When the modern income tax was first instituted in 1913, it was levied on only the top 1 percent of earners, and when the payroll tax was added in 1937, it started at a rate of only 2 percent. As a result, the tax system effectively ignored low-income households. But a steady broadening of the income tax base and increases in payroll taxes meant that, by the late 1960s, the tax system was adding substantially to poverty by requiring payments from households that pushed some of them under the poverty line and pressed others still deeper into poverty.
A series of legislative measures passed since the 1970s has reversed this trend. In 1975, the earned income tax credit (EITC) was created; in 1997, the child tax credit became law. Since their creation, both have been extended, with an expansion included in almost every major tax bill since the mid-1970s. As a result, over the past century we have moved from a tax code that ignored the poor, to one that exacerbated their condition, to the one we have today that directly reduces poverty for households with children, while increasing incentives for work, education, and advancement.
The recent financial crisis dealt a severe blow to American families, wiping out more than $13 trillion in household wealth, causing median household wealth to fall by 39 percent, and forcing eight million people out of their jobs. Without any tax or benefit policies, the poverty rate measured by market incomes alone would have risen by 4.5 percentage points from 2007 to 2010. That amounts to about 14 million more people, including many from the middle class, who would have fallen into poverty, just based on the economy.
Instead, the comprehensive measure of poverty fully reflecting taxes and benefits went up only half a percentage point — about 1.5 million people. While that amount is certainly lamentable, and we should be doing our best to avoid even that outcome, it is a massive difference from the 14 million that would have fallen into poverty absent those policies.
Moreover, this improvement in poverty was the result of a combination of pre-existing policies and important expansions in the American Recovery and Reinvestment Act, which bolstered tax credits such as the EITC and child tax credit, temporarily expanded SNAP benefits, and extended and temporarily expanded unemployment insurance benefits, in addition to giving states incentives to undertake ongoing unemployment insurance reforms. All told, the expansions in 2009 and beyond were responsible for more than 40 percent of the total poverty reduction from tax credits and benefits.
The EITC and partially refundable child tax credit (CTC) have dramatically altered the impact of the tax code on poverty. In 1967, a household at the poverty line paid about 12 percent of its income in federal taxes all told, including payroll taxes. Paying those taxes pushed millions of families below the poverty line, in turn raising the overall poverty rate by 3.2 percentage points. The impact of the tax system on poverty for non-elderly households with children was even more pronounced, raising the poverty rate by 3.9 percentage points largely because, for those households, the poverty line is somewhat higher to reflect the greater needs of larger families.
The tax system today is dramatically different, working not to increase but to reduce the overall poverty rate by 1.3 percentage points in 2012. Instead of exacerbating the poverty rate for families with children, it lowers the rate — by a total of 3.7 percentage points in 2012. But the tax system still taxes low-income childless households, raising their after-tax poverty rate.
Although the changes to the tax system since the 1990s have reduced its contribution to poverty among families with children, it has only been since Democrats insisted that the refundability of the child tax credit be expanded as part of the 2008 stimulus that the tax system stopped increasing overall poverty. In 2009, the Recovery Act further expanded the refundability of the child tax credit and made two critical enhancements to the EITC: reducing the marriage penalty that had dramatically cut down on the credit for some low-income people with children who married; and expanding the tax credit for families with three or more children to reflect both their greater expenses and higher poverty rates. Taken together, the anti-poverty policies under the Recovery Act reduced poverty rates by 2.6 percentage points for families with three or more children and 1.3 percentage points for families with one or two children. The EITC and child tax credit policies first enacted in the Recovery Act now benefit 16 million families a year by an average of $900 per family.
The major changes described thus far apply almost exclusively to households with children. As a result, the federal tax rate for a married couple with two children and with income just at the poverty line has gone from 10 percent in 1967 to -16 percent in 2012. But the tax rate for a married couple with no children at the poverty line has been practically constant, going from 12 percent in 1967 to 11 percent in 2012. The same divergent trends appear among single parents.
Overall, the emphasis on families with children has been appropriate. The tax system used to do more to add to poverty for households with children than for households without. And even with these changes, the poverty rate for non-elderly households with children is still 1.8 percentage points higher than it is for households without children, due to those families’ often higher needs — which is why it would not make sense to expand the childless EITC at the expense of the EITC for households with children.
The president’s proposal would double the childless EITC to be worth up to $1,005 and lower the age threshold from 25 to 21 to help more lower-income young people, while also increasing the upper age limit from 65 to 67 to align with scheduled changes to Social Security’s normal retirement age. The household at the poverty line would see its EITC expand from $170 to $842, more than eliminating its income taxes, although it would still pay net taxes on earnings when including payroll taxes. (Note that these workers would receive returns during retirement through Social Security and Medicare.)