Top Things to Know About a State EITC for California

As policymakers grapple with how to ensure economic security for the 5.6 million Californians living in poverty, one option needs to be part of the discussion: a state Earned Income Tax Credit (EITC). A state EITC could give millions of Californians a much-needed economic boost by building on the successful federal EITC, a tax credit that has been instrumental in lifting families out of poverty and helping them make ends meet.

How would a state EITC work in California? And what should policymakers consider when designing one? Last week, we released a report answering these questions. Here are some of the most important things to know about a state EITC:

• To be effective, a state EITC must be refundable. While Californians pay a variety of state and local taxes — and low-income households on average pay a larger share of their income on taxes than do higher-income households — many low-income households do not pay income tax because of its graduated structure. If a tax credit is refundable, then a taxpayer receives the credit even if they do not owe any income tax. This is key if policymakers want a state EITC to reach those who would most benefit from it. A refundable state EITC would reach about one in five California families, while a nonrefundable state EITC would reach less than 0.5 percent of California families.
• A state EITC is typically set as a percentage of the federal credit. Generally, a state EITC is directly based off the federal EITC and will simply “add on” to what the federal credit provides. (For additional detail on how the federal EITC works, see this useful summary.) This means that the main features of a state EITC — who is eligible for a credit and how the size of the credit varies for different types of households — are already established. If California were to pursue this path, one of the most important decisions is at what percentage of the federal EITC to set the California credit. The higher this percentage, the larger the credit to families. For example, a refundable, 15 percent state credit would provide, on average, a $321 tax credit to families in the bottom fifth of the income distribution, while a 30 percent credit would provide an average tax credit worth $638 to these families.
• A state EITC structured as a simple add-on to the federal credit would primarily benefit families with children. Under this model, a larger share of families with children than without children would receive a credit, and the credit would be, on average, substantially larger for families with children. For example, if California had a refundable state EITC that was 15 percent of the federal credit, a little more than one-third of families with at least one child (36 percent) would receive a credit, compared to just 7 percent of households without children (see table). Moreover, the average credit for families with at least one child would be $481, compared to just $61 for childless adults.

As our report outlines, there are plenty of reasons to pass a state EITC. Not only would it give more than 3 million households additional economic support, it would also help rebalance California’s tax system, which currently asks the lowest-income households to pay the largest share of their income in taxes. Further, a state EITC would help strengthen California’s safety net. It’s a smart approach to the crisis of poverty in California. In the coming weeks, additional posts on this blog will look in depth at different aspects of a state EITC.

— Luke Reidenbach

Many Californians Struggle to Make Ends Meet Despite a Growing Economy

The economic recovery has continued to largely bypass low- and middle-income Californians, according to new Census data released last month. These latest Census figures show that California households in the bottom three-fifths of the income distribution saw their incomes essentially stagnate last year, even though the economy had been expanding for four straight years in California and nationally. The absence of any significant income gains is especially bad news given that these households suffered steep declines in their incomes in each of the prior five years.

California households in the bottom fifth, whose incomes fall below about $23,600, fared the worst in recent years. Their average inflation-adjusted income dropped by about 19 percent between 2007 and 2012, then flat-lined in 2013. This means that the lowest-income state residents have yet to gain back any of the nearly $3,000 they lost, on average, due to the weak job market during and in the aftermath of the Great Recession. While sobering, this trend is not entirely surprising given that hourly wages stagnated or declined for low-earning workers throughout the recovery.

High-income Californians also saw their incomes fall in recent years, but unlike state residents at the low end of the distribution, they regained in the last year much of what they had lost in prior years. The average inflation-adjusted income for households in the top fifth dropped by about 8 percent ($18,200) between 2007 and 2012, but then rose by about 4 percent ($9,500) in 2013. This means that in a single year the highest-income households — whose incomes averaged $224,000 — regained more than half of the income they lost, on average. The top 5 percent of California households — whose incomes averaged $399,000 — fared even better: Last year alone, they regained nearly two-thirds of the income they lost during the prior five years.

 

The Uneven Economic Recovery Is Exacerbating Inequality in California

As the benefits of recent years’ economic growth largely accrue to Californians at the top of the distribution, income gaps are widening, exacerbating already high levels of inequality in the state. Last year, the average household in the top 5 percent had an income of $399,000 — 31 times the income of the average household in the bottom fifth ($12,700). Just six years earlier, at the height of the housing boom, the average household in the top 5 percent earned 26 times as much as the average household in the bottom fifth. This widening divide means that nearly one-quarter of total household income now goes to the wealthiest 5 percent of Californians, while less than 3 percent goes to the bottom fifth. And as striking as these figures are, they actually understate the extent of inequality in California. This is because they exclude one of the most significant sources of income for the wealthy — capital gains — and also because the Census does not report income changes for most millionaires.

Rising Inequality Isn’t Just Bad for Low- and Middle-Income Families, It’s Bad for the Economy

Should we be concerned that our nation’s economic rebound isn’t translating into income gains for a broad swath of the population? Certainly if you’re among the majority of families who have yet to see their incomes rise after years of decline, you have good reason to be concerned. As one recent New York Times analysis put it: “You can’t eat G.D.P. You can’t live in a rising stock market. You can’t give your kids a better life because your company’s C.E.O. was able to give himself a big raise.” In other words, without broadly shared income growth, an expanding economy can do little to help most families be economically secure or move up the economic ladder.

But there’s another reason we should be worried about uneven income gains. Recent reports, including one by Standard and Poor’s (S&P) Financial Services, have suggested that income inequality could be holding back our nation’s economic growth. One explanation could be that when many people’s incomes don’t keep up with their expenses, they often spend less. And when large numbers of people spend less, businesses produce less. The end result: an economy that grows more slowly than it otherwise would if fewer families were struggling to pay their bills.

