Report :: Half A Leg Up: New Jersey Still Trails in Crucial Help for Working Poor by Sarah Stecker

Rarely has a poverty-fighting tool been so highly regarded as the Earned Income Tax Credit. Liberals and conservatives embrace it; Democrats and Republicans vote for it. When it comes to "making work pay" the features of the EITC are seen as exemplary. Indeed, it is assistance available only to working people.

When New Jersey enacted its own version of the EITC in 2000 it joined other states in taking a major step to help people who are working hard but having trouble getting by. At the time, however, there were aspects of the EITC that made New Jersey stand out from other states in a negative way. To put it bluntly, New Jersey's EITC was decidedly less generous than those elsewhere.

Two years have passed. Information now exists as to how many New Jerseyans have claimed state EITC benefits. During that period some changes have occurred in the federal EITC, more states have established EITCs, some states have expanded benefits and New Jersey's budget crisis has contributed to expansion of some taxes that fall disproportionately hard on lower income people. This report examines where New Jersey now stands, and offers recommendations for improving the EITC. Unquestionably, the more than $100 million New Jersey has given out in tax credits over two years has been very helpful to the recipients. But the state EITC could become a better, more effective path out of poverty for the men, women and children of the state.

The federal Earned Income Tax Credit came into being in 1975 and has been broadened four times since. The most recent expansion came last year, liberalizing eligibility for married filers. The tax credit grew under Presidents Ronald Reagan, George H.W. Bush and Bill Clinton. Expressing his support for the EITC, Reagan said, "Giving a leg up to those struggling to move up is what America is all about." ¹

Depending on workers' income level and family size, the EITC provides a credit against the federal income tax. A major impact of this is to lessen the burden of regressive payroll taxes for Social Security and Medicare that fall unequally hard on lower income workers. Most EITC dollars go to parents, as opposed to workers without children, reflecting the substantial extent to which raising children adds to the cost of living. In each of the last four years, approximately 19 million working poor Americans claimed the federal EITC-about 16 percent of US taxpayers-including more than 3 million low-income workers without children. In each of those four years, about 440,000 working New Jersey families and individuals received the federal EITC-just over 11 percent of the state's taxpayers. In 2000, New Jersey ranked 14th among all states in EITC recipients.

According to the Center on Budget and Policy Priorities, in 1998 some 4.8 million people, including 2.6 million children, were removed from poverty as a result of the federal EITC.² The federal EITC now lifts more children out of poverty than all other federal means-tested programs combined. What makes the federal EITC an especially effective anti-poverty program is that the credit is refundable. Most families qualifying for the federal EITC make too little to owe federal income tax. But if the amount of EITC they are eligible for exceeds their income tax obligation, they receive a check for the difference. According to one study, "this lump sum check can constitute 20-40 percent of the filer's total income for those who receive the maximum benefit." ³

Because it lessens the burden of income taxes, provides refunds for some people and is available only to jobholders, the EITC has been described as public policy that makes work pay. At the lowest income levels, the credit increases with every extra dollar a worker earns. When income reaches the federal poverty line, the credit flattens. Then it gradually decreases as income begins to rise above the federal poverty standard-as opposed to cutting off abruptly. The gradual decrease reduces the likelihood of a situation where someone with a higher gross income than another person sees the difference reduced because of the impact of paying taxes after an abrupt eligibility cutoff. Abrupt cutoffs create what is called a "cliff" effect, reflecting the steep drop in benefits.

The way the EITC is structured, for example, in 2002 a married worker with one child could earn up to $30,201 and still receive a credit. But it would be far lower than the maximum credit of $2,506 that could be claimed by a working family with one child that earned between $7,370 and $14,520. Similarly, a married worker with no qualifying children could earn up to $12,060 and still receive a credit, but to get the maximum benefit of $376 the worker would have to earn between $4,910 and $7,150.

In contrast to government programs that are criticized by some as having the effect of discouraging work because earning more means an immediate loss of benefits, the EITC concept is widely praised. The consensus is that it rewards people for their effort to get out of poverty and provides an opportunity to transition with some assistance into a stable working arrangement. According to the Center on Budget and Policy Priorities, "the federal EITC has been proven effective in encouraging work among welfare recipients; studies show it has a large impact in inducing single mothers to work."

