Introduction
The Earned Income Tax Credit (EITC) is a large and critically important anti-poverty program that encourages and rewards work, yet contains one significant flaw – the single, lump sum nature of the payment. This annual disbursement is a challenge for many families, who must reconcile the once-a year payment with their week-to-week needs.
The positive effect of the EITC is lessened by high interest rates incurred by many recipients in the months prior to receiving their refund. Many low-income families are extremely dependent on their tax refund, and the EITC along with other tax credits make up a large portion of their annual income. A single mother with two children who makes $15,000 per year receives over $7,200 from the state and federal EITC each spring. This comprises nearly half her annual wage earnings. Maintaining household spending discipline for the subsequent year is quite difficult, and many households find themselves in a precarious financial position a few months after receiving their tax refund. This challenge is exacerbated by the factthat many low-income workers are employed seasonally, and have to manage through significant periods each year with no wage income.
To address this shortcoming locally, Rochester residents should be given the opportunity (and an incentive) to save a portion of their annual EITC, which would then be disbursed monthly throughout the year. Doing so would transition the EITC from a once-a-year lump sum payment to a type of wage supplement, giving families a steadier stream of income and allowing them to better manage their household finances.
Background on the EITC
The EITC is the largest federal anti-poverty program for families with children, and has traditionally enjoyed strong bipartisan support from both major political parties. The EITC, unlike some other means-tested anti-poverty programs, is designed to continually encourage more work and higher earnings. The credit equals a percentage of earnings until a maximum point, and then gradually phases out as earnings continue to rise. Crucially, the program is structured so that it always makes economic sense for an individual to earn an additional dollar of wage income. The graph below demonstrates how the program works in New York State at various income levels for a single mother with two children.
Unlike certain means-tested anti-poverty programs such as housing choice vouchers or child care subsidies, the EITC does not contain a benefits cliff that (in some circumstances) can create an incentive against higher household earnings. Instead, the EITC manages to simultaneously provide crucial financial support to low-income households and encourage those families to increase their wage earnings. Studies have shown that by increasing the value of low-wage work, the EITC generates higher workforce participation and removes people from the public assistance rolls.
In the City of Rochester alone, over 27,000 tax filers received more than $69 million in federal EITC tax refunds in 2013, with nearly 98% of funds going to tax filers with children. New York State matches 30% of the federal EITC, so the average Rochester family with children that received an EITC payment in 2013 received roughly $4,000 in state and federal refunds from the EITC program. Along with food stamps, the state and federal EITC programs are the most widely used form of government support for low-income families in this community.
The Rochester-Monroe Anti-Poverty Initiative aims to build a new system of social supports to help families move out of poverty and into economic self-sufficiency. The EITC is a powerful tool to support this effort by rewarding work and providing substantial financial resources to low-income households.
Other countries, including England, France, Canada, and Australia, have reformed their versions of the Earned Income Tax Credit in recent years to allow workers to receive the payments on a monthly or quarterly basis. This regular disbursement option has become increasingly popular among low-income workers in those nations.
Within the United States, a consortium of organizations in Chicago, IL recently piloted a form of a year-round EITC, paying out a portion of the anticipated refund on a quarterly basis. The initial evaluation of this year-round EITC yielded a number of promising findings, and was viewed favorably by most program participants.
A Proposal For Rochester
Community organizations and funders in Rochester should establish a program to encourage low-income residents to commit a substantial portion of their tax refund to a savings account. The incentive for enrolling in this program would be a substantial percentage match of any funds committed to the program. The funds in this savings account would be paid out proportionally throughout the year.
Program participants would agree to commit some share of their tax return to a savings account after receiving the funds. The program’s funders would agree to match a significant share (perhaps 25%) of the amount committed. A portion of the EITC funds would be transferred each month to a checking account, and would be supplemented by the funder’s incentive match.
Eligibility determinations and enrollment in this program could be managed by different community based organizations, as many already offer support for tax refunds. Local credit unions or banks could provide the administrative and banking infrastructure for the effort. Anyone with a household income below some level of the poverty line (perhaps 150%) would be eligible to join the program, and could remain in the program until their income exceeded federal EITC eligibility.
A participant would forfeit the match for any funds withdrawn in advance of the original schedule, but would still be eligible to receive the match for any remaining savings account funds. The two examples described below demonstrate how the program would be structured.
