Thursday, May 15, 2008

ECON 365: A lingering EITC Question

In class, I wasn't 100% sure that the EITC was paid only once a year. It turns out it is, but you can also sign-up for the AEITC which is paid every month. The question -- which is better for recipients. Here's Mark Thoma:

Most people know about the Earned Income Tax Credit (EITC). Under this program, payments to qualifying individuals are made once a year. There is also something called the Advance Earned Income Tax Credit (AEITC) that allows qualifying individuals to receive the credit with each paycheck. But even though this program exists, most of the payments are made under the EITC and come around the time tax returns are filed.

I've often thought this was a potential disadvantage relative to the minimum wage for people living close to the margin. With a minimum wage, the extra income comes with every paycheck and helps with monthly bills, etc., but with the EITC, it comes as one large payment leaving families to struggle each month in return for a feast once a year. [Why more people don't enroll in the monthly payment plan I'm not sure, that seems like the better option (you can always save a bit of each monthly check and mimic the EITC plus interest), but I suspect it is partly the administrative hassles with getting the AEITC put into place, and the restrictions on who qualifies.]

But maybe this is a feature, not a bug, at least that's the argument below, i.e. that the once a year payment allows households to buy needed durable goods such as cars they wouldn't otherwise be able to purchase. Is it a feature? In essence, this is like forced saving (even under the AEITC only part of the credit is paid), requiring households to give up monthly consumption for one large annual payment. The fact that they are able to buy more durable goods - cars - with the one time payment is nice, and the argument is that this helps them find employment, but we need to know what they gave up each month before we can conclude they are better off.

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