The Downside of the Tax Credit That Keeps Millions Out of Poverty

“I get paid nothing to do everything,” Lance had told me last summer. “I come home every day mentally, physically exhausted from the amount of work I’ve put in, and my checks are pocket change basically. I personally don’t think it’s fair.”

Lance, then a full-time shift manager at a fast-food chain restaurant, made $9.75 an hour, while his wife also worked full-time at a fast-food chain restaurant for less than $10 an hour. But despite their two incomes, they were coming up short on rent and having car troubles. After years of living with relatives, they had finally been able to rent a home for themselves, but some weeks during that trying summer, they wondered how they were going to pay the next month’s rent.

Fortunately, Lance and his wife were able to hold on until February, when they received their tax refund: almost $10,000. He estimated that about 90 percent of that went straight to repaying debts they had accumulated: family members from whom they were forced to borrow in order to pay rent, electric bills, gas, and the like. They put some of it back into their life insurance, which they had once been forced to borrow from in order to pay bills. They did use a small portion to pay for their son’s birthday party, but Lance was quick to add, “We didn’t do anything irresponsible with it at all.”

Paying back debts had become something of an annual ritual for the couple. “That’s kind of what we do: basically use our tax return as credit,” Lance explained. “We borrow money then pay it [back].” He added that the family members from whom they borrow had learned to “pretty much expect their money back at the end of the year.” They didn’t want to ask for help, but when you make low wages and come up short, you learn to “either swallow your pride and ask for help or lose what you have.”

Lance had never heard of the earned income tax credit (EITC) when I asked him about it—“The only thing I know about taxes is that you have to pay them”—but that’s the main reason he and his wife receive a large tax return each year. In 2013, a married couple with a combined income of about $20,000 and three children would have received about $6,200 in the EITC.

When I asked Lance if he had the choice between having the tax return put into his paycheck (spread out over the course of the year) and receiving one lump sum at tax time, he said he would choose the latter. “Because tax returns, they help you out of a tight spot,” he said. “And then if you’re not in a tight spot at the end of the year, then good for you, you’ve got some money to save.” He added, “your tax return lifts a lot of stress on your shoulders.” In fact, he noted that he always elects to claim no dependents when he fills out a W-2 form at work—even though he could claim his wife and three children—so that his tax refund is larger.

‘That’s kind of what we do: basically use our tax return as credit.’

In fact, the financial and psychological benefit of that one lump sum is so great for Lance that, when I asked him if he would rather have a $15 hourly wage and receive a smaller tax return, or stick with his current wage (about $10 an hour) and receive a large tax return, he initially said he’d prefer the lower wage and the larger tax return. However, upon thinking about it further, he realized that if his boss came to him and said they’re offering him a $15 wage, he’d “of course” take it. “That’s financial security,” he noted, adding that it would enable his family to afford everything they need when they need it and “to stay ahead of things.”

As Sarah Halpern-Meekin and her colleagues show in It’s Not Like I’m Poor, Lance’s preferences regarding the EITC are widespread. Halpern-Meekin and coauthors, in an in-depth qualitative study of 115 EITC recipients in Boston, found that almost everyone preferred the lump-sum payment, even though at the time, recipients had the option of receiving advance payments of their credit throughout the year. (Due to very low take-up rates, the advance option was gutted in 2010. It’s possible that many people simply didn’t know about it.)

This was despite the fact that most recipients struggled to pay for basic necessities throughout the year. In fact, many who filed with a for-profit tax preparer were so desperate for their tax refund that they were willing to pay a significant fee in order to receive their tax refund immediately, rather than wait the one to two weeks that it would take for the IRS to mail them a check. As one woman said, “All I was thinking about was survival. All I was thinking about was ‘What do I need to do to save this family from eviction?’”

Like Lance, most families in the Boston study used their tax refund to catch up on debt, meet current needs (like stockpiling food and paying bills ahead of time), and perhaps buy a large-ticket item that they had been waiting for (like a used car or a bunk bed for their kids). Only 11 percent of refund money went to “treats” like paying for a child’s birthday party, or taking the family out to eat, and six months after tax filing, only 7 percent of total refund dollars were left for savings.

As the authors noted, “What savings there were often ended up providing a rainy day fund to smooth income fluctuations—a valuable asset to be sure—rather than a nest egg for longer-term goals.” And that’s understandable, considering that wages only covered 68 percent of families’ monthly expenditures on average. They had to rely on food stamps, help from family and friends, credit cards, the EITC, and other tax credits to make up for the rest.

In other words, what the tax refund gave at tax time, their low wages simply could not sustain. A boom-and-bust cycle has thus become the norm for low-wage workers and their families.

The EITC is clearly an extraordinary help to recipients. Without it, Lance and his family might be homeless today. In 2013, it enabled over 6 million people to climb out of poverty, including over 3 million children. The authors of the Boston study suggest that, while very few recipients are actually able to use funds to buy a house or pay for more education, it helps to keep the dream of upward mobility alive. Moreover, they find that while direct cash assistance from the state comes with a great stigma and is therefore “citizenship-stripping,” the EITC is perceived as a “just reward” for hard work and therefore enables a greater sense of citizenship.

But is there a way to avoid the boom-and-bust cycle that many recipients experience? That’s the question I’ll take up in my next post.