Legislative Analyst’s Office Presented to: Ryan Woolsey, Fiscal and Policy Analyst CSDA/CWDA Policy Symposium March 4, 2015

 The LAO’s Primary Activities Include: Analysis and recommendations on the Governor’s budget proposals. Oversight of executive branch implementation of the state budget. Special reports on topics of interest to the Legislature. Analysis of statewide ballot initiatives for the Official Voter Information Guide. What Is the LAO? The California Legislature’s Nonpartisan Fiscal and Policy Advisor 1

“The Legislative Analyst shall evaluate the costs, benefits, and trade-offs of various options for establishing a state Earned Income Tax Credit and submit a report with its findings to the Legislature by January 1, 2015…” Recent Report Prepared Pursuant to Legislative Direction 2

 Background on the Federal EITC  State-Level EITCs  Options for a California EITC  Potential Implementation Issues Agenda 3

4 Background on the Federal EITC

 The Federal EITC Was Established in 1975 Initially intended to compensate low-income workers for federal payroll taxes that fund Social Security and Medicare. Was expanded significantly in 1986, 1990, and  The Federal EITC Is Fully Refundable The federal EITC reduces tax liability for eligible filers. Because the federal EITC is fully refundable, if the amount of the credit exceeds the filer’s tax liability, the filer receives the difference in the form of a tax refund.  Primary Goals of the Federal EITC Include: Increase the rewards of paid work. Reduce poverty. History 5

 Federal EITC Was Claimed on Nearly 28 Million Income Tax Returns... Just over 3 million of these were in California. ... For a Value of $64 Billion in Total Credits Roughly $7 billion in federal EITC was received by filers in California. Of this total amount, about 15 percent offset income tax liability, while the remaining 85 percent was disbursed in the form of tax refunds. History Tax Year

Basic Structure of the Federal EITC Credit Amount, Single Filer With Two Dependent Children, 2014 Tax Year 7

Federal EITC Benefit Schedule Credit Amount for Single Filers, 2014 Tax Year 8

 Work Participation Decisions Are Affected by Earnings, Taxes, and Public Assistance As an individual increases work participation, they receive additional earnings, which add to the total resources available to the individual to meet basic needs. As earnings increase, taxes increase, which reduce the individual’s available resources. At the same time, tax credits become available, which can increase available resources. If the individual receives public assistance, these benefits generally phase out as earnings increase. This reduces the individual’s available resources. Conceptually, an individual will make decisions about whether and how much to work based on how these decisions affect the total amount of available resources, an individual will receive, after accounting for earnings, taxes, and public assistance benefits. Federal EITC Affects Work Incentives 9

Employment Opportunity IS NOT Taken… Employment Opportunity IS Taken…Difference Earnings—$900 Income and payroll taxes—-77 Federal additional CTC—98 Federal EITC—360 CalWORKs cash assistance$ CalFresh food assistance Total Available Resources$1,197$2,027$830 Federal EITC Affects Work Incentives For example, if an unemployed single parent with two children that received public assistance was considering an employment opportunity that would pay $900 per month in wages (roughly 20 hours per week at $10 per hour)… 10 CTC = Child Tax Credit and EITC = Earned Income Tax Credit.

 Federal EITC Directly Reduces Poverty by Providing Resources to Low-Income Households We estimate that in 2012, roughly 10 million Californians were in a household that benefitted from the federal EITC. Of these, we estimate that the federal EITC kept roughly 750,000 above the poverty threshold, as defined by the U.S. Census Bureau’s Research Supplemental Poverty Measure (SPM).  Federal EITC Encourages Work Among Single Parents, Slightly Discourages Work Among Second Earners Increased work participation is particularly prominent among relatively low-earning workers and those who have low initial skill levels.  Federal EITC Linked to Improved Child Educational and Health Outcomes Does the Program Work? 11

12 State-Level EITCs

 For the 2014 Tax Year states and the District of Columbia had EITC provisions in their own income tax laws. All but two “piggybacked” on the federal EITC by matching a specified percentage, ranging from 3.5 percent to 40 percent, of the federal EITC. All but four state EITCs were fully refundable. Two states had EITCs in law but that were not in effect. Most State EITCs “Piggyback” on Federal EITC 13

14 Options for a California EITC

 Possible Policy Goals for a State EITC Might Include... Encouraging work. Supplementing resources of working families at specific income levels. Filling in perceived gaps in the federal EITC (such as a relatively low benefit for filers with no dependents). Potentially all of the above. Possible Policy Goals 15

 Key Decision Points in Designing a State EITC Include... Relationship to federal credit—to piggyback or not? Will the credit be refundable or not? What total level of funding (in the form of lost tax revenues) will be dedicated? What specific populations will be targeted? Key Decision Points in Designing a State EITC 16

Option 1: Piggyback on Federal Credit 17 Option 1 would piggyback on the federal EITC and would have a value equal to 15 percent of the federal credit.

