Expanding Iowa’s Earned Income Tax Credit

IFP Backgrounder
Helping to Fill Gap between Income and Basic Needs for Working Families

Policy Brief (2-pg PDF) April 5, 2013

The Iowa General Assembly is once again considering expanding Iowa’s meager Earned Income Tax Credit (EITC). The Cedar Rapids Gazette editorial board recently had this to say about these efforts: “A state that hands out tens of millions of dollars in tax breaks to large firms in the name of job creation should be able to afford providing a justifiably bigger break to Iowans already on the job. The earned income tax credit expansion is an endorsement of work over dependency, a pushback against a growing tide of child poverty, an economic shot in the arm for local business and tax relief for families that need it most.”[1]

Just how much working families do need a boost from the EITC can be seen in light of the actual costs of raising a family in Iowa. Working full time, year round, even at the median wage of about $15 an hour ($31,200, less $2,387 in payroll taxes), is not enough for families with children to cover the costs of food, rent, child care, transportation, and other essentials even on a very basic, no-frills budget. We estimated such basic household budgets for Iowa families of various sizes in our 2012 report, The Cost of Living in Iowa.[2] The results for two family types are shown in the table below. A single parent working full time with a small child would need about $32,300 to meet basic expenses, while a married couple, two-earner family with two children would need over $50,000.

Table — Basic Household Budgets in Iowa, 2011Half the jobs in Iowa pay less than the $32,300 needed by the single parent in Table 1. Many jobs pay minimum wage, which means about $15,000 per year if she works full time. At that income level, the federal and state EITC, along with other refundable credits (Iowa’s child and dependent care credit and the federal additional child tax credit), will raise her after-tax income $4,100 closer to the basic needs budget line, filling about a quarter of the gap between basic needs and disposable income. These credits continue to boost after-tax income as she earns a higher and higher wage but they are reduced as income increases. An increase in the state EITC from 7 percent to 20 percent of the federal would not get this family to the basic needs level, but it will help to undo some of this problem of family income adequacy. This change in the law means an additional $400 for the single parent working minimum wage.

A similar picture emerges for the two-parent family with two children (one under age 6, the other age 6 to 18). With two people earning minimum wage and working full time, the family has $30,200 in total annual earnings, but $1,700 in payroll taxes and $500 in Iowa income tax subtracts from this income. The fact that low-income families do not pay federal income tax at this income level while the state requires taxes demonstrates the lack of recognition for the costs of raising a family under the Iowa income tax. Also it needs to be noted that these working families are taxpayers: In addition to payroll taxes, they pay sales taxes and gas taxes and property taxes, included in cost of household expenses, rent and transportation in our cost of living figures. The refundable credits (state and federal) are sufficient to offset payroll and income taxes and provide an additional $3,780 toward filling the gap between basic needs and disposable income (Figure 1). An increase in the state EITC to 20 percent would add $430 to this amount. The family would still be $15,900 short of the $50,300 in disposable income needed to meet basic needs.

Increasing the Iowa EITC to 20 percent of the federal, from its current 7 percent, would not undo the shortfall minimum-wage families face in getting to a no-frills budget level, but it would help fill the basic-needs gap for over 200,000 Iowa households, including 37 percent of Iowa children.[3] In fact, a strong case can be made for increasing the credit to 30 percent, which would align the EITC with the Iowa income tax overall, which on average is about 30 percent of the federal. Such an increase would also help offset the Iowa tax system’s poor treatment of families, with a personal credit of just $40 per child compared to the $3,800 federal personal exemption.

[1] The Gazette, Cedar Rapids. Editorial: “More to spend: Raise tax credit to help working families, boost economy.” Sunday, March 31, 2013.
[2] Lily French, Peter Fisher and Noga O’Connor. The Cost of Living in Iowa, 2011. The Iowa Policy Project. May 2012.
[3] Iowa Department of Revenue. Iowa’s Earned Income Tax Credit Tax Credits Program Evaluation Study, revised February 2012.
[4] Charles Bruner. Resolving Inequities in Iowa Taxes. Iowa Fiscal Partnership. February 2012.