Last year's changes to the federal EITC are seen as boosting the prospects for low-income, two-earner families where the workers are married. Included in the tax cut signed by President George W. Bush, the newest expansion lessens the so-called marriage tax penalty in two ways: it allows more married filers earning near poverty to receive the maximum credit; and expands the top income eligibility level for married filers. Where, for example, in 2001 the EITC began to phase down at $13,090 for both married and non-married couples with children, a married couple can earn an additional $1,000 in 2002 before benefits are reduced. Starting in 2005 the figure rises to $2,000 and in 2008 it goes to $3,000. ⁴

Additionally, more married filers will qualify for a federal EITC because the income ceilings will begin to be higher for such couples in contrast to criteria used for unmarried couples. In 2002, a married couple with two or more children can earn $34,178 and still receive the federal EITC while an unmarried couple with two or more children could earn only $33,178 and still qualify for the federal credit.

To give working people an additional boost, states over the past few years have been establishing their own EITC programs. Like their federal counterpart, state EITCs are only for residents who work. And because state sales taxes and local property taxes take a larger percentage of a poor person's income than that of a wealthy person, state EITCs help to serve as an offset to those regressive levies. Usually the credit that a state EITC provides is a certain percentage of what the federal EITC provides. Twelve state EITCs are-like the federal program-refundable; most include workers without qualifying children though, as is the case with the federal EITC, benefit levels are far below what families can receive. Qualifying children are defined as those under 19 (under 24 if full time students) or disabled and who lived with the parent, grandparent great grandparent who is claiming the EITC benefit for more than half the year, or in the case of foster children, the full year.

The most recent state EITCs have been created in New Jersey, Illinois, Indiana, Maine and Oklahoma as well as the District of Columbia, all since 1999. During that period another six states that already had EITCs-Colorado, Kansas, Maryland, Minnesota, New York and Vermont-substantially expanded benefits.

New Jersey's EITC took effect in 2000. Like the federal program, the proposal enjoyed broad bipartisan support. Also like the federal program, New Jersey's EITC is refundable, as are those of 11 other states.

In the year the state EITC took effect, New Jersey offered a tax credit at 10 percent of the federal EITC. Under provisions of the state law, the benefit rose to 15 percent in 2001 and 17.5 percent in 2002. It is scheduled to top out at 20 percent in 2003. This puts New Jersey around the middle, relative to what other states offer. At 20 percent of the federal EITC, New Jersey is less generous than six other states. The Wisconsin and Minnesota state EITCs vary with family characteristics rather than being set at an identical percentage for all low-income families and individuals. Wisconsin offers an EITC of up to 43 percent of the federal credit for families with three children and lower percentages for smaller families. Minnesota's EITC averages around 33 percent of the federal EITC, ranging from 25 to 45 percent depending on earnings. Vermont offers a 32 percent EITC. In 2003, New York State's EITC is scheduled to rise to 30 percent of the federal credit. The District of Columbia offers a 25 percent EITC. Rhode's Island's EITC is 25 percent but it is non-refundable, so the actual dollar amount of benefits is lower.

Where New Jersey's EITC differs the most from other states and the federal program is in terms of who is eligible for the tax credit.

When it was created, New Jersey's was the only state EITC pegged to the federal program where income eligibility levels were below those of the federal EITC. Today, several more states have added an EITC-and still New Jersey is the only state that cuts off eligibility at an income level below that of the federal program. Additionally, New Jersey is one of only three states-along with Maryland and Wisconsin-that do not provide any EITC credit for workers without qualifying children.

Once a New Jersey worker's income reaches $20,000, he or she is no longer eligible for the state EITC. The gradual descent from benefits that helps workers to transition out of poverty does not exist in New Jersey. As a result, significant numbers of New Jersey residents find themselves eligible for the federal EITC but not the state program. In other words, they fall off the cliff.

Two examples show how the cliff effect plays out, using 2001 eligibility levels and tax rates.

At $19,000 of gross earnings the family would be eligible for both the federal and state EITCs. This family would owe no state or federal income tax. Because the EITCs at both levels are refundable, the family would receive $2,763 from the federal government and another $414 from the state-for a combined EITC benefit of $3,177.

Compare them to a married, two-child family with gross earnings of $21,000. This family would get a $2,342 benefit from the federal EITC, but nothing from the state. Indeed, the family would have to pay $297 in state income tax, having crossed the $20,000 threshold. Adjusting incomes to reflect benefits and taxes we find that the second family, though it had $2,000 more in gross income, netted only $868 more than the first family because of the EITC eligibility rules.

Again, one family grosses $19,000 and the other $21,000. The first family pays $55 in federal income taxes but gets back $1,483 from the federal EITC. It pays $126 in state income tax and gets back $222 from the state EITC. So the net combined state and federal EITC is $1,705.

The second family pays $255 in federal income tax but gets back $1,164 from the federal EITC. This family gets no state EITC and pays state income taxes of $297. When all of this is tallied, a family that grossed $2,000 more, netted only $1,088 more than the other family.

