As detailed in our May 1999 fiscal brief, Tax Relief for the Working Poor: Proposals for an Earned Income Tax Credit, large numbers of working poor New Yorkers are burdened by city personal income tax liability, even though their incomes are low enough to escape state and federal income taxes. Taxing the income of households struggling to escape poverty strikes many observers as unfair. Moreover, these taxes are likely to be counterproductive, decreasing incentives for labor force participation and making it more difficult to move welfare recipients into the paid workforce. In this issue of Inside the Budget, we provide an update on the status of recent changes in the city and state earned income tax credits (EITC).
New York City EITC. When the budget for city fiscal year 2000 was adopted in June, the Mayor and City Council agreed to establish a refundable EITC against New York City personal income tax liability. However, the state has not passed the enabling legislation needed to enact the credit into law, and there is no indication that it will do so in its special session in December.
The EITC is a form of tax relief for low-income, working households in which the amount of the credit increases as income rises up to a specified level of income. The agreed-to city credit would equal 5 percent of the existing federal EITC. Similar to the existing state and federal EITCs, the city's credit also would be refundable, meaning that if the value of the credit exceeds pre-credit tax liability, the remaining credit would be refunded to the tax filer as a check in a lump-sum after the end of the year. These refunds are expected to account for roughly 80 percent of the EITC's estimated $48 million cost to the city.
A pre-condition of the newly created city EITC is that the state's surplus from the federal Temporary Assistance to Needy Families (TANF) block grant be tapped to pay for the credit refunds that would be given. Federal regulations issued this past spring permit states to pay for refunds issued under state and local EITCs using TANF dollars or, alternatively, to count EITC refunds as part of TANF's "maintenance of effort" requirement for state welfare spending. It is considered unlikely, however, that the state will agree to spend TANF dollars on the city EITC.
New York State EITC. The enacted state budget for fiscal year 1999-2000 includes a phased-in increase in the EITC against the New York State personal income tax, though stipulations about the availability of TANF funds may mean that the increase is temporary.
Under the terms of the enacted budget, the state EITC would rise from the current 20 percent to 22.5 percent of the federal EITC in tax (calendar) year 2000 and to 25 percent in the following year, at an estimated cost of $125 million annually when fully phased in. These terms also provide that the refunds paid due to the EITC enhancement count as TANF maintenance-of-effort spending.
The budget stipulates, however, that if the federal government "materially reduces or eliminates" either the TANF block grant to New York or the state's ability to utilize TANF monies (through either direct or maintenance-of-effort spending), the state EITC would revert to 20 percent of the federal credit. The current TANF block grants to the states are authorized only through 2002, and given the dramatic declines in welfare caseloads that have occurred since the first block grant was set, many observers believe that New York State's TANF grant will be significantly reduced after 2002. While the language of this stipulation is open to interpretation, it could mean that the state EITC increase will be temporary.
For more information about earned income tax credits contact Michael Jacobs, a senior economist at IBO, at (212) 442-0597.