Extending the EITC to Noncustodial Parents: Potential Impacts and Design Considerations

Submitted to:
Office of the Assistant Secretary for Planning and Evaluation (ASPE)
U.S. Department of Health and Human Services

Submitted by:
The Urban Institute

Authors:
Laura Wheaton and Elaine Sorensen

Under current federal income tax rules, low-income noncustodial parents are ineligible for the EITC benefits available to low-income families with children, even when they support their children through full payment of child support. While the EITC and child support have successfully removed many low-income working families from poverty, the combined effect of taxes and child support payments can impoverish noncustodial parents working at or near the minimum wage. Noncustodial parent (NCP) EITC policies work to reduce this disparity. This report provides background and rationale for an NCP EITC. It examines three policy scenarios for a national NCP EITC, which are based on the NCP credits adopted by New York and Washington, D.C., and proposed in S. 1626. Estimates are provided for the number of noncustodial parents who would be eligible for an NCP EITC and for the size of the benefit and overall cost. Lastly the report identifies key design and implementation issues to be considered when enacting an NCP EITC.

Executive Summary

The state of New York and the District of Columbia are the first jurisdictions to implement an innovative policy—an earned income tax credit (EITC) for low-income noncustodial parents who work and pay their child support in full. A similar tax credit was introduced by Senator Bayh and then-Senator Obama in 2007 (S. 1626). A noncustodial parent (NCP) EITC operates like the child-based EITC, which provides a refundable tax credit to low-income working families with children and encourages work. Under current federal income tax rules, low-income noncustodial parents are ineligible for the EITC benefits available to low-income families with children, even when they support their children through full payment of child support. While the EITC and child support have successfully removed many low-income working families from poverty, the combined effect of taxes and child support payments can impoverish noncustodial parents working at or near the minimum wage. NCP EITC policies work to reduce this disparity and to increase incentives for work and payment of child support.

We examine three policy scenarios for a national NCP EITC, which are based on the NCP credits adopted by New York and Washington, D.C. and proposed in S. 1626. Based on the NCP EITC policies examined here, we estimate that as many as 645,000 noncustodial parents (5 percent of all noncustodial parents) would be eligible for an NCP EITC, depending on the age and income criteria for the credit. On average, these policies would increase the annual incomes of eligible noncustodial parents by between $500 and $1,900—an increase of 6 to 12 percent in income after taxes and payment of child support. Estimated costs for an NCP EITC range from under $100 million to $1.1 billion (in 2004 dollars) depending on the policy option chosen.

We review several key design and implementation issues that should be considered when enacting an NCP EITC. Specifically, we note the following:

• Limiting an NCP EITC to those in the child support enforcement program, as is done in New York and Washington, D.C., would simplify the administration of an NCP EITC, but some people who pay the full amount of their child support order would not be eligible.
• New York and Washington, D.C. limit eligibility to noncustodial parents who pay at least the amount of current support due during the tax year. Requiring that each month’s payment be made on time or that the noncustodial parent have no child support arrears could substantially reduce eligibility. Eligibility could be expanded by providing a partial credit to those paying some, but not all, of the amount due.
• Because many noncustodial parents are eligible for the child-based EITC, policymakers should consider whether these parents should be eligible for both a child-based EITC and an NCP EITC. In New York, noncustodial parents can only receive one credit.
• The interaction of the NCP EITC with federal and state tax intercept programs should be considered. If a noncustodial parent’s tax refund is intercepted to pay child support arrears, as is done in New York and Washington, D.C., then custodial families and the government would benefit, but incentives to work and pay child support would be lower than if the credit were not intercepted.
• There are important steps that the government can take to encourage participation in an NCP EITC. If child support enforcement agencies pre-certify that noncustodial parents are eligible for the credit, then applications can be kept simple (for example, by not requiring Social Security numbers for the children) and noncustodial parents can be notified that they meet the child support criteria for the credit. Neither of these steps was taken in New York or Washington, D.C., but these steps would likely increase participation in an NCP EITC.

An NCP EITC provides an additional tool for encouraging child support payments by low-income noncustodial parents. Modifying and establishing child support orders that reflect the circumstances of low-income noncustodial parents would further reduce the likelihood that low-income noncustodial parents are impoverished as they work and pay child support. Custodial families would also benefit from the increased child support payments produced in response to the incentives generated by an NCP EITC.

