In a saga that falls into the category, “you just can’t make this stuff up” . . . Illinois policymakers recently enacted one of, if not the largest, tax hike in state history only to find themselves faced with threats of companies leaving the state. The response, give away special tax breaks of course!
Both Sears and the Chicago Mercantile Exchange have threatened to leave Illinois if something isn’t done about their tax burden. So now the legislature is debating SB 397 which would carve out special tax treatments for Sears and CME (pdf).
Included in this discussion is a proposal to increase the state’s Earned Income Tax Credit from to 15 percent from 5 percent of the federal EITC (though the specifics are still in flux). However, the EITC is a deeply flawed policy that hurts the working poor more than it helps. My latest study on the EITC proposal published by the good folks at the Illinois Policy Institute (pdf) finds:
Because taxpayers lose out on the earned income tax credit as their income increases, there is incentive for workers to keep their income under the “phase-out” level. Specifically, the only time during which the government rewards the worker for earning more money is when the worker’s income is moving from zero to $12,750. The federal earned income tax credit only encourages work effort in the phase-in income range where the effective marginal tax rate is negative 40 percent.
The taxpayer is, at best, indifferent during the plateau stage where the effective marginal tax rate is 0 percent. During the phase-out state – $41,000 for a single person and $46,000 for a married couple – the taxpayer is actually penalized with an effective marginal tax rate of 21 percent. Since the income range of the phase-out (21,800 to $46,000) is twice as large as the income range of the phase-in ($0 to $12,750), the federal earned income tax credit is spreading more work disincentive than incentives.
The state earned income tax credit, since it is an add-on to the federal earned income tax credit, only serves to exacerbate the work disincentives. The current state earned income tax credit is worth 5 percent of the federal earned income tax credit, which creates an effective marginal tax rate during the phase-out of 22 percent (versus 21 percent under the federal earned income tax credit alone). When the proposed state earned income tax credit worth 15 percent of the federal earned income tax credit takes effect in 2013, the effective marginal tax rate during the phase-out will increase to 24 percent. Expanding the state earned income tax credit will only serve to further discourage work.
Compounding the work disincentive related to the phase-out of the earned income tax credit are other federal, state and local taxes and other government welfare programs. These other factors increase the effective marginal tax rate faced by people in the earned income tax credit’s phase-out income range. Other taxes add to the tax burden on each additional dollar earned while, at the same time, the money received from other government welfare programs begins to phase out at approximately the same income range that the earned income tax credit begins to phase out.
In fact, a more comprehensive effective marginal tax rate estimate found that the effective marginal tax rate can reach as high as 65 percent! Faced with an effective marginal tax rate that high, many people will find themselves trapped by the earned income tax credit rather than helped by it. Expanding the state earned income tax credit will only dig the hole deeper for those people working desperately to better their economic situation.
Illinois would be better off using this money to lower the personal income tax rate or increase the exemption for all taxpayers, rather than expanding the deeply flawed earned income tax credit.
This was a fun study for me as there was a good deal of nostalgia since it was based on work from one of my first studies that I ever published for the Tax Foundation: “Growth of the Earned Income Tax Credit” (pdf) co-authored with Arthur P. Hall
Additionally, the EITC does nothing for Illinois’s middle class which has gotten clobbered by the recent tax hikes. Watch the video below from Kristina Rasmussen of the Illinois Policy Institute which explains how “the deal is, they take three months of grocery money in exchange for chips and a sandwich.” It’s no wonder why taxpayers are fleeing Illinois.