connecticut are eligible for the federal EITC. The number of those who would be eligible for a state earned income tax credit depends on how many are Connecticut residents for tax purposes.

Since over 98% of the active duty military personnel stationed in Connecticut are stationed at the New London submarine base, the Groton-New London area would see the biggest economic impact from a state credit available to military families.

Children in Low-Income Families

Although there is little research on the specific effect of state and federal earned income tax credits on children in low-income families, several studies document the positive effect of increased family incomes on children's academic performance. The direct benefit for children depends on the uses to which such families put their EITC income. Children can also benefit indirectly from expenditures that make a parent more employable.

CHAPTER I: INTRODUCTION TO THE EARNED INCOME TAX CREDIT

THE FEDERAL EARNED INCOME TAX CREDIT

Congress enacted the federal earned income tax credit in 1975. The credit is designed to offset the impact of Social Security and Medicare taxes on low-income individuals and to encourage them to work instead of relying on welfare benefits. It does so by offering a refundable tax credit to low-income individuals and families with or without children.

People who work and earn incomes below certain levels qualify for the credit. Credit amounts vary according to a taxpayer's income and the number of children in the family. Income limits and credit amounts are adjusted annually for inflation. The credit is called “refundable” because even those people who owe no federal income taxes or owe less than the credit amount receive the excess of the credit in the form of a refund. (Working poor people typically do not owe federal taxes but pay a significant portion of their income in Social Security and Medicare taxes. )

Recipients can choose to receive the credit as a lump sum payment, like a regular income tax refund, or can receive part of it in each paycheck throughout the year. The latter option is called “advance payment. ” To receive an advance payment, the employee must have at least one child. The amount an employee can receive as an advance payment is limited. The limit for the 2007 tax year is $ 1,712. The advance payment limit is adjusted annually for inflation.

To receive a federal EITC, a worker must file a federal income tax form for the year and specifically claim the credit. The credit is available only to those who were U. S. citizens or resident aliens for the entire tax year.

Federal EITC Filing Categories

A person's federal EITC varies according to income, number of children, and filing status. To claim the federal credit, a person must file a tax return as single, head of household, or married filing jointly. For purposes of determining the credit amounts, single and head of household are combined into one category. For each income level in the two filing categories, there are three possible EITC amounts depending on whether a filer has no children, one child, or two or more children.

Thus, to determine a person's federal EITC, one must know (1) the person's federal adjusted gross income, (2) filing status (single/head of household or married filing jointly), and (3) the number of children (none, one, or two or more).

Federal EITC Income Limits

The federal EITC is available only for filers who have wages and whose federal adjusted gross income (AGI) falls below certain limits. The limits vary according to EITC category. As with other federal income tax thresholds and exemptions, the federal EITC income limits are adjusted every year for inflation.

For the 2007 tax year, a person qualifies for a federal EITC if he or she has at least $ 1 of earned income, investment income of $ 2,900 or less, and a maximum AGI and maximum earned income of:

● $ 12,590 ($ 14,590 for married filing jointly) with no children,

● $ 33,241 ($ 35,241 for married filing jointly) with one child, and

● $ 37,783 ($ 39,783 for married filing jointly) with two or more children.

Federal EITC Credit Amounts and Distribution

Like the income limits, EITC credit amounts are adjusted annually for inflation.

Credit amounts follow a bell curve for all six filing categories (see Chart I-1). Credits are lowest for those with the lowest and highest eligible incomes and highest for those in the middle of the qualifying income range. Although the credits start as equal for single/head of household and joint filers within each category at lower incomes, because the credit phases out at a higher income level for joint filers, amounts diverge according to filing status as they phase down from the maximums.

Maximum credits for the 2007 tax year are:

● $ 428 for a worker with no children

● $ 2,853 for a worker with one child

● $ 4,716 for a worker with two or more children

THE FEDERAL EARNED INCOME TAX CREDIT IN CONNECTICUT

The most recent Internal Revenue Service data shows that 165,026 Connecticut income tax filers claimed the federal EITC in the 2005 tax year. This number is just over 10% of the total Connecticut returns filed for that year. The average federal credit was $ 1,658.

Of those claiming the federal credit, 61,657 had federal AGIs of under $ 10,000; 73,098 had AGIs between $ 10,000 and 25,000; and 30,271 had AGIs between $ 25,000 and $ 50,000. The average federal credit each of these groups received in 2005 and the assumed state credits at 10% and 20% of the federal credit are shown in Table I-1.

TABLE I-1: CT AVERAGE FEDERAL AND ASSUMED STATE EITC FOR 2005,

BY AGI BRACKET

*Federal AGI*	*Filers Claiming Federal EITC*	*Total Federal EITCs Claimed 2005*	*Average 2005 Federal Credit*	*Assumed 10% State* *EITC*	*Assumed 20% State EITC*
Under $ 10,000	61,657	$ 64,021,000	$ 1,038	$ 104	$ 208
10,000 - $ 24,999	73,098	180,341,000	2,467	247	493
25,000-49,999	30,271	29,692,000	981	98	196
TOTAL/AVERAGE	165,026	$ 274,054,000	$ 1,658	$ 166	$ 332

Map I-1 shows the average 2005 federal EITC for each Connecticut zip code area. Map information comes from the IRS. White spaces represent zip code areas in which fewer than 10 returns were filed and for which the IRS suppressed its data reporting.