In both cases the absence of a state Earned Income Tax Credit made a significant difference. With any program like an Earned Income Tax Credit there must be some level at which a family no longer is eligible for benefits. The issue of whether there is a dis-incentive to work when an extra dollar translates into a loss of benefits will always be raised. But the federal EITC system has taken steps to minimize this problem by gradually phasing out benefits, up to a reasonable level of income. Instead of gradually phasing out as a family approaches self-sufficiency, New Jersey's EITC abruptly cuts off the family that still is highly vulnerable just as it tries to gain financial footing.

The number of New Jersey filers who received the state EITC in 2000 was 188,272, according to unaudited figures provided by the state Division of Taxation in July. The state returned $44 million in tax credits to these working families, with an average refund of $233.97. According to the federal Internal Revenue Service, 440,175 New Jersey families and individuals received the federal EITC in 2000, amounting to $701.4 million in tax credits. ⁵

For 2001, preliminary data from the Division of Taxation indicates that 189,623 New Jersey families received the state EITC, totaling $69.7 million with an average check of $367.51 (the checks are higher because the percentage of the federal EITC used to calculate benefits increased). Based on preliminary data for 2001, the IRS indicates that 426,730 New Jersey filers have gotten $689.4 million in federal EITC benefits.

The bottom line, then, is that more than 250,000 New Jerseyans who received federal EITC benefits in 2000, and nearly 237,000 who did so in 2001, were not getting the state EITC. These numbers are higher than the 165,000 estimated to be in that position when NJPP wrote a report in 2000 on the state EITC based on figures provided by the state as estimates of how many would be eligible for the new program.

In 2000, approximately 110,203 were families that earned more than the $20,000 limit for receiving the New Jersey EITC but less than the $31,152 federal EITC ceiling. ⁶ In 2000, to get federal EITC benefits a family with one child could earn up to $27,413 and still receive the federal credit and a family with two or more children could earn up to $31,152.

Another 73,945 could get the federal EITC but not New Jersey's because although they are working adults they had no qualifying children. ⁷

That still leaves 67,755 filers whose failure to receive state EITC benefits could be explained by a few possible factors. Taxpayers might easily be confused by the mismatched income eligibility standards of the federal and New Jersey EITC programs, so that even people who are eligible do not apply. NJPP's 2000 report raised this concern: "A two-tiered eligibility system would add unnecessary confusion to this effort, creating uncertainty among potential recipients as to whether they qualify and how much they can expect to get."

Further, some low-income workers with children might simply be unaware that a state EITC exists, or be unable to fill out the necessary forms. Commonly, EITC programs in other states experience less than full participation by eligible workers. The Center on Budget and Policy Priorities has found that, in practice, some portion of federal EITC claimants fail to apply for state level credits, particularly when the program is new. ⁸ New Jersey's Office of Legislative Services indicates that, based on such findings about other state EITC programs, the Whitman Administration expected the New Jersey EITC program would experience an 85 percent participation rate. ⁹ However, based on the most recent participation figures from the Division of Taxation and the state's original projection that 280,000 families ¹⁰ would be served by the EITC, New Jersey's program in 2000 had only a 67 percent participation rate.

Problems also exist with regard to eligible persons dealing with the application process for EITCs. To get the state EITC, an eligible worker must have filed for the federal credit, which has an off-putting 54-page brochure associated with it. ¹¹ In fact, the Brookings Institution found that the daunting federal form pushes 68 percent of EITC filers nationwide to pay commercial tax preparers. ¹² Brookings estimated that private firms took in nearly $2 billion nationally in 1999 for preparing EITC forms. In addition to charging for preparation of EITC forms, these commercial firms also offer "fast cash" loans or Refund Anticipation Loans, where borrowers get the dollar value of their refund in advance at high interest rates ranging up to 1,500 percent. Use of RALs from commercial companies is widespread in northern and central New Jersey, according to the Brookings study. It found that five New Jersey metropolitan areas had large percentages of federal EITCs returned with fast cash loans. These were: the Newark metropolitan area, 39.8 percent; Bergen-Passaic, 32.4; Jersey City, 28.8; Monmouth-Ocean, 27.4; and Middlesex-Somerset-Hunterdon, 24.4.

