Does the EITC Reduce Savings Among the Poor?

by Alex Durante, The Tax Foundation, April 11, 2016

We have previously discussed some of the drawbacks of the Earned Income Tax Credit (EITC), including a high rate of improper payments and work disincentives as the credit phases out. Recent research has found that these work disincentives may apply to more workers than previously thought. Less explored in the literature, however, is the effect of the EITC on the savings behavior of poor households.  A recent paper published in the National Tax Journal by University of Oregon Professor Caroline Weber addressed this very issue, and found that nearly 40% of the decline in saving from 1988-2006 for those who claim the credit can be explained by recent expansions in the EITC.

It is not uncommon for poor households to have some savings. In 1988, 26.2% of individuals that claimed the EITC had some dividend and interest income. In 2006, that share had fallen dramatically by more than half to only 12.3%. Weber found that savings declined during the phase-out range of the credit, as workers lose some proportion of their credit for each additional dollar they earn. She estimated that if the EITC’s disincentives to save had remained at the 1988 level, the average stock of savings would have been a staggering $1,030 for the program’s recipients. Given that accumulating savings remains essential to escaping poverty, this is a troubling finding.

Weber excludes households without children from her sample because the phase-out range begins at very low incomes for those taxpayers. However, her research suggests negative effects if the EITC were more generous for this particular group, as both House Speaker Paul Ryan and President Obama have recently proposed. Both have called fordoubling the credit amount for childless adults from approximately $500 to $1000 and extending the range of income over which the benefit applies. Unfortunately, as this group earned more income, they would likely face similar disincentives to save as families that receive the EITC currently do.

Few policies have enjoyed as much bipartisan support as the EITC. While there is no doubt that the EITC has reduced the depth of poverty for some families, any benefits from poverty reduction must be weighed against the exorbitant costs of the program, the risk of trapping workers in low-wage employment as the credit phases out, and the program’s disincentives to save. We hope policymakers will consider all of the benefits and costs before deciding whether to expand the EITC.