Example 1: Assuming a 25% match, a family commits $2,000 of tax return funds to a savings account. Each month, one-twelfth of that total ($166.67) is transferred to a checking account, and is supplemented by $41.67 in incentive funds, for a monthly total of $208.33. The table below details the monthly and annual amounts received by this family. This family has maximized their funding in this program.
| Month | Program Participant | Funder | Total |
|---|---|---|---|
| May | $166.67 | $41.67 | $208.33 |
| June | $166.67 | $41.67 | $208.33 |
| July | $166.67 | $41.67 | $208.33 |
| August | $166.67 | $41.67 | $208.33 |
| September | $166.67 | $41.67 | $208.33 |
| October | $166.67 | $41.67 | $208.33 |
| November | $166.67 | $41.67 | $208.33 |
| December | $166.67 | $41.67 | $208.33 |
| January | $166.67 | $41.67 | $208.33 |
| February | $166.67 | $41.67 | $208.33 |
| March | $166.67 | $41.67 | $208.33 |
| April | $166.67 | $41.67 | $208.33 |
| Total | $2,000 | $500 | $2,500 |
Example 2: Again assuming a 25% funder match, a family commits $2,000 of EITC funds to a savings account. The first 3 months, they withdraw the agreed upon amount, but due to an unexpected household expense in August, they withdraw more than 1/12th of the original deposit. The subsequent monthly withdrawal amounts and matching funds are adjusted downward to account for that additional withdrawal.
| Month | Program Participant | Funder | Total |
|---|---|---|---|
| May | $166.67 | $41.67 | $208.33 |
| June | $166.67 | $41.67 | $208.33 |
| July | $166.67 | $41.67 | $208.33 |
| August | $500.00 | $41.67 | $541.67 |
| September | $125.00 | $31.25 | $156.25 |
| October | $125.00 | $31.25 | $156.25 |
| November | $125.00 | $31.25 | $156.25 |
| December | $125.00 | $31.25 | $156.25 |
| January | $125.00 | $31.25 | $156.25 |
| February | $125.00 | $31.25 | $156.25 |
| March | $125.00 | $31.25 | $156.25 |
| April | $125.00 | $31.25 | $156.25 |
| Total | $2,000 | $417 | $2,417 |
Program Benefits
This proposed program aims to demonstrate the value of shifting the federal and state EITC programs to a monthly basis. The savings match included as an incentive for participating in this program also represents a real tangible benefit for lower income families with limited financial resources, equal to an additional bi-weekly paycheck for a worker earning the minimum wage.
This program would also help connect program participants to mainstream banking services. Over 11,000 households in the 9-county Rochester region were defined as “unbanked” by the FDIC in 2013, meaning that they are completely disconnected from mainstream financial institutions. Another 80,000 households in the region were classified as “underbanked,” representing nearly 17% of all households in our area. These underbanked households have some form of a bank account, but often rely on non-bank financial services like pre-paid debit cards, checking cashing services, pawn shops, and rent-to-own stores.
These alternative financial services typically charge higher service charges and interest rates than mainstream banking services and are accompanied by fewer consumer protections. These services are more heavily relied upon by those who can least afford their fees. This program would encourage these households to become more engaged in the mainstream banking system.
Finally, this program builds upon the existing infrastructure of the federal and state EITC programs, and could be administered by a partnership between community based organizations, a funder and local banks or credit unions. Therefore, the program’s administrative overhead should be quite low, ensuring most of the benefit goes to program participants.
Evaluation
A rigorous evaluation of this proposed program is necessary to determine the intervention’s effectiveness, allow for improvements in the program model, and hopefully demonstrate the case for EITC structural reforms at the state and federal level, The Chicago EITC pilot model mentioned above differs with this proposed approach in several key ways, but the evaluation of that effort provides a helpful example of how to assess the impact of this proposed program .
An external evaluation of that program revealed several promising findings:
- A vast majority of program participants preferred periodic payments to a single tax time payment.
- Participants were three times more likely than a control group to have more disposable income in October than the same time the prior year.
- Most families used the periodic payments to cover pre-existing debt, pay bills, and meet everyday expenses
- Periodic payment recipients were twice as likely to ultimately save a portion of their tax refund.
Members of the control group were twice as likely as the intervention group to report having paid late fees in the prior two months - Control group members were twice as likely to report higher levels of stress regarding their ability to make ends meet compared to the prior year.
An evaluation of this proposed approach in Rochester should also attempt to assess similar outcomes, including expenditure patterns of program participants, the availability of funds throughout the year to cover unanticipated expenses, participant satisfaction, mental health concerns due to financial stress, and savings rates. We would also like to learn whether access to a conventional banking relationship improved financial stewardship and financial literacy. Were participants less likely to employ costly alternative financial services? Did they take advantage of other mainstream banking services like fixed rate mortgages or car loans?
Participants could be interviewed before and after each year of program participation to assess the impact of the program on their well-being. With sufficient funding, an evaluation could also include a control group of households that were willing to participate in this program, but were not chosen to do so (either as the result of insufficient funds to cover demand or to allow for a robust evaluation).
Project Cost
Assuming the average program participant contributes two-thirds of the family’s EITC tax refund, and there is a 25% incentive match for participating in the program, this effort would cost approximately $750 per participant. There would also likely be administrative costs associated with establishing and managing the monthly disbursements, and adjusting the percentage matches if participants withdraw funds ahead of schedule. Finally, while this program could be built upon existing tax preparation efforts like the C.A.S.H. Coalition, there would probably be small expenses associated with advertising the initiative and educating both participants and community providers about the mechanics of the program. An evaluation component, if desired, would add further cost.
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