I. Introduction

In 2006, the state of New York and the District of Columbia became the first jurisdictions to implement an earned income tax credit (EITC) for low-income noncustodial parents who work and pay their child support in full. The Responsible Fatherhood and Healthy Families Act of 2007 (S. 1626), introduced by Senator Bayh and then-Senator Obama, would create a similar tax credit at the federal level. Under current federal income tax rules, low-income noncustodial parents are ineligible for the EITC benefits available to low-income families with children, even when they support their children through full payment of child support. While the EITC and child support have successfully removed many low-income working families from poverty, the combined effect of taxes and child support payments can impoverish noncustodial parents working at or near the minimum wage. Noncustodial parent (NCP) EITC policies work to reduce this disparity.

Like the EITC, an NCP EITC also increases work incentives by supplementing the incomes of low-wage workers. Because noncustodial parents must pay child support to be eligible, incentives to pay child support are increased, which can in turn produce more child support payments to custodial families. If an NCP EITC extends eligibility to noncustodial parents with child support arrears, then custodial families will also benefit when the noncustodial parent’s tax refund is intercepted to repay arrears owed to the family.

We examine three policy scenarios for a national NCP EITC, which are based on the NCP credits adopted by New York and Washington, D.C. and proposed in S. 1626. Based on the NCP EITC policies examined here, we estimate that as many as 645,000 noncustodial parents would be eligible for an NCP EITC, depending on the age and income criteria for the credit. On average, an NCP EITC would increase the annual incomes of eligible noncustodial parents by between $500 and $1,900. Estimated costs for an NCP EITC range from under $100 million to $1.1 billion (in 2004 dollars) depending on the policy option chosen.

There are several key design and implementation issues that need to be considered when enacting an NCP EITC. One of these issues is whether the credit should be limited to those in the child support enforcement program or open to all with a child support order. Also, the definition of “full payment” has important implications for the administration of the credit and how many noncustodial parents would benefit. Another key issue is how dual-eligibility should be treated, as many noncustodial parents live with some of their children while living apart from others and thus could be eligible for both the child-based EITC and the NCP EITC. Also of interest is how the NCP EITC would interact with the tax offset program. Lastly, different strategies to encourage participation should be considered.

Below, we provide background and rationale for an NCP EITC, present alternative designs for an NCP EITC, and estimate their costs and effects. We then discuss key issues to consider when designing and implementing an NCP EITC.

II. Background

The federal EITC is the nation’s largest antipoverty program, providing $44.4 billion in benefits to 23 million low-income working families and individuals in 2006 (IRS 2008). A key attribute of the federal EITC is that it is refundable—the credit first reduces a family’s tax liability (if any) to zero, and the remaining credit is then paid to the family. The federal EITC was enacted in 1975 to offset Social Security taxes for low-income families and to increase work incentives; it has been considerably expanded over the years. Childless workers and those whose children live elsewhere were initially ineligible for the EITC, but they became eligible for a small credit beginning in the 1994 tax year. In addition to the federal EITC, 23 states, the District of Columbia, and several local governments have EITCs.[1]

To receive the more generous “child-based” EITC, a taxpayer must have a “qualifying child” who resides with the taxpayer for more than half the year. Thus, noncustodial parents are ineligible for the EITC on behalf of children living elsewhere—even if they meet their child support obligation. In 2008, a taxpayer with two resident children could receive up to $4,824 in EITC, compared with $438 in “childless” EITC benefits for a taxpayer without resident children. With some exceptions, noncustodial parents are ineligible for other tax benefits on behalf of their nonresident children, including the dependent exemption, head-of-household filing status, child tax credit, and child and dependent care credit.

While the child-based EITC removes many low-income families from poverty (Holt 2006), the combined effect of child support payments and taxes can drive a low-wage noncustodial parent into poverty (Primus 2006; Wheaton and Sorensen 1997). Since 1989, the federal government has required that states have mandatory judicial guidelines for setting child support awards. However, states vary considerably in the definition of income, the amount of award levels, and the treatment of low-income noncustodial parents. In most states, child support awards are regressive, meaning that the higher the income of the noncustodial parent, the lower the percentage of income devoted to child support. Moreover, many states impute a minimum level of income to noncustodial parents when determining their child support award on the assumption that everyone should be able to work at least at a full-time year-round minimum-wage job. Thus, even though noncustodial parents’ income may be lower than this amount, their orders are not reduced. In a study of seven large states, half of noncustodial parents with child support orders and reported incomes under $10,000 were required to pay at least 83 percent of their income in child support. Of those with reported income between $10,000 and $20,000, half were required to pay at least 22 percent of their income in child support (Sorensen, Sousa, and Schaner 2007).

