Half of the states and the District of Columbia have enacted earned income tax credits (EITCs) to supplement the federal EITC, the nation’s most effective tool for reducing poverty among working families and children. The federal EITC lifted 6.2 million people — more than half of them children — out of poverty in 2013 and has lasting benefits for low-income children, helping them do better (and go further) in school and improving their earnings as adults.
State EITCs combat poverty further by reducing state and local taxes for low-income people and helping families keep working despite low wages. Like the federal EITC, a state EITC allows working families to keep more of what they earn and helps them meet basic needs.
Policymakers considering a state-level EITC can estimate its budget cost using a simple three-step process outlined below.
CBPP’s methodology for estimating the cost of a state EITC employs two data sources. First, we use Internal Revenue Service (IRS) statistics on the value of all federal EITC claims filed by residents of each state to determine the state’s share of total U.S. EITC claims. The most recent full-year data, shown in the second column of Table 1, are for claims made for the 2012 tax year.
Second, projections by the congressional Joint Committee on Taxation (JCT) of the future cost of the federal EITC provide a base for estimating the cost of a state EITC. For fiscal year 2016, the JCT estimates that the federal EITC will cost some $71.1 billion.
The federal EITC is refundable, meaning that people whose EITC exceeds their federal tax liability receive the difference as a refund. Most state EITCs are refundable as well. The JCT estimate of the federal EITC’s cost includes both the tax expenditure (non-refundable) and outlay (refundable) portions.
Step 1: Estimate the total value of federal EITC claims in a given state for a future fiscal year.
To estimate the total value of the federal EITC in a state in a future fiscal year, we first use the IRS data on EITC claims to divide the value of EITC claims in a given state by the value of all U.S. EITC claims. This percentage is the share of the federal EITC cost attributable to that state in the base year (2012). Then, to estimate the cost of the federal EITC in the state for a future year, we apply that percentage to JCT’s projected total cost of the federal EITC for the chosen year.
For example, for tax year 2012, Alabama EITC claims were $1.42 billion, or 2.21 percent of the nationwide total. Assuming that Alabama’s share of federal EITC claims remains constant, Alabama’s federal EITC claims in fiscal year 2016 would be 2.21 percent of $71.1 billion, or $1.57 billion, as shown in the fourth column
of Table 1.
Step 2: Multiply the expected value of the state’s federal EITC claims by the percentage at which the state credit is to be set.
Most states’ EITCs provide benefits as a set percentage of the federal credit. This percentage ranges from 3.5 percent to 40 percent, depending on the state. To estimate the cost of a state EITC, multiply the federal EITC cost for the state, as determined in Step 1, by the percentage at which the state EITC is to be set. This calculation yields an estimate of what the state credit would cost in a given fiscal year if everyone who received the federal credit also received the state credit.
Step 3: Adjust the estimate for the fact that not all federal EITC claimants will claim the state credit.
In practice, a substantial portion of those who receive the federal EITC fail to claim state EITCs. This is especially true in the first few years after a state credit is enacted, when awareness of it may be limited. In addition, some eligible families have the IRS compute their federal credit and may not receive a state EITC if the state does not compute the state credit amount for them. For these and other reasons, the cost of a refundable state EITC in its initial years will likely be lower than the full cost of the federal credit multiplied by the state percentage. To account for this, the cost estimate should be reduced by at least 10 percent.
The estimated fiscal year 2016 costs to states of implementing a refundable EITC for tax year 2015 set at 5, 10, or 20 percent of the federal credit are shown in the last three columns of Table 1. Other percentages may be calculated based on those numbers; for instance, a 15 percent credit would cost one-and-a-half times as much as a 10 percent credit. The methodology outlined above may be used for other years using the projections of federal costs presented in Table 1.
None of these figures includes the costs of changing tax forms to include a space to claim an EITC or the costs of processing and administering EITC claims; these would likely raise the overall cost of the credit by less than 1 percent. The estimates presented here apply only to credits that are refundable and are set at a flat percentage of the federal EITC.
Further information on these estimates, as well as methods of estimating the costs of non-refundable credits and different credit structures, may be obtained from the staff of CBPP’s State Fiscal Project. Information on the policy implications of state EITCs may be obtained by reviewing the CBPP publication, A Hand Up: How State Earned Income Tax Credits Help Working Families Escape Poverty . available on our website.