 Poverty Reduction Had Option 1 been available in 2012, we estimate that roughly 10 million individuals would have been in households that would have benefitted. Of these, roughly 125,000 would have been moved above the SPM poverty threshold.  Changes to Work Incentives Option 1 would increase incentives both to move from no work, to part- or full-time work and to move from part-time work to full-time work.  Administrative Costs The Franchise Tax Board (FTB) estimates that annual administrative costs for Option 1 would be roughly $20 million.  Revenue Loss Had Option 1 been available in 2012, we estimate that the state’s personal income tax revenues would have been reduced by roughly $1 billion. Option 1: Piggyback on Federal Credit Criteria for Comparison 18

Option 2: Focus on Working Families With Lowest Incomes 19 Option 2 would match the federal EITC for filers with very low incomes (generally less than 70 percent of the federal poverty level) up to a certain level of earnings and then phase out before the earnings level at which the maximum federal EITC is reached.

 Poverty Reduction Had Option 2 been available in 2012, we estimate that roughly 2.7 million individuals would have been in households that would have benefitted. Of these, roughly 45,000 would have been moved above the SPM poverty threshold.  Changes to Work Incentives Option 2 would greatly increase the incentive to move from no work to part-time work, but would reduce incentives to move from part-time to full-time work. Option 2 would not affect incentives to move from no work to full-time work.  Administrative Costs The FTB estimates that annual administrative costs for Option 2 would be roughly $7 million.  Revenue Loss Had Option 2 been available in 2012, we estimate that the state’s personal income tax revenues would have been reduced by roughly $450 million. Option 2: Focus on Working Families With Lowest Incomes Criteria for Comparison 20

Option 3: Supplement Federal Credit for Childless Adults 21 Option 3 would match the amount of the federal EITC for filers with no dependents such that the combined state and federal EITC would be double the federal EITC and the range of earnings over which such filers could claim the state credit would be extended.

 Poverty Reduction Had Option 3 been available in 2012, we estimate that roughly 3.2 million individuals would have been in households that would have benefitted. Of these, roughly 21,000 would have been moved above the SPM poverty threshold.  Changes to Work Incentives Like Option 2, Option 3 would increase the incentive to move from no work to part-time work, but would reduce incentives to move from part-time to full-time work. Option 3 would not affect incentives to move from no work to full-time work.  Administrative Costs The FTB estimates that annual administrative costs for Option 3 would be roughly $14 million.  Revenue Loss Had Option 3 been available in 2012, we estimate that the state’s personal income tax revenues would have been reduced by roughly $400 million. Option 3: Supplement Federal Credit for Childless Adults Criteria for Comparison 22

23 Potential Implementation Issues

 Addressing Issues With Improper Payments The Internal Revenue Service (IRS) estimates that, in 2013, the rate of federal EITC overpayments was between 22 percent and 26 percent. Should the state enact an EITC, it would want to consider strategies to minimize the risk of improper payments in the state EITC.  Considering Outreach to Maximize Take-Up The IRS also estimates that, in 2010, only 71 percent of California tax filers that qualified for the federal EITC claimed it. Should the state enact an EITC, it may wish to consider strategies to promote participation and maximize the effects of both federal and state EITCs. Potential Implementation Issues 24

lao.ca.gov 25

26 Appendix

Federal EITC Affects Work Incentives Changes in Work Incentives: Details For a Single Filer With Two Dependent Children 27

Option 1: Piggyback on Federal Credit Poverty Reduction: Details Poverty Impacts in

Option 1: Piggyback on Federal Credit Changes in Work Incentives: Details For a Single Filer With Two Dependent Children 29

Option 2: Focus on Working Families With Lowest Incomes Poverty Reduction: Details Poverty Impact in

Option 2: Focus on Working Families With Lowest Incomes Changes in Work Incentives: Details For a Single Filer With Two Dependent Children 31

Option 3: Supplement Federal Credit for Childless Adults Poverty Reduction: Details Poverty Impact in

Option 3: Supplement Federal Credit for Childless Adults Changes in Work Incentives: Details For a Single Filer With No Dependent Children 33

Summary of LAO Options 34