Politics & Policy

Where Tax Credit Is Due

Republicans are in a mess of their own making.

Republicans are having a hard time getting traction on the idea that it is wrong to increase refundable child tax credits to families with no income-tax liability. It’s not a question of being stingy; many are genuinely concerned about the growth of a non-taxpaying class that potentially can vote subsidies for itself under the guise of tax reduction. In practice, however, this is less of a problem than it appears.

In truth, Republicans have no one but themselves to blame for the mess they have gotten into. It was they who invented the first refundable tax credit, the Earned Income Tax Credit (EITC), back in the 1970s. And it was Republicans who invented the child credit in the 1990s. Both were bad ideas that have come back to haunt them.

The EITC has a sterling Republican heritage. It was first instituted in the 1920s by a Republican Congress at the instigation of Treasury Secretary Andrew Mellon. Repealed in 1943, Republican President Gerald Ford revived it in 1975. In part, Ford was responding to the argument for a negative income tax that had been advanced by free-market economist Milton Friedman.

#ad#Advocates of the EITC in the 1970s made two principal arguments. First, rising payroll taxes meant that many low-income workers now paid more of these taxes than they paid in income taxes. But it was impractical to cut their payroll taxes because there was a strong tradition of having a single tax rate that every worker paid on the first dollar of earnings. Supporters of Social Security viewed this as essential to the structure of the system, so that workers would view the money withheld as a “contribution” rather than a tax. Moreover, Social Security’s finances were precarious in 1975, having required a big tax increase just two years earlier.

Second, EITC supporters argued that because the credit would be available only to those with earned income, it would reinforce work incentives and help get people off welfare. By making the credit refundable, it would offset the disincentive effects of higher payroll tax rates, which had risen from 4.8 percent on workers and employers in 1970 to 5.85 percent in 1975. The legislative history makes clear that Congress and the White House both viewed the EITC as a de facto payroll-tax cut, not a welfare program.

In the 1980s, Ronald Reagan supported a big increase in the EITC rate from 10 percent to 14 percent. In 1990, George H.W. Bush supported a further increase. But it was not until Bill Clinton’s administration that the EITC really became an all-purpose welfare program. As a result, spending shot up. The refunded portion of the credit, which is scored as direct spending in the budget, rose from $10 billion in 1992 to $26 billion in 2000. Even before welfare reform significantly reduced outlays for Aid to Families With Dependant Children, the federal government’s principal welfare program, the refunded portion of the EITC was greater. Now it is two and a half times greater.

Despite the exploding cost of the EITC, Republicans in Congress created another tax credit in the 1997 tax bill. The child credit was intended to make it easier for mothers to stay at home and raise their children, rather than work outside the home. Although not refundable at first, it was in effect refundable for many because it increased their EITC payments. In 2001, the child credit was made explicitly refundable. Shortly, Congress will likely increase its refundability still more.

As a result of the EITC, the child credit and other tax cuts, the percentage of those with no income-tax liability has risen to 30 percent of all tax filers, according to the Tax Foundation. The combination of EITC and the child credit offsets 100 percent of the income-tax liability for almost all families with incomes below $30,000. And because of refundability, 100 percent of the payroll tax is also offset for those with incomes below $20,000. Those with earnings below $10,000 pay no income taxes and get a check from the government for 2.6 times their payroll-tax liability.

Some now worry that having so many citizens free of taxation is a threat to democracy. In principle, there is nothing to stop them from voting themselves larger and larger benefits at the expense of the taxpaying class. Offsetting this possibility, however, is the fact that those with low incomes vote in low percentages, while those with high incomes vote in high percentages. Thus, in practice, the electoral clout of the taxpaying class has tended to rise as it bears more and more of the total tax burden. That is why Republicans control Congress and the White House despite the growth of nontaxpayers.

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