IMPACT OF THE FEDERAL EARNED INCOME TAX CREDIT

Several studies have documented the history and effects of the federal earned income tax credit, including its impact on income and poverty, work effort, household spending and asset development, and the economy. To summarize, researchers have concluded the following:

● The federal EITC lifts more than four million people out of poverty each year, more than half of them children.

● The federal EITC has played a critical role in bringing single mothers into the workforce.

● Taxpayers claiming the federal credit most often receive it as a lump sum payment during tax season.

● Most families use the credit for short- and medium-term needs (e. g. , paying off debt, paying current bills, buying furniture, and repairing vehicles).

● A minority of families apply the credit toward longer-term asset development (e. g. , saving to buy a house).

● The number of households receiving the credit can have a potentially large effect on local economies, particularly in cities, as the money cycles through the community.

● Data resource limitations prevent precise studies of the impact of the federal EITC. For example, the EITC participation rate cannot be known because a majority of people eligible for but not claiming it do not file tax returns. Thus, tax records do not contain the information necessary to identify these people.

STATE EARNED INCOME TAX CREDITS

Twenty-two of the 42 states with state income taxes have their own EITCs. Colorado is not included in this total because its state EITC is currently suspended for lack of funding. Of the 22 active state credits, 19 are fully or partially refundable. All state EITCs are based on the federal EITC and provide a state income tax credit equal to a percentage of the federal credit amount. Percentage amounts range from a low of 3. 5% of the federal credit to a high of 50%. Some state credits have varying percentages depending on income or number of children.

The first state EITC was enacted in 1986. Six states passed state EITCs in the 1980s and seven more followed in the 1990s. Since 2000, 12 states have enacted state EITCs. Three states enacted credits in 2007. Many of the states have increased their credits several times since first passing them and have also made them refundable.

Table I-2 provides information on each state's EITC as of the date of this report.

TABLE I-2: STATES WITH EARNED INCOME TAX CREDITS

*State*	*% of Federal* *EITC*	*Refundable*	*Year Passed*	*Changes Since Enactment*	*Citation*
COLORADO	10%	Yes	1989	Colorado's EITC was funded by a state surplus. It is currently suspended.	CRS §39-22-124
DELAWARE	20%	No	2005	None	30 Del. Code Ch. 11, § 1117 as amd by SB 230 (2005)
ILLINOIS	5%	Yes (subject to availability of funds from the federal Temporary Assistance for Needy Families (TANF) block grant and the state's ability to meet its required maintenance of effort. )	2000	The state EITC was to expire after two years, on June 1, 2003. In 2003, the legislature made the credit permanent and also made it refundable, subject to federal funds availability.	35 ILCS § 5/212
INDIANA	6%	Yes	1999 (scheduled to expire in 2011)	Indiana's first state EITC was not based on the federal EITC. The state switched to a credit based on the federal EITC in 2003.	Indiana Code § 6-3. 1-21
IOWA	7%	Yes	1989	Increased from 6. 5% in 2007 and made refundable.	Iowa Code § 422. 12B, as amd. by S. J. 1578 (2007)
KANSAS	17%	Yes	1998	In 2002, the Kansas legislature increased the credit to 15% of the federal EITC from 10%. The cost was partially offset by federal money through the EITC's designation as maintenance of effort for TANF purposes. In 2007, it increased the credit to 17% of the federal EITC, effective for the 2007 tax year.	KSA § 79-32, 205, as amd by HB 2031 (2007)
LOUISIANA	3. 5%, effective January 1, 2008	Yes	2007	None	Act 278, Reg. Session 2007
MAINE	5%	No	1999 law effective in 2000 tax year	Credit reduced to 4. 92% for the 2003, 2004, and 2005 tax years.	36 MSA § 5219-S
MARYLAND	20% or 50%	20% credit is refundable, 50% credit is not. Taxpayers may claim either credit but not both.	1987 (refundable portion passed in 1998)	1998 & 1999 – 10% 2000 – 12. 5% 2001 – 15% 2002 – 18% 2004 – 20%	Md. Code § 10-704
MASSACHUSETTS	15%	Yes	1997	Credit increased from 10% to 15% in 1999, effective with tax years starting on or after 1/1/01.	62 Mass G. L. § 6(h)

