BILL ANALYSIS �
Senate Appropriations Committee Fiscal Summary
Senator Kevin de Le�n, Chair
SB 1189 (Liu) - Income Tax: Earned Income Tax Credit
Amended: April 29, 2014 Policy Vote: G&F 5-0
Urgency: No Mandate: No
Hearing Date: May 12, 2014 Consultant: Robert Ingenito
This bill meets the criteria for referral to the Suspense File.
Bill Summary: SB 1189 would establish a nonrefundable state
Earned Income Tax Credit (EITC), equal to 15 percent of the
federal EITC.
Fiscal Impact:
The Franchise Tax Board (FTB) estimates that this bill
would reduce General Fund revenues by $24 million in
2014-15, $120 million in 2015-16, and $130 million in
2016-17.
The FTB would incur increased administrative costs to
incur the provisions of the bill. Specifically, the bill's
requirements would impact FTB's programming, printing,
processing, mailing, and storage costs for tax returns.
These costs are currently unknown, but would likely amount
to a minimum of hundreds of thousands of dollars annually
(General Fund).
Background: Tax credits differ from other tax expenditures in
that they directly reduce income tax liability, as opposed to
indirectly by reducing taxable income. For instance, a one
dollar credit reduces tax liability by one dollar, whereas a tax
deduction of one dollar will reduce taxable income by one
dollar, but reduces tax liability by the marginal tax rate. For
example, an additional one dollar of deduction for a taxpayer in
the 10 percent tax bracket reduces tax liability by 10 cents,
while a taxpayer in the 39.6 percent tax bracket reduces tax
liability by 39.6 cents.
The federal EITC was enacted in 1975. It was originally intended
to be temporary in nature, to mitigate the impact of (1) the
Social Security payroll tax, and (2) rising food and energy
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prices. Instead, the EITC was made permanent in 1978. The Tax
Reform Act of 1986 indexed both the maximum earned income and
phase-out income levels to inflation. The EITC differs from most
other tax credits in that it is partially or fully refundable. A
taxpayer with $100 in tax liability and $200 in a refundable tax
credit would receive a tax refund of $100.
The EITC is considered both (1) an anti-poverty program and (2)
an alternative to cash-transfer programs because it incentivizes
work. The EITC is work-oriented in that the amount of the credit
is based on earnings. The amount of the credit (which varies
depending on the number of qualifying children in addition to
earned income) initially rises as earnings increase, then
reaches a plateau, and then falls as earnings increase further.
For example, for a couple with two children in 2014, the credit
is equal to 40 percent (the credit rate) of the first $13,650 in
earnings. The maximum credit of $5,460 is received by taxpayers
with earnings between $13,650 and $17,830. The credit phases out
at a rate of 21.06 percent (that is, it is reduced by 21.06
cents for every additional dollar of earnings) for earnings over
$17,830 and is zero for taxpayers with earnings over $43,756.
The value of the EITC has increased over time. For example, the
maximum credit for a worker with three children has increased
from $400 in 1978 (roughly $1,465 in 2014 dollars) to $6,143 in
2014.
Current state law provides that individuals with income below
specified levels are not required to file a return, as the
standard deduction and personal exemption credit eliminate any
tax liability. For 2013, these thresholds are $12,562 in
adjusted gross income for single filers, and $25,125 in adjusted
gross income for married individuals filing jointly. These
thresholds are increased based on the number of dependents
claimed and are increased annually for inflation.
Twenty-five states, the District of Columbia, and two local
jurisdictions (New York City and Montgomery County, Maryland)
currently provide the EITC in varying forms and amounts.
Proposed Law: SB 1189 would allow a nonrefundable state tax
credit equal to 15 percent of the federal EITC. SB 1189 would
take effect immediately as a tax levy and be effective beginning
in the 2015 tax year. The bill would sunset at the end of 2025,
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and would require FTB to report annually to the Legislature
regarding utilization of the credit.
Related Legislation:
AB 1974 (Dickinson), of the 2011-12 Legislative Session,
would have established a refundable EITC equal to 15
percent of the federal EITC. AB 1974 was held by the
Assembly Appropriations Committee.
AB 1196 (Allen), of the 2011-12 Legislative Session,
would have established a refundable EITC equal to 15
percent of the federal EITC. AB 1196 was held by the
Assembly Appropriations Committee.
Staff Comments: FTB reports that taxpayer error rate and fraud
concerns on the federal EITC cause the IRS to adjust many
returns. Consequently, the correct federal EITC amount may be
unknown until after the taxpayer has filed the state return,
claimed the proposed California credit, and received a refund.
To the extent that this occurs, FTB would be required to issue
assessments to correct and collect tax due as result of a change
to the federal EITC, which would increase administrative costs.
The actual revenue loss associated with the bill is difficult to
estimate with precision. In order to claim the federal EITC, a
qualifying taxpayer must file a federal income tax return. This
is the only way to claim the credit, even for those taxpayers
who do not earn sufficient income to be required to file. As a
result, it has been estimated that in 2009, about 800,000
Californians (about 20 percent of those eligible) failed to
claim EITC refunds. The revenue estimate for SB 1189 must
incorporate assumptions regarding (1) whether the introduction
of the state-level EITC increases the extent to which the
federal EITC is claimed, and (2) the future growth of wage
income (and by extension the growth of the economy). Greater
EITC participation and a stronger wage growth would increase the
revenue loss associated with this bill.