A simple example illustrates how the current tax system and child support guidelines improve the incomes of low-income custodial families but can drive low-income noncustodial parents into poverty. In 2008, a full-time, full-year minimum-wage worker would earn $12,775 for the year, which is equal to 74 percent of the poverty level for a single parent with two children and 114 percent of the poverty level for a single individual (table 1). A custodial parent with two children and earnings of $12,775 would pay $977 in payroll taxes, and would receive $641 in refundable child tax credits and $4,824 in EITC benefits. A noncustodial parent with the same earnings would pay $1,360 in payroll and federal income taxes and receive $8 in childless EITC benefits, resulting in after-tax income of $11,423. A typical child support guideline would require noncustodial parents with two children to pay 25 percent of gross income on child support, for a total of $3,194 for the year. Child support and federal taxes would thus increase the custodial family’s income to $20,456 (118 percent of the poverty level for a single parent with two children) while reducing the noncustodial parent’s income to $8,229 (73 percent of the poverty level for a single individual).

An NCP EITC could reduce the negative effects of the current tax system and child support guidelines on low-income noncustodial parents (Primus 2006; Sorensen 1999; Wheaton and Sorensen 1997). Another approach would be to change the treatment of low-income noncustodial parents in state child support guidelines. In combination, these two approaches could help ensure that orders for low-income noncustodial parents are set at an amount where full payment is possible, reduce the likelihood that noncustodial parents who work and pay support will be impoverished, and encourage work and child support payment among noncustodial parents. Custodial families would benefit from the increased child support payments produced in response to the incentives generated by these policies.[2]

III. Noncustodial Parent EITC Policies

Various approaches could be taken to constructing an NCP EITC.

Line graph showing credit amounts at different income levels for six different scenarios.

• For Income $0 Childless EITC credit amount equals $0; for income $5,100, 390.15; for income 6390, 390.15; for income 11490, 0.
• For Income $0 Twice the Childless EITC credit amount equals $0; for income $5,100, $780; for income $6,390, $780; for income $11,490, $0.
• For Income $0 Twice expanded childless EITC (S.1626) credit amount equals $0; for income $5,866, $897; for income $11,733, $897; for income $17,599, $0.
• For Income $0 2/3 EITC for 1 qualifying child (NY) credit amount equals $0; for income $7,660, $1,736; for income $14,040, $1,736; for income $30,338, $0.
• For Income $0 EITC 2+ qualifying children (DC) credit amount equals $0; for income $10,750, $4,300; for income $14,040, $4,300; for income $34,458, $0.
• For Income $0 EITC 1 qualifying child (DC) credit amount equals $0; for income $7,660, $2,604; for income $14,040, $2,604; for income $30,338, $0.

Notes: The 2004 values shown here are equivalent to 2008 values deflated to 2004 dollars. The EITC phases out with earnings or with adjusted gross income, whichever is larger.

Under our specifications, the D.C.-based scenario provides the most generous credit, followed by the New York–based scenario, and then the S. 1626-based scenario. Specifically, if the NCP EITC is equal to the full child-based EITC, then a noncustodial parent would receive a maximum credit of $2,604 (if one child—phasing out at $30,338) or $4,300 (if two or more children—phasing out at $34,458). Table 2:
Estimated Earnings and Child Support Payment Status of Noncustodial Parents in 2004 Earnings¹ Noncustodial Parents (1000s)² Percent Paying No Child Support³ Some of Child Support Due All of Child Support Due <=0 1,655 84% 12% 4% 0<-$5,000 502 68% 29% 3% $5,000-<$10,000 452 68% 24% 8% $1-$9,999 954 68% 27% 5% $10,000-$19,999 1,461 62% 22% 16% $20,000-$29,999 1,755 57% 18% 25% $30,000-$39,999 1,398 52% 16% 32% $40,000+ 4,692 49% 14% 37% Subtotal $1-$29,999 4,170 61% 22% 17% Total 11,915 58% 17% 25% Source: TRIM3 Microsimulation Model Using Data from the 2005 ASEC. ¹ Earnings include earnings of a spouse, if present. ² Noncustodial parents represented here exclude institutionalized parents and cases in which the child
   lives with neither parent, but include all other noncustodial parents resident within the United States,
   including those for whom paternity has not been established or there is no child support order. ³ The "no child support" column includes cases where paternity has not been established or there is no
   formal child support order, as well as cases where the noncustodial parent pays none of the support due.

