By Andy Nielsen
In a legislative session dominated by the biennial budget and pandemic response, Indiana lawmakers took an important step to strengthen our state’s social safety net for many Hoosiers across the state. House Enrolled Act 1009 increased the state’s Earned Income Tax Credit (EITC) from nine percent to ten percent of a taxpayer’s federal EITC, which had been largely untouched since 2011. Many thanks to our lawmakers for recognizing the effectiveness of this tried and true tool to help combat poverty in Indiana.
The federal EITC was created in 1975 as a tool to incentivize work, boost earnings, and combat poverty. Eligibility and the amount of the credit are a function of a taxpayer’s earned income, filing status, and the number and age of children claimed on the tax return. Simply put: the more you (and/or your spouse) work, the higher the credit, and once you earn a certain amount, the credit begins to phase out. Have kids? Then you may receive a larger credit.
The federal credit phases out at a higher income for married couples filing jointly compared to individuals filing single or head of household. However, the maximum credit is determined by the number of children (under age 19 or 24 if full-time student and must have a valid SSN) claimed on the return and whether or not the filer is single or married. The table below illustrates these differences. Income ranges provide the minimum earned income to receive any EITC and the maximum amount where credit is zero (completely phased out).
The federal EITC has been extremely effective at combating poverty and is quite popular. In 2018, the credit lifted approximately 5.6 million people out of poverty – including about three million children. Data from the Internal Revenue Service (IRS) for tax year 2019 demonstrates the credit’s popularity with about 25 million individuals and families nationwide receiving an average EITC of around $2,461, including 515,000 Hoosiers with an average credit of $2,424. Unfortunately, only 78% of eligible taxpayers (79.8% in Indiana) claimed the federal tax credit in 2017. To put this in perspective, nearly 135,000 additional Hoosiers were eligible but did not claim the credit – that’s over $324 million gone unclaimed.
One of the more important features of the credit is that it is fully refundable, meaning the "unused" portion of the credit is recouped through a refund at tax time. A quick refresher on tax credits. Unlike tax deductions that lower taxable income, tax credits offset tax liability dollar-for-dollar. Say you owe $2,000 in taxes and have a $2,400 credit. If the credit is refundable, your tax liability is reduced to $0 and you receive the remaining $400 of the credit as a refund on your return. If the credit is non-refundable, the remaining $400 is left on the table. Refundability ensures the credit is fully realized by low-income taxpayers who may reduce their tax liability to zero through other credits or deductions.
In 1999, Indiana followed the federal government’s lead by creating its own EITC. While the credit was modified several times and remains decoupled (stay tuned for future blog post) from its federal counterpart, the state credit is still an important tool for Hoosiers. Like the federal EITC, Indiana’s credit is fully refundable, making it among the most effective and targeted tax reduction strategies to help offset regressive state taxes. According to an analysis provided by the Institute on Taxation and Economic Policy (ITEP), recent changes (effective tax year 2022) made to Indiana’s EITC in the 2021 Legislative Session will provide a tax cut to 13 percent of Hoosiers (see table below). Again, this is an important change and a moment to celebrate the legislature’s efforts towards a stronger social safety net, but we need to keep up the momentum.
Looking ahead, Indiana needs to focus even further on using the tax code to strengthen Hoosier households and families. Given the substantial changes made to the federal EITC, Indiana lawmakers should create parity between the federal and state credits, which would be a critical step towards further improving the livelihoods of our most vulnerable fellow Hoosiers.