*State*	*% of Federal* *EITC*	*Refundable*	*Year Passed*	*Changes Since Enactment*	*Citation*
MICHIGAN	10% through 2008, 20% in 2009 & after	Yes	2006	None	Act 372, Public Acts of 2006
MINNESOTA	Varies depending on income. Families with children may claim from 25% to 45% of federal credit. Childless taxpayers get 25%. Average credit is 33%.	Yes	1992 (restructured in 1997/98)	Increases were passed in 2002. Another increase is scheduled for 2008.	Minn. Stats § 290. 0671
NEBRASKA	10%	Yes	2006	Increased from 8%; 10% credit takes effect in 2008.	LB 968, effective April 6, 2006
NEW JERSEY	20% in 2007 22. 5% in 2008 25% in 2009 and after	Yes	2000	When passed in 2000, the law required the following phased increase in the credit percentage: 10% in 2000 15% in 2001 17. 5% in 2002 20% in 2003 and after. 2007 law added credit increases for 2008 and 2009 and after and eliminated a previous $ 20,000 income limit on those who qualify for a state credit.	NJSA § 54A: 4-6, as amd. by P. L. 2007, c. 109
NEW MEXICO	8%	Yes	2007, effective starting in 2007 tax year	None	HB 436, Ch. 45
NEW YORK	30%	Yes	1994	Original credit was 7. 5% of federal credit. The credit increased to 10% in 1995. Later in 1995, the legislature increased the percentage to 20% starting with the 1996 tax year. Legislation enacted in 1999 increased the EITC to 22. 5% in tax year 2000, and to 25% in tax years beginning after 2000. The rate reverts to 20% if the federal government reduces New York's TANF grant allocation, or does not permit spending on the EITC to apply toward the TANF maintenance of effort requirement. Legislation enacted in 2000 further increased the EITC to 27. 5% in 2002 and to 30% after 2002. 2006 legislation created an enhanced state EITC for certain noncustodial parents in lieu of the existing state EITC. To qualify, claimants must be state residents, age 18 and over, and have a minor child with whom they do not reside. They must also have made child support payments pursuant to a court order through a state support collection unit for at least half of the tax year. The enhanced credit is equal to the greater of (1) 20% of the federal EITC the taxpayer would otherwise be able to claim for one qualifying child as a custodial parent or (2) 2. 5 times the federal EITC for taxpayers without qualifying children. The enhanced credit is refundable and is available for the 2006 through 2012 tax years.	McKinney's Ann. Laws of NY, Tax Law, Ch. 60, § 606 (d-1)
NORTH CAROLINA	3. 5%	Yes	2007, effective January 1, 2008 (expires after the 2012 tax year)	None	S. L. 2007-323, § 31-4
OKLAHOMA	5%	Yes	2001, effective January 1, 2002	None	Okla. Stats. § 68-2357. 43
OREGON	5%, then 6% in 2008 and after	Yes, starting with 2006	1997	Credit made refundable in 2005, effective January 1, 2006	ORS § 315. 266
RHODE ISLAND	25%	15% refundable	1986	Credit reduced from 27% to 25% as a result of federal tax changes (RI income tax is piggybacked on federal taxable income)	RI Gen Laws Ann. § 44-30-2. 6
VERMONT	32%	Yes	Passed in 1987, effective June 16, 1988	25% increased to 32% in 1999	32 Vt. Stats. Ann. § 5828b
VIRGINIA	20%	No	2004	From 2000 to 2005, VA offered a low-income tax credit of $ 300 each for the taxpayer, spouse, and dependent, if the taxpayer's VA AGI was no more than 100% of poverty. A 2004 omnibus tax reform law gave taxpayers a choice of the low-income tax credit or a credit equal to 20% of federal EITC, starting in the 2006 tax year.	Va. Code § 58. 1-339. 8
WISCONSIN	4% for one child, 14% for two children, 43% for three or more children	Yes	1989	Credit percentages increased	Wis. Stats. § 71. 07(9e)

Sources: Center on Budget and Policy Priorities, National Conference of State Legislatures, National Governor's Association, State EITC Online Resource Center, state statutes.

EARNED INCOME TAX CREDIT PROPOSALS IN CONNECTICUT

Since 1998, 21 bills have been proposed in the Connecticut General Assembly to establish a state EITC. All of the proposals would have established a state credit that was (1) available to those who qualify for and claim the federal credit and (2) a percentage of the federal credit. None of these proposals became law. In 2007, an act that included a 20% refundable state EITC passed the General Assembly but was vetoed by the governor (PA 07-248).

Table I-3 lists each bill introduced in the General Assembly since 1998 that would have established a Connecticut EITC, along with the type of credit, and the final disposition.

TABLE I-3: PROPOSED EITC LEGISLATION IN CONNECTICUT

*Year*	*Bill Number*	*Credit Amount* *(% of Federal EITC)*	*Refundable*	*Final Disposition*
1998	SB 532	10%	Yes	Senate - Passed File 525 w/Senate A House – No action
1999	HB 6161	10%	Yes	Ref. to Finance – No action
	HB 6186	15%	No	Ref. to Finance – No action
	SB 116	Not specified	No	Ref. to Finance – No action
	SB 788	Not specified	Yes	Ref. to Finance – No action
	SB 1173	10%	Yes	Senate - Ref. File 586 to Appropriations Appropriations – No action
2001	HB 6939	10%	Yes	House – Ref. File 383 to Appropriations Appropriations – JF substitute bill deleting EITC provision
2001	SB 1338	10%	Yes	Senate – Move File 728 to Foot of Calendar
2002	HB 5131	20%	No	Ref. to Finance – No action
2002	SB 1338	10%	Yes	Senate – Ref.