By: Leandra Lederman
On April 5, the Indiana University Maurer School of Law’s Tax Policy Colloquium welcomed Len Burman from Syracuse University and the Urban Institute/Tax Policy Center, who presented “The Rising Tide Wage Credit.” This intriguing new paper is not yet publicly available.
The paper proposes replacing the existing Earned Income Tax Credit (EITC) with a new credit, the Rising Tide Wage Credit (RTWC), which, unlike the EITC, would be universal for workers, rather than phased out above low income levels. The RTWC also would differ from the EITC in that the amount of the RTWC would not depend on the number of children the taxpayer has. Instead, the RTWC would be a 100% credit in the amount of a worker’s wages, up to $10,000 of wages. The credit could be claimed on the taxpayer’s tax return, or subject to advance payment via the taxpayer’s employer. Thus, the maximum credit for an unmarried taxpayer would be $10,000, and for a married couple filing jointly would be $20,000. (The credit would not have a marriage penalty.) The credit would be indexed to increase with increases in GDP.
Because the proposed new credit would not vary with the number of children the taxpayer is supporting, the paper also proposes increasing the child tax credit from $2,000 to $2,500, and proposes making the child tax credit fully refundable (rather than partly refundable, as it is under current law). The RTWC and the increase in the child tax credit would be funded by a value added tax (VAT). The paper estimates that the proposal could be fully funded with an 8% VAT, along with federal income tax on the RTWC. A VAT was chosen as the funding mechanism because it is closely correlated with GDP. The paper discusses 3 illustrative examples and includes a table that shows the overall progressivity of the proposal under certain assumptions.
The motivation for the proposal is the idea that although economic growth generally benefits society, it may not benefit lower-wage workers if machines disproportionately replace low-skilled workers. That is, although capital traditionally increased the productivity of labor, a newer kind of capital may replace labor of certain types. The paper uses the example of self-checkout machines in the supermarket, which replace cashiers by requiring only one worker to supervise numerous checkouts. The idea behind the proposal is to help the low-income and middle class avoid wage stagnation by receiving a credit that increases as GDP increases.
The goal of helping the middle class, rather than just the lowest income, is one reason why the proposed credit would be universal for workers, rather than phased out. (Making the credit universal makes it analogous to one possible alternative, Universal Basic Income, which the paper argues is less attractive because it is not keyed to participation in the labor force.) Universality would also make the credit more readily available as advance payments from an employer, although it is unclear how attractive an option that would be, given the lack of uptake of the advance EITC, when that existed. Among other reasons for the very low uptake, it appears that many low-income taxpayers prefer receiving a large lump sum (particularly to spend on lumpy purchases), rather than smaller amounts throughout the year.
The RTWC itself might not face a lot of political opposition, in part because it is keyed to working (like the EITC), and in part because it is universal (by design), so everyone would have a stake in it. However, as Len recognizes, a VAT would be a harder political sell. Using a VAT to fund the RTWC would mean using a regressive tax to fund a benefit with a progressive impact. Some might fear that the RTWC would go away and the VAT would remain, or that the VAT, once in place, would be expanded to fund other programs.
The RTWC, like the current EITC, would be based on employment or self-employment income. As with the EITC, this would give some taxpayers (or their tax preparers) an incentive to invent self-employment income. This type of fraud is not particularly easy for the IRS to detect, and the cost of it would likely be greater than under current law because the credit is larger—$20,000 for a married couple filing jointly, if both spouses earn at least $10,000 from working. (For tax year 2017, the maximum EITC is $6,318.) One way that taxpayers might cheat is by having a spouse who does not actually work outside the home invent $10,000 of self-employment income. (Of course, the RTWC also increases the incentive for a taxpayer to earn up to $10,000 in actual employment or self-employment income.) The already strapped IRS likely would need further funding to implement the proposal and to deter increased fraud, although further increasing the audit rate on lower-income individuals could raise political issues.
The paper assumes that prices would increase by the amount of the VAT, and it recognizes that this would make people who do not receive the RTWC worse off. The paper notes that retirees with assets would be among those who would be worse off. The proposal would address that issue by giving retirees and those near retirement a one-time benefit. The RTWC and VAT also would be phased in over four years.
It is hard to predict what all of the effects of the proposal would be if implemented. One important question is to what extent the credit would be captured by employers. The paper argues that employers likely would not capture the full benefit of the RTWC, and that although an increase in labor supply spurred by the credit could cause wages to decline at the bottom, that decrease would be tempered by state and federal minimum-wage laws.
There could be other dynamic effects, as well. For example, taxpayers who invent self-employment income would need to report that on a tax return in order to claim the RTWC. The (fraudulent) self-employment income would then be subject to self-employment taxes on the same return (and an income tax deduction for one-half of that amount). That would mean increased payments into Social Security in the short term, and increased Social Security collections (based on the fraudulent income) in the longer term. Some of these effects might also affect the prices of goods.
There is more in the paper, such as possible effects on the tax bases of state and local governments, but the basics of the proposal are described above. It’s a great project, and Len plans to expand on some aspects of the proposal in later drafts. He said in the workshop that he has not yet run the proposal through the Tax Policy Center’s Tax Model, but that he plans to. That will show the estimated revenue and distributional effects of the proposal.
Thank you again to Len for sharing his very interesting paper, and for a terrific workshop!
The final Colloquium talk of the year was cancelled, so David Gamage and I look forward to seeing everyone next year!