When the Iowa legislature was considering a big boost in the state earned income tax credit, I pointed out how the credit phase-out punishes additional income. The phase out works like a special high tax bracket on low-to-moderate income increases. Today a New York Times opinion piece (via the TaxProf) makes the same point:
The earned-income tax credit is often said to encourage work, but it may do just the opposite.
The chart below shows the credit’s schedules for the 2011 tax year as a function of annual earned income for a given family situation (other family situations have the same basic shape). The schedule shown illustrates the mountain-plateau pattern described above: an increasing portion for the lowest incomes, a flat portion, a decreasing portion and then finally a flat portion of zero.
So while the credit encourages work until the maximum credit is achieved — under these facts, at $9,100 — it actively punishes increases in income from $21,770 to $41,132. It’s the same point I made with this chart about the proposed increase in the Iowa EITC from 7% of the federal credit to 15% in one of the failed compromises to achieve property tax reform:
The EITC is credited with reducing abject poverty by its advocates. Unfortunately, the phaseout punishes attempts to move to middle income status, locking people into relatively low income lives. It’s an unintended consequence that EITC advocates never seem to address.