Gov. Scott Walker recently proposed expanding Wisconsin’s Earned Income Tax Credit, or EITC. To the casual observer, this may not sound like exciting news, but for more than 100,000 Wisconsin families, expanding the EITC will mean more job opportunities, higher take-home pay and a less-resistant path to prosperity.
Wisconsin was among the first states to adopt an EITC program, implementing it in 1983, repealing it in 1985 and making it permanent in 1989. The basic idea of the EITC is straightforward: Offer workers with earnings below a set level a percentage refund of the taxes they pay; the current levels depend on a worker’s number of children and marital status. For workers with sufficiently low earnings, the tax break turns into a work-based subsidy. Wisconsin’s EITC is based on the federal program but includes a supplement on top of what the feds offer.
The EITC is smart policy for a many reasons. Chief among them is that it promotes the expansion of the labor market by increasing the reward to work, while at the same time making it more attractive for businesses to hire.
The “secret sauce” of how the EITC does this is through its effect on earnings: Workers are willing to accept lower starting wages because they have the EITC to make up the difference; businesses are able to offer lower starting wages because they have the EITC to make up the difference. This means that net (after EITC) wages are higher for workers, while gross (before EITC) wages paid by businesses are lower — so that the number of workers and their hours expand in the market. The EITC is the policy-darling of economists, and they have shown that previous EITC expansions do manifest themselves in this manner.
The EITC represents a clear, positive way for government to improve labor market outcomes for employees that works in tandem with business interests. This is in sharp contrast to the often-proposed populist solution of increasing the minimum wage. While the EITC expands labor market opportunities, the minimum wage destroys them by making workers more expensive for businesses to hire.
In a 2014 report for the Wisconsin Policy Research Institute, “Raising Wisconsin’s minimum wage: Who would be helped? Who would be hurt?” I estimated that a move to a $10.10 minimum wage would cost the state up to 55,000 jobs. Minimum wage supporters argue that many workers will receive a pay bump, which is true. But the cost of job loss among the state’s most vulnerable workers is unnecessary when a better policy — in the form of the EITC — can provide an equal or greater income boost along with job gains. Along with Capital Policy Analytics President Ike Brannon, I recommended in that WPRI report that Wisconsin policy-makers consider expanding the EITC instead.
Of course, the EITC is not without costs. Wisconsin’s EITC cost about $102 million in FY2016, and the proposed increase would raise that by $20 million. Like anything government does, these costs are spread among state taxpayers. In contrast, the cost of a minimum wage increase would be borne by low-wage workers who lose their jobs and the customers of low-wage businesses through higher-priced goods and services.
The EITC program is not without flaws. A major oversight in the current design is that because the program’s income limits are not properly aligned for married and single taxpayers, the EITC can create a “marriage penalty,” or a sharp reduction in payments to married couples relative to similar cohabitating couples. Since Wisconsin uses the federal guidelines, state EITC dollars are also subject to the penalty. Part of Walker’s proposal is to eliminate the marriage penalty for newly married couples for the first three years of marriage.
There are other aspects of the EITC that could be improved. Expansion should include reducing work penalties that kick in at higher earnings levels, enhancing the credit for workers without children and spreading payments beyond tax refund season. Continuing to update and expand the EITC will benefit Wisconsin workers and businesses alike, paving the way for prosperity.
Andrew Hanson, PhD, is an associate professor of economics at Marquette University. This column expresses his personal opinion.