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Last summer a woman came to a free tax-assistance clinic for low-income individuals. She had already filed her federal and state income taxes but needed assistance with her Minnesota property tax rebate.
In completing the property tax return, the grandmother mentioned caring for her 8-year-old granddaughter. The tax volunteer asked some further questions and then told the grandmother some good news: She qualified to claim the child as a dependent and for the federal Earned Income Tax Credit (EITC) and Minnesota's state earned income tax credit (the Working Family Credit, or WFC). Rather than owing several hundred dollars in income taxes, this grandmother, who earned less than $18,000 in 2002 but cared for her granddaughter, was eligible for more than $2,200 in income and property tax refunds.
"Why didn't you claim her on your income taxes?" the volunteer asked.
"I don't know. The guy who prepared my taxes didn't ask, and I didn't think I could claim her. She moved in and out a couple of times while my daughter tried to get on her feet," was the response.
As the above true story illustrates, the impact of the EITC and other refundable tax credits can be enormous for low- to moderate-income working families. They use these tax benefits to lift themselves out of poverty, provide for their children and begin to develop financial assets.
Their testimonials provide complementary evidence to Ronald Wirtz's piece "Anti-Poverty Design: The Cash-Out Option" (June 2003 Region magazine, published by the Minneapolis Fed). Wirtz praises the EITC as an anti-poverty program that rewards work while claiming "high participation, good targeting to low-income families, low bureaucracy and unique flexibility when it comes to how resources are actually used by recipients."
The little policy engine that could
From a policy design standpoint, the EITC offers both relative simplicity and efficacy, particularly compared with other anti-poverty efforts: Low-income workers—and workers only—get a sizable, supplemental check come tax time.
The sum of the EITC and Minnesota's WFC can potentially add almost 50 percent of income to a family's earnings. For example, a single parent of two earning minimum wage working full time in 2003 earned only $10,712 but is eligible for $5,256 from just the EITC and WFC. The average combined refund for working Minnesotans from these tax credits was $2,000 in 2003.
The importance of the EITC as a local economic development tool should also not be underappreciated. Last year, Minnesotans claimed more than $310 million in federal funds.
However, claiming the EITC is far from easy and straightforward. Laws and procedures governing the eligibility for low-income tax credits are increasingly complex. For example, the eligibility criteria for the EITC have changed five of the last six years. Moreover, many low-income families face language and literacy barriers, making the task even more difficult.
Such obstacles should provide a good, value-added focus for the philanthropic community. As the grandmother's story demonstrated, it is imperative that EITC claimants have access to affordable, well-trained tax preparers. Some nonprofit organizations recognize the opportunity and have created programs to help low-income taxpayers help themselves.
For example, AccountAbility Minnesota is a nonprofit organization that recruits and trains community volunteers to offer free tax preparation to low-income taxpayers. It is part of the Internal Revenue Service's VITA (Volunteer Income Tax Assistance) program, which means that its volunteers are free from legal liability, and it receives tax preparation software at no cost, as well as other limited, nonfinancial resources from the IRS.
Last year, AccountAbility Minnesota engaged 400 volunteers at 38 sites to help file federal and state tax returns for more than 8,400 taxpayers and their more than 4,400 children. As a result, these families claimed more than $9.5 million in federal and state cash refunds. Part of the success of this organization can be attributed to its accessibility for low-income clients. AccountAbility partners with existing local organizations to offer its assistance within community centers that families already know, frequent and trust. In addition, AccountAbility maintains very high quality standards. Volunteers are specifically trained in low-income tax issues, and every completed return is examined by a more experienced volunteer preparer prior to being filed.
Private sector can help and be helped
The EITC also offers the private sector—most obviously banks—new market opportunities.
Federal Reserve statistics indicate that only one of four families with incomes less than $25,000 have a bank account of any kind. Only 49 percent of the more than 210,000 Minnesota EITC filers had their 2001 refunds directly deposited into a bank account. There are advantages for both individuals and banks to push those numbers higher. With a bank account, a tax filer can have the credit deposited directly and quickly. This individual can then also avoid the necessity of a refund anticipation loan and check cashing fees. Both erode the benefit of the EITC and are exceedingly expensive for EITC families.
From the bank's perspective, the EITC offers a new client base. Though this group comes with some financial literacy needs, it also comes with a reasonable initial deposit and the opportunity to begin the road to asset accumulation—building their credit and eventually being eligible for additional bank products, like electronic bill payment programs and longer-term loans.
Efforts to partner free tax assistance with financial institutions are proving successful. ShoreBank in Chicago found that 60 percent of the clients who opened an account at a free tax clinic continued to use their account to complete regular transactions over the year, as a vehicle for medium-term storage of their refund or as a vehicle for savings. More than 70 percent said that opening the account influenced how they used their refund and helped their savings.
The EITC also offers many businesses some wage leverage. Unbeknown to many, the EITC essentially acts as a wage subsidy of approximately $2 per hour for a full-time worker at minimum wage, yet few businesses capitalize on this opportunity to put more income into their own workers' pockets at virtually no additional cost. Some scattered business associations are active players in local outreach coalitions, but a collective effort on the part of businesses is lacking.
Outreach efforts face other limitations, the most immediate of which are recruiting tax preparation volunteers and publicizing the availability of tax credits and free (or reduced-fee) assistance.
Many outreach efforts also struggle to keep their technology up to date. Last year, AccountAbility increased its capability to electronically file tax returns by 90 percent but has since been told that this summer the IRS will permanently reclaim 48 computers it lent the organization, with no promise of replacements. This will drastically reduce the organization's ability to electronically file its clients' returns.
Poverty has devastating effects on children's development as well as on the broader community. Although certainly not the only solution, the EITC has proved to be an effective, resource-efficient method for putting money into the pockets of low-income people, while at the same time encouraging—indeed, demanding—work.
But the EITC is still underutilized. More than 21 million working families across the country claimed the EITC in 2003, but research suggests that 15 percent to 20 percent of eligible taxpayers fail to claim it each year. This represents enormous potential for families, local communities and businesses across the country.
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