Opinion

A better way than Cooper’s poorly targeted tax credits

Gov. Roy Cooper at a July 28, 2020 COVID-19 news briefing (Pool photo)
Gov. Roy Cooper at a July 28, 2020 COVID-19 news briefing (Pool photo)
  • Neither of Gov. Roy Cooper’s proposed tax credits, which would total $366.5 million in the next fiscal year, makes for good policy
  • A small Earned Income Tax Credit would mostly be spending, not tax relief, and would have little benefit at a high cost
  • The Child and Dependent Care Tax Credit would be better as a one-time grant to an Education Savings Account or other investment in the potential of children and young people

It says a lot about federal anti-poverty programs that the Earned Income Tax Credit is considered a success. The EITC is costly and complicated with high error rates, but it is better than the alternatives. North Carolina has a simpler way to provide assistance through a large standard deduction and the child tax deduction. There is no reason to complicate the tax form with either of Cooper’s proposals for a state-level EITC or a tax credit for child and dependent care expenses.

The EITC reduces market wages, leads people to work fewer hours, is costly to administer and is so complex that it makes excess payments to some taxpayers while keeping others from getting their full benefits. The Tax Policy Center Briefing Book states, “[A 2014] IRS study of returns claiming the EITC found that from 2006 to 2008, between 28.5 and 39.1 percent of all EITC dollars claimed were over-claims totaling between $14.0 billion and $19.3 billion.”

About three-quarters of EITC recipients are in the flat or phase-out region of the credit, where economists Nada Eissa and Hilary Hoynes found there is “an unambiguous reduction in hours worked.” Some people earning just above the EITC limit may also cut their hours to qualify. As a result, Eissa and Hoynes wrote, “the EITC will reduce the number of hours worked by most eligible single taxpayers already in the labor force.”

Despite its challenges, “The EITC has become the centerpiece of the U.S. safety net,” wrote researchers Austin Nichols and Jesse Rothstein, “dwarfing other means-tested programs in terms of the number of beneficiaries, total expenditures, or poverty reduction impacts.”

Nearly 90% of EITC claims in North Carolina were refunds. Of 913,060 returns claiming $2.276 billion in credits, the IRS reported 811,380 taxpayers had $1.996 billion refunded. As researchers Veronique de Rugy  and Chris Edwards noted, “While the EITC is administered through the tax code, it is primarily a spending program.” A state EITC would inherit the federal EITC’s problems with few of the benefits.

Similarly, Cooper’s child tax credit would be an inefficient means of providing relief. According to Locke senior economist emeritus Roy Cordato,

Part of the original plan for [North Carolina’s 2013] tax reform was to remove the double taxation of saving and capital investment. The fact is that in the long run children are a contribution to what economists call human capital, and therefore at least a portion of income spent on child rearing can be viewed as long term investment that should, ultimately, be exempt from taxation since it will generate an income stream in the form of future earnings that the child, when he or she becomes an adult, will generate.

This is an argument for a large child tax deduction that helps all parents regardless of work or marital status, not a narrowly targeted child and dependent care tax credit (CDCTC).

Because Cooper’s proposed CDCTC would cost $219 million in the first year and $87 million in the second year of the biennium, the bulk of the benefit is clearly COVID-related. It would make more sense as a one-time payment for COVID-related care and education expenses, either for “investments in the human capital of North Carolinians age 25 and younger, including tutoring, tuition, child care, career training, and related expenses” or for education savings accounts, as my colleague Bob Luebke recommends.