Low- and moderate-income people are eligible for certain refundable tax credits under the individual income tax if they meet the specified criteria. Refundable tax credits differ from other tax preferences, such as deductions, in that their value may exceed the amount of income taxes that the person owes. Refundable tax credits thus can result in net payments from the government to a taxpayer: If the amount of a refundable tax credit exceeds a taxpayer’s tax liability before that credit is applied, the government pays the excess to that person. Two refundable tax credits are available only to workers: the earned income tax credit (EITC) and the refundable portion of the child tax credit (referred to in the tax code as the additional child tax credit).
To qualify for the EITC and the refundable portion of the child tax credit, people must meet several income tests. First, they must have income from wages, salaries, or self-employment. Second, their adjusted gross income cannot exceed thresholds that vary with family characteristics. (A special rule applies to the EITC when a person’s earnings are higher than his or her adjusted gross income because of investment losses. In that instance, eligibility for the EITC is denied if the earnings exceed the specified thresholds. Adjusted gross income includes income from all sources not specifically excluded by the tax code, minus certain deductions.) For the EITC, the income thresholds for 2013 range from $14,340 for an unmarried worker who does not live with a child to $51,567 for a married couple that files jointly and has three or more children. For the child tax credit, the income threshold for 2013 is $95,000 for an unmarried person with one child and $130,000 for joint filers with one child; the income thresholds increase with the number of children in the family. Finally, eligibility for the EITC is restricted to filers with investment income that is $3,300 or less in 2013. Investment income includes interest (counting tax-exempt interest), dividends, capital gains, royalties and rents from personal property, and returns from passive activities (business pursuits in which the person is not actively involved). The limitations on adjusted gross income and investment income are adjusted, or indexed, for inflation each year.
This option would lower the threshold for the EITC investment income test from $3,300 to $1,650. As under current law, that threshold would be indexed for inflation. Moreover, the option would extend that requirement to the refundable portion of the child tax credit. If implemented, the option would raise $11 billion from 2014 through 2023, according to estimates by the staff of the Joint Committee on Taxation.
The main rationale for the option is that it would better target the credits to people without substantial means by denying the credits to people who have low earnings but have other resources to draw upon. Asset tests—requirements that recipients do not have savings in bank accounts, stocks, and other types of investments whose value is above a specified threshold—serve a similar role in some spending programs that provide benefits to lower-income populations. However, asset tests would be very difficult for the Internal Revenue Service (IRS) to administer because the agency does not collect information on the amount of assets held by individuals. By contrast, the IRS does have extensive information on the income from most of those investments, and much of that information is accurate because it is reported independently to the agency by financial institutions as well as by taxpayers on their returns.
An argument against the option is that it would reduce the incentive to save, especially among people whose income from investments is near the threshold amount and who could become (or remain) eligible for the credits under the option by making small reductions in their assets. However, some people would not respond to the lower thresholds by reducing their saving but instead by shifting their investments to less liquid forms (such as cars) that are not subject to the investment test or by changing the timing of the return from their investments (for example, by retaining stocks for longer periods in order to avoid realizing capital gains). For people with very low income, the investment test would probably have little effect because they have little means to save and invest.
|(Billions of dollars)||2014||2015||2016||2017||2018||2019||2020||2021||2022||2023||2014-2018||2014-2023|
|Change in Revenues||*||1.2||1.2||1.2||1.3||1.1||1.2||1.2||1.2||1.3||4.9||10.9|
Source: Staff of the Joint Committee on Taxation.
Notes: This option would take effect in January 2014. The estimates represent the change in the overall budget balance that would result from the sum of changes to revenues and outlays.
* = between zero and $50 million.