The intent of New Jersey's EITC is to help people out of poverty. By one measure, the thousands of workers with children that cannot get the state EITC are not considered poor because their earnings are above the federal poverty line. But that definition of poverty-for example, $14,269 annually for a single parent with two children in 2001 ¹³- is unrealistically low. That standard was created in the 1960s and, though adjusted yearly for inflation, it fails to account for childcare costs, increasing health care costs and wide regional variation in housing prices. ¹⁴ Arguably, the people who qualify for the federal EITC but not New Jersey's are squeezed especially because they live in the fourth most expensive state in the nation for renters. ¹⁵ Last year, fair market rent in New Jersey was $929 per month. Only in the District of Columbia ($943), California ($957) and Massachusetts ($1,033) was rent higher.

A more accurate measure of economic status can be found in figures released in June by Legal Services of New Jersey. A LSNJ report analyzed the cost of basic necessities crucial to working and raising a family in the state without public assistance of any type. This "Self-Sufficiency Standard" takes into account the market-determined prices for housing, childcare, food, transportation, healthcare and taxes for families living in each of New Jersey's 21 counties. The report found that, depending on the county where a family lives, a New Jersey family of four-with one school-age child and one preschool-age child-needs to earn between $37,516 (Union) and $56,670 (Hunterdon) to pay for basic necessities.

A single parent with one child (a preschooler) would need to earn between $28,623 (Camden) and $39,090 (Somerset) to support a family without government help. Another example: in Mercer County an adult with one preschooler would need $36,451 to be self-sufficient. At the current minimum wage, he or she would need to work 135 hours a week or 19 hours a day seven days a week to afford a two bedroom apartment in the county as well as other necessities. ¹⁶ Obviously this is impossible.

The State of New Jersey currently is in the process of adopting a "standard of need," which under law was supposed to have been issued nine years ago. State law defines this standard as "the minimum amount of income and in-kind benefits or services needed by families and single persons living in New Jersey in order to maintain a decent and healthy standard of living." ¹⁷ The proposed standard of need is to include costs of housing, utilities, food, work-related transportation, clothing and household items, but not healthcare or childcare. Establishing a standard of need conceivably could influence decisions about the levels of benefits offered by state programs, leading to expansion of the state EITC.

But in the immediate future, the number of New Jerseyans hurt by the state's EITC rules is only likely to increase. For one thing, New Jersey's EITC is not indexed for inflation. Every year the income level for federal EITC eligibility rises, but New Jersey's remains at $20,000-guaranteeing that more people will qualify for the federal program but not the state's.

A similar situation exists with regard to the new federal EITC provisions for married couples' state EITCs. While the provision allowing more married couples near the poverty line to receive the maximum credit will help New Jerseyans, the higher incomes they will be able to earn and still get federal benefits will not help because those levels already are above the point where New Jersey refuses to give any EITC benefits.

New Jersey took an important, positive step by implementing a tax credit to complement the federal EITC program of tax reductions and wage supplements. But it left many workers behind. With New Jersey's EITC, only half of the EITC structure seen elsewhere exists.

Workers in New Jersey can make their way up from beneath the federal poverty line (defined in 2001 as $14,255 for a three-person family with one child and $17,960 for a four-person family with two children ¹⁸), assisted by both the federal and state tax credit programs. But, when a New Jersey family reaches the federal poverty level or goes a little beyond, the state EITC drops them off the cliff. New Jersey chose this abrupt income cut-off rather than following the federal program and other state programs, which gradually phase down benefits at higher income levels to allow working poor families to ease their way to greater financial self-sufficiency.

Compounding the problem is the dramatic shift in the state's economic situation since the EITC was started. When the EITC was initiated in 2000, New Jersey's economy was strong and the state budget was in surplus. Today things are different. The state responded to its current budget crisis by raising new tax revenue and cutting spending. These measures included a higher cigarette tax and a freeze of aid to schools and municipalities. Like all excise taxes, the cigarette tax falls especially hard on lower income people because of its regressive nature. The aid freezes are likely to result in increases in the local property tax, already a significant and regressive burden in New Jersey because the state has the highest property taxes per capita ($1,744) in the country. ¹⁹ These regressive taxes make the effects of the national recession worse, both for low-wage workers who have never been on welfare and those who have recently left the rolls.

So New Jersey finds itself in a situation where people need the Earned Income Tax Credit even more than before in their effort to achieve or maintain self-sufficiency. Some states are facing this problem squarely. Kansas, for example, in its most recent legislative session, passed a broad tax-raising package that increased the cigarette and sales taxes, but also offset these regressive increases by expanding the state EITC to 15 percent of the federal credit, up from 10 percent.

And, New Jersey now is enduring budget cuts that have an even more direct impact on lower income people than increasing cigarette taxes or freezing aid. For example, the FamilyCare program that was providing health insurance coverage for 93,400 children, 129,000 parents of minor children and about 44,000 single adults and childless couples has been reduced to where "an extensive set of premium increases, higher co-payments and coverage reductions for children and adults" ²⁰ will result. Additionally, new applications from parents who earn at or near the federal poverty line will no longer be accepted.