Policymakers Can Reduce Inequality in California

But now for some good news: Inequality is not inevitable. As Nobel Prize-winning economist Joseph Stiglitz recently wrote, “widening and deepening inequality is not driven by immutable economic laws, but by laws we have written ourselves.” That means policymakers have the tools to reduce our growing income divide and mitigate the hardship it inflicts on low- and middle-income families. One way state policymakers could do this is by making investments to ensure that all children have sufficient opportunities to move up the economic ladder. Increasing access to high-quality education, from preschool through college, for example, would set low-income children on a path toward greater economic security in the future. State policymakers could also take steps to make California’s income tax system more progressive. Creating a state Earned Income Tax Credit (EITC), for instance, would not only help workers with low to moderate earnings better support their families, but it also would reduce after-tax income gaps. To learn more about how California could reduce inequality by establishing a state EITC, watch for our forthcoming publication on the topic.

— Alissa Anderson

CBP Infographic: Poverty Is a Problem We Can Address

Census Bureau data released yesterday show that poverty in California remains high. Our brief report on the new Census data shows that the share of all Californians with incomes below the federal poverty line in 2013 remained significantly higher than in 2006, the year before the Great Recession began. More than 5.6 million Californians — over one in seven — had incomes below the poverty line in 2013.

What’s more, nearly 2 million California children were living in poverty in 2013. Although the state’s child poverty rate — 20.3 percent — is down significantly from that in 2011 (24.3 percent), children still account for a disproportionate share of Californians living in poverty.

This CBP infographic (below) highlights the new top-level poverty data from the Census and shows why state policies that boost workers’ earnings can play a major role in reducing poverty and fostering greater economic opportunity across our state. A full-size (PDF) of this infographic is available here.

— Steven Bliss

How Should California Spend Nearly $2 Billion?

The state of California is poised to direct an estimated $1.8 billion over the next four years to new and expanded tax breaks for specific industries and businesses based on actions recently taken by state lawmakers, or actions pending and likely to be approved by state lawmakers in the coming days. These include:

• Nearly $420 million in tax breaks for aerospace companies — specifically targeted to Lockheed Martin and Northrop Grumman — that are competing to build the next generation of stealth bombers, an incentive package approved by the state Legislature and signed into law by Governor Brown earlier this month;
• Expansion of a state tax credit for film and TV production — from $100 million to $400 million annually — that is currently working its way through the Legislature; and
• Efforts to lure Tesla Motors to build a new “gigafactory” in California, which are likely to include tax credits to help meet Tesla’s demands that state and local governments help pay for 10 percent (estimated at $500 million) of the cost of construction. The legislation, expected to emerge in the coming days, is also likely to exempt Tesla from some environmental (CEQA) requirements.

All told, these actions stand to commit the state to nearly $2 billion over the next four years in targeted tax breaks for business and industry.

We think that California would benefit more from investing this money in vital public systems and services. While we don’t question that state leaders should place a high priority on boosting employment and expanding opportunity, we do question whether these new and expanded credits and incentives are the best strategy for meeting those objectives. Consider just a few alternatives for the state’s $2 billion:

• Phasing in a refundable state Earned Income Tax Credit (EITC) to further leverage the federal EITC, which would boost the incomes of working families most in need of assistance, raising thousands Californians out of poverty each year;
• Continuing to restore the 110,000 subsidized child care and preschool slots (nearly one-quarter of the total) cut since 2007-08 that help working parents find and keep jobs and build a foundation for children’s success; and
• Making a down payment on reinvesting in the economic engines that are the state’s higher education systems, for which state General Fund spending per student has declined significantly over the last three decades.

All of these alternatives, among others, are proven winners at helping working families to prosper, while the evidence on targeted tax breaks for businesses is mixed at best.

As state leaders clamor to give away tax credits to high-profile businesses and projects, we should all be asking the question “How should California spend nearly $2 billion?”

— Chris Hoene

Stanford’s “Pathways” Magazine Echoes Our Report’s Key Findings on Poverty

The latest issue of Stanford University’s Pathways, a magazine featuring articles about poverty, inequality, and social policy, perfectly echoes a number of the key messages in our recent report, Five Facts Everyone Should Know About Poverty.

An article by Marianne Page, deputy director of the Center for Poverty Research at UC Davis, for example, calls into question the “common mantra [that] the only enduring solutions to poverty are economic growth and the jobs it delivers.” Page shows that economic expansions reduce poverty less than they did in the past partly because a growing share of the new jobs pay low wages. Similarly, our Five Facts report shows that poverty in California is more often due to low-wage work than to a lack of employment. Like Page, we argue that reducing poverty will take policies that boost workers’ earnings, such as continuing to increase the state’s minimum wage and establishing a state Earned Income Tax Credit (EITC).

Hilary Hoynes, professor of public policy and economics at UC Berkeley, demonstrates the resounding success of the federal EITC in another Pathways article, suggesting that it “may ultimately be judged one of the most successful labor market innovations in U.S. history.” Hoynes writes:

The effects of EITC extend well beyond simple income support and poverty reduction. … It leads to various improvements in the mental and physical health of mothers. It brings about a reduction in low birth weight among infants. And it improves the performance of children on cognitive tests. This burgeoning body of work suggests, then, that income support programs have benefits that extend well beyond an increase in cash flow for families in poverty.

With evidence like that, it’s no wonder that half of all states have created their own EITCs to further leverage the benefits of the federal credit. And it’s why California should do the same. Poverty is a problem state policymakers can address if they choose to prioritize investments in proven strategies.

— Alissa Anderson