Cross-Border Economic Bulletin - February/March 2002
Could a Local Anti-Poverty Program Pay for Itself?

Inflation in San Diego has outstripped income gains, housing prices continue to spiral upwards, and the national recession has made its way into the San Diego economy. There are lots of reasons for pessimism on both sides of the border, particularly declining real incomes at a time when the US tax season is just ahead.
	Jim Gerber

Since April 15 is just around the corner, and given the bleak news about housing affordability and the impact of rising rents on low income residents of San Diego, now is a good time to look at an anti-poverty provision of the federal US tax code—the Earned Income Tax Credit (EITC). The EITC brings well over $250 million of federal money into the San Diego region and puts it directly into the pockets of low income families. Nationally, it lifts more children out of poverty than all other means tested federal programs combined. A closer look at this program might offer some insights into how governments and NGOs could reduce local poverty rates in San Diego.

The key ideas of this issue of the Cross-Border Economic Bulletin are:

• The EITC added over $253 million to the local economy in 1998, the most recent year of published data;

• In 1998, 14.3% of San Diego tax filers claimed an EITC;

• Hispanic workers are less likely to know about the tax credit, particularly non-English speakers;

• A 1% increase in the number of claimants would add over $2.7 million to the budgets of 1,710 low income, local households.

The Earned Income Tax Credit

The EITC began in 1975 as a program to offset Social Security taxes paid by low income parents and to encourage parents to work. Currently, it is the largest cash transfer program for low income parents in the United States. In 1998 it put about $253 million into San Diego’s economy, all of which went to 171,381 low income working families. Adjusted for inflation, that’s equivalent to $275 million in 2002, or nearly $1,600 per household.

The EITC is a system of cash payments to supplement the wages and salaries of working people. In order to qualify, a household must work and have income below a fairly high threshold. Payments rise with increases in income up to the maximum payment, then hold constant over a fairly wide range of income, after which it is gradually phased out with further income gains. Table 1 illustrates the limits for the current tax year.

As stated, the purpose of the EITC is to compensate low income families for Social Security taxes and to increase work effort. Because families without at least one working member do not qualify for the tax credit, it is thought that the program provides an incentive to increase work effort, especially for single parents who might otherwise choose public assistance over a low paying job. Empirical studies cited in Smeedling, Phillips, and O’Connor (2000) confirm this effect, particularly for single mothers. Although most studies were conducted prior to the welfare reform of the mid-1990s, different studies using different methods and data confirm that the EITC was the main driving force behind the increased labor force participation rate of single mothers prior to welfare reform.

A secondary effect appears to be that the phasing out of the tax credit at relatively modest income levels reduces the work effort of married women. This follows from the fact that the elimination of the credit for households earning $28,250 (one child) to $32,120 (two or more children) reduces the monetary value of work for households that already have at least one income.

Who Knows about the EITC?

In order to receive the EITC, a claimant must file a tax return, but they do not have to know about the program. Many low income claimants may use a tax preparation service that automatically files for them, and if the IRS receives a return that appears to qualify but that has not claimed the credit, it notifies the taxpayer that they may be eligible. Nevertheless, research confirms that an undetermined percentage of eligible recipients do not claim the credit.

The demographic characteristics of people who do not know about the credit are fairly predictable: they tend to be less well educated and non-English speaking. What is perhaps surprising, however, is that, regardless of race, Hispanics are less likely to be familiar with the credit than any other ethnicity. Consequently, non-English speaking Hispanics are very likely to lack knowledge about the credit.

Table 2, from Phillips (2001), is based on data taken from the 1999 National Survey of American Families, a representative sample of the noninstitutionalized civilian population under 65, and their families. It shows a wide and statistically significant gap between Hispanics and Non-Hispanics, both in their knowledge and utilization of the program. The figures in Table 2 do not reflect that fact that many families may collect the EITC even if they are unaware of the program, since paid tax preparers often claim it automatically. Even in that case, however, the figures in Table 2 make it impossible to believe that there is no difference between Hispanics and Non-Hispanics in their actual rates of program utilization, or that all eligible recipients of either group are claiming the credit.

Where are the eligible claimants in San Diego County?

While the numbers in Table 2 are based on a national survey, residents of San Diego are probably no different in their general pattern of information and utilization. In other words, eligible claimants in San Diego County who do not take advantage of the credit would tend to be relatively heavily concentrated in low-income Hispanic communities. Table 3 shows the ten cities in the county with the lowest household income. It also shows the number of households and the percent headed by a Hispanic householder.

Would an outreach program pay for itself?

It is worth asking the question if a campaign to sign-up eligible households could cover its own costs through increased sales or other tax collections. The average return to San Diego recipients in 1998 was just below $1,500, or about $1,600 at today’s prices. In 1998 (tax year 1997) 171,381 San Diego residents claimed the EITC. A modest 1% increase in the number of claimants would generate about $2.7 million in federal payments into the San Diego economy. How much of this ends up in increased sales or other local tax payments depends on a number of factors. Cities normally collect 1% of the sales taxes generated in their jurisdiction (0.01 x 2.7 million = 27,000), but not all of the increased income would be spent on taxable items, nor necessarily even in San Diego. Nevertheless, the relevant question is whether or not their is a better use for city and county money than an outreach program to educate families about the tax credit, particularly in jurisdictions that say they are interested in combating poverty.

The Brookings Institution, “Rewarding Work: The Impact of the Earned Income Tax Credit in Greater San Diego.” June, 2001. Available: http://www.brro.edu/es/urban/eitc/sandiego.pdf

Phillips, Katherine Ross, “Who Knows about the Earned Income Tax Credit.” The Urban Institute. Series B, No. B-27. January, 2001. Available: http://newfederalism.urban.org/html/series_b/b27/b27.html

Smeedling, Timothy, Katherine Ross Phillips, and Michael O’Connor, “The EITC: Expectation, Knowledge, Use, and Economic and Social Mobility,” The National Tax Journal. 53(4): 1187-1209. 2000.

The Cross-Border Economic Bulletin is prepared monthly by Dr. Jim Gerber, professor of economics at San Diego State University. It is underwritten by