Restoring critical programs like FamilyCare to their previous levels should be a high priority for the state, perhaps higher than expanding programs like the state EITC. But when all is said and done, there is no reason for New Jersey to live with an EITC program that is so much less generous than the federal program and those of other states.

New Jersey should raise state EITC income eligibility standards to match the federal program.

If the state EITC had included those people who fell off the cliff in tax year 2000, the cost would have been $26 million in addition to the current cost reported by the state of $44 million. If New Jersey had matched federal guidelines for tax year 2001, the additional cost would have been $33.7 million.

Clearly, families in New Jersey who earn above $20,000 are still struggling to provide basic necessities for their children and themselves. If families need to earn $30,000 to $57,000 to achieve self-sufficiency in New Jersey, a tax credit for the working poor that cuts off eligibility at $20,000 rather than the federal government's level of more than $32,000 falls far short of what is needed.

Low-income workers without qualifying children should be eligible to receive EITC benefits, though at lower levels, as with the federal EITC and most state programs.

It is appropriate that the bulk of credits go to people who are raising a family. But rewarding work is important for everyone, and the current policy fails to take into account that some people without children might be trying to save money to start a family. This change, which would cost about $3 million, ²¹ also would mean that New Jersey's EITC eligibility rules totally matched the federal EITC-further reducing chances of confusion.

New Jersey's EITC benefit should be raised to 25 percent of the federal EITC.

This would make New Jersey one of the nation's most generous states, an important consideration in light of New Jersey's high cost of living. And it would help reduce the burden of regressive taxation on lower income people. If New Jersey's EITC had been 25 percent of the federal program in 2001, the additional cost to the state would have been $68.6 million.

New Jersey should take steps to more aggressively promote awareness of the state EITC.

The 67 percent participation rate in 2000 is unacceptably low. Better outreach, coupled with matching eligibility levels to the federal program to avoid confusion, would help.

The effort by the state should include working with the federal government to establish more IRS Volunteer Income Tax Assistance sites around the state where low-income people can get free tax preparation help and electronic filing is available.

The state standard of need should be adopted quickly and should include costs for health care and childcare-and be updated yearly to accurately reflect what people must earn to be self-sufficient.

Given the difference between the federal poverty line and the income needed in New Jersey to be self-sufficient, the importance of implementing a realistic standard of need is great.

State	Percent of federal credit	Refundable?	Same income cutoff as federal EITC?	Covers workers with no qualifying children?
Minnesota	25% to 45% (avg. 33%, depends on income)	YES	YES	YES
Wisconsin	4% to 43% (depends on family size)	YES	YES	NO
Vermont	32%	YES	YES	YES
Rhode Island	25%	NO	YES	YES
New York	27.5% (30% for 2003)	YES	YES	YES
District of Columbia	25%	YES	YES	YES
Maryland	16% (20% by 2004)	YES	YES	NO
New Jersey	17.5% (20% for 2003)	YES	NO	NO
Massachusetts	15%	YES	YES	YES
Kansas	15%	YES	YES	YES
Colorado	10%	YES	YES	YES
Iowa	6.5%	NO	YES	YES
Indiana	6%	YES	YES	YES
Oklahoma	5%	YES	YES	YES
Illinois	5%	NO	YES	YES
Maine	5%	NO	YES	YES
Oregon	5%	NO	YES	YES

Source: Center on Budget and Policy Priorities, A Hand Up: How State Earned Income Tax Credits Help Working Families Escape Poverty in 2001, with figures updated for 2002.

NEW JERSEY STATE EARNED INCOME TAX PROGRAM
(Note: In 2003, the NJ EITC will be 20% of the federal credit.)

Source: Center on Budget and Policy Priorities and the New Jersey State Treasury Department

FEDERAL EARNED INCOME TAX PROGRAM

An EITC For New Jersey's Working Families. Association for Children of New Jersey. December 1999. <www.acnj.org>.

Johnson, Nicholas. A Hand Up: How State Earned Income Tax Credits Help Working Families Escape Poverty in 2001. Center on Budget and Policy Priorities. 2001. <www.cbpp.org>.

Shure, Jon. The Earned Income Tax Credit in New Jersey: Beware of the Cliff. New Jersey Policy Perspective. April 2000.

NJPP appreciates technical assistance provided by Nicholas Johnson, John Wancheck and Robert Zahradnik of the Center on Budget and Policy Priorities; Legal Services of New Jersey; and the Association for Children of New Jersey.