The EITC is primarily a spending program. As noted, 88 percent of the benefits—$60 billion a year— are payments to people who owe no income tax. While the recipients gain from this largess, every dollar of that gain is a dollar of direct loss for other people who pay the taxes to support the program. There is an indirect loss as well. The process of extracting taxes damages the economy because it causes people to reduce their productive activities, such as working and investing. The harm from the behavioral responses to higher taxes is called “deadweight losses.”
For the federal income tax, studies have found, on average, that the deadweight loss of raising taxes by a dollar is roughly 30 to 50 cents. Based on his pioneering work, Harvard University’s Martin Feldstein thinks that the loss may be higher, perhaps exceeding “one dollar per dollar of revenue raised, making the cost of incremental governmental spending more than two dollars for each dollar of government spending.”
But other estimates are lower than Feldstein’s. Suppose that Congress expands EITC spending by $10 billion a year. Does this expansion make any economic sense? The benefits would have to be higher than the total cost of about $15 billion, which includes the $10 billion direct cost to taxpayers plu s another $5 billion or so in dead weight losses. EITC proponents do not seem to consider the high costs. American Enterprise Institute scholar Michael Strain cheerleads for the EITC, saying it “channels social resources to meet a social goal.”
The problem is that there is no such thing as “social resources” in the sense of a free pool of community money. All $60 billion of annual refundable EITC payments must be extracted from taxpayers at a loss of about $90 billion, including the dead weight losses from higher taxes. Jobs are destroyed by that extraction and many investments are not made. Analysts and reporters often point to the anti-poverty benefits of the EITC, claiming things such as the credit “pulled 6.5 million people out of poverty.” But that is a meaningless statistic. If the government gives low-income individuals $60 billion, of course they will have more money in their pockets, and fewer of them will be below a measured poverty line.
But why not double or triple EITC benefits and try to pull even more people out of poverty?
The answer is that we need to worry about the costs of federal programs, which are the harms done to other citizens and the broader economy. Expanding the EITC would create more fraud, higher administration costs, and added disincentives to increase hours worked in the phase-out range. Furthermore, expanding the EITC—or any other federal spending program—would ultimately mean higher taxes, and thus more tax distortions and higher deadweight losses. Indeed, the deadweight losses from higher taxes rise more than proportionally as tax rates rise, which means that additional federal spending is more economically damaging than existing spending.
Conservative supporters of the EITC often talk as if the credit is one welfare program that actually works. But they seem to be looking only at the benefits, and not the costs. One conservative writer, for example, says that expanding the EITC would be much better than raising the minimum wage because “it poses no threat of destroying
But this ignores that extracting taxes from them economy to pay for the EITC certainly does destroy jobs.
The EITC was designed to counter the anti-work effects of welfare programs and
the federal payroll tax. But as we have seen, the EITC creates a range of problems of its own, including errors and fraud, disincentives to increase earnings in the phase-out range, and deadweight losses caused by extracting taxes to pay for it. The EITC should not be expanded. Indeed, the best long-term solution would be t o end the EITC, while also cutting other welfare programs and the payroll tax. At the same time, policymakers should pursue policies to boost wages and increase job growth. For example, cutting the corporate income tax rate would boost business capital investment. That would generate higher demand for labor, and thus raise wages and create more opportunities for
American workers over time. In sum, we do not think that the argument for the EITC is very convincing. The credit creates a modest increase in workforce participation by single mothers, but that benefit is outweighed by the work disincentives during the phase-out range, billions of dollars of errors and fraud, substantial paperwork costs, and the damage caused by the higher taxes needed to fund the program.
Veronique de Rugy, Mercatus Center