What is the Earned Income Tax Credit?
The Earned Income Tax Credit (EITC) is a federal credit available to families with low and moderate incomes. The credit helps workers pay for things like transportation costs or child care and other daily necessities, and because the credit is refundable (meaning you get cash back, not just a reduction in the taxes you owe), money is put back into local economies. Michigan supplements the federal credit with its own state credit, but it’s one of the weakest state EITCs nationwide. It once was 20% of the federal credit, but is now just 6%. In tax year 2018, more than 729,600 families statewide received an average state credit of $150, putting $110 million back into the local economy.
The EITC is a proven anti-poverty tool that rewards work and helps workers take steps toward self-sufficiency. It helps workers in every area of the state: rural and urban, and in a variety of industries. Research shows that the EITC has a long-lasting, positive effect on children, immediately improving their well-being but also helping them do better and go farther in school and to have higher earnings in adulthood.
Improvements on the EITC for the realities of the COVID-19 Pandemic – The “lookback” provision
In December 2020, the federal government passed a comprehensive COVID-19 relief bill that included what is known as the EITC lookback provision. This provision allows tax filers who were eligible to claim the federal EITC for 2019 to make a choice of whether to use their 2019 earned income or their 2020 earned income to calculate their EITC and/or Child Tax Credit. Earned income consists of wage and self-employment income as well as some relatively uncommon sources. What this means for a taxpayer’s bottom line is that if their income declined in 2020 in such a way that the amount of EITC they could claim is reduced, then that taxpayer will be able to claim the higher credit from 2019. This is intended to limit COVID-19’s impact on a filer’s EITC, regardless of the pandemic’s impact on their income.
In practice, the filer or preparer will enter both 2019 and 2020 earned income into their worksheet or chosen tax software. If the resulting 2019 earned income is greater than the 2020 earned income, then the filer or preparer may choose to use that prior year earned income amount to calculate the EITC.
The amount of the EITC is based on a person’s income and the number of kids they have, so the decision of whether or not to take advantage of the EITC lookback will be based on each taxpayer. For example, if a parent with one child earned $30,000 in 2019 and $10,000 in 2020, then they would get a higher credit by using their 2020 earned income. If a parent with one child earned $15,000 in 2019 and $5,000 in 2020, then the lookback would provide the family with a higher credit.
For those taxpayers that make less than $57,000 a year, Michiganders can take advantage of the Internal Revenue Service’s Volunteer Income Tax Assistance (VITA) program to help prepare their taxes. This free resource is particularly useful for families who are eligible for the Earned Income Tax Credit or Child Tax Credit.
State policy can improve outcomes through the Michigan Earned Income Tax Credit
The lookback provision is a helpful way to strengthen the federal EITC’s impact during COVID times, but there are also opportunities to better support EITC-eligible workers and families at the state level. To maximize its benefit, the Michigan EITC should be restored to 20% of the federal credit, where it was before being cut to 6% in 2011. In 2011, the last year that the state EITC was calculated at 20% of the federal EITC, the credit put an average of $446 back into workers’ pockets and into Michigan’s economy. At this higher rate, the state EITC pulled 22,000 households above the poverty line. If the Earned Income Tax Credit were expanded back to 20%, then the average return to taxpayers in 2018 would have been $366 million, or an average of $500 per taxpayer, as compared to the $110 million and $150 per taxpayer that was distributed in 2018. Increasing the state Earned Income Tax Credit is critical to ensuring that working families earn enough to support themselves.
The state EITC should also be expanded to students, caregivers, all immigrant workers and workers not raising children in their homes. The state credit currently provides little to no help to these taxpayers, and they are groups of taxpayers taxed into—or deeper into—poverty by our tax system. These changes will ensure that the Earned Income Tax Credit is distributed more equitably to Michigan’s many working individuals and families that could use a boost to their incomes to ensure that they are financially stable.
Finally, families who are eligible for the credit should be informed of their eligibility and be able to file for the credit seamlessly. Studies show that nearly 1 in 5 eligible Michigan workers do not claim the EITC. Well-funded and concerted outreach efforts as well as methods such as automatic filing will ensure that each eligible family receives their maximum credit.
As COVID-19 has impacted our workers and economies in a variety of ways, we need to look at a variety of policy changes to help them. That includes looking at our state and federal tax policy. As they already have with the lookback provision, our state and federal government can build on the EITC’s established positive impact on workers and families with lower incomes. The EITC can and should be used to do even more to offset the impact of COVID and other economic challenges on certain workers.