The NCP EITC policies considered here require full payment of child support due under a child support order, a requirement that the majority of noncustodial parents do not meet. Of the estimated 11.9 million noncustodial parents in 2004, 25 percent paid all child support due under a child support order during the year, and another 17 percent paid some of the support due. Those not paying any support include cases for which paternity has not been established or there is no child support order, as well as cases where an order has been established but the noncustodial parent does not pay any of the required child support. Full payment is less likely at lower earnings levels. Seventeen percent of noncustodial parents with earnings below $30,000 and 5 percent of noncustodial parents with earnings below $10,000 paid the full amount of child support due under a child support order. Table 3: Estimated EITC Eligibility of Noncustodial Parents Earnings¹ Noncustodial Parents (1000s)² Percent of Noncustodial Parents who are: Ineligible for EITC Eligible for EITC Total Childless Child-Based <=0 1,655 100% 0% 0% 0% $1-$9,999 954 30% 70% 46% 24% $10,000-$19,999 1,461 58% 42% 10% 31% $20,000-$29,999 1,755 65% 35% 0% 35% >$30,000-$39,999 1,398 76% 24% 0% 24% >$40,000+ 4,692 100% 0% 0% 0% >Subtotal $1-$29,999 4,170 55% 45% 14% 31% >Total 11,915 81% 19% 5% 14% Source: TRIM3 Microsimulation Model Using Data from the 2005 ASEC. EITC eligibility is estimated on 2004 income using 2008 rules deflated to 2004 dollars. ¹ Earnings include earnings of a spouse, if present. ² Noncustodial parents represented here exclude institutionalized parents and cases in which the
  child lives with neither parent, but include all other noncustodial parents resident within the United
  States, including those for whom paternity has not been established or there is no child support order.

V. Estimated Impact of Different NCP EITCs

Holding the eligible age range constant, the S. 1626-based NCP EITC policy (which is equal to twice an expanded childless EITC) would cost the least, reach the smallest number of noncustodial parents, and yield the smallest average increase in EITC benefits. If all noncustodial parents age 18 or older who paid their full child support were eligible, then an estimated 162,000 noncustodial parents would qualify for an average $541 increase in EITC benefits for a total $87 million in additional benefits (table 4). Table 4.
Tax Units Eligible for the NCP EITC, Under Three Alternative Scenarios, by Eligible Age Range (All results are shown in 2004 dollars) NCP EITC Scenario Tax Units Eligible for NCP EITC (thousands) Average After-Tax Income (Before EITC)¹ Average Annual Child Support Paid Average EITC Average Percent Increase in Income after Child Support, Taxes, & EITC Estimated Cost (millions) Under Current Rules Under Modeled Scenario Average Increase Twice the Expanded Childless EITC (based on S.1626) 18+  162 11,854 2,821 44 585 541 6% 87 18-30 36 11,739 2,488 21 646 625 7% 23 25-64² 136 11,990 2,991 53 566 513 6% 70 2/3 EITC for Single Filer/One Child (based on NY policy) 18+² 521 18,773 3,807 14 908 894 6% 466 18-30 115 17,712 3,046 7 979 972 7% 112 25-64 485 19,161 3,919 15 871 856 6% 415 Full Qualifying Child EITC (based on DC policy) 18+ 645 20,354 4,080 94 1,826 1,732 11% 1,117 18-30² 131 18,723 3,310 101 1,985 1,884 12% 246 25-64 604 20,675 4,194 96 1,792 1,696 10% 1,025 Source: TRIM3 Microsimulation Model Using Data from the 2005 ASEC. Taxes and EITC eligibility are estimated on 2004 income using 2008 rules deflated to 2004 dollars. ¹ After-tax income is equal to cash income, less the employee share of payroll taxes, less federal income
  taxes (excluding the EITC). ² Indicates the actual eligible age range for the policy on which this scenario is based.

Imposing an age limit would reduce the eligibility and costs of an NCP EITC, especially if it is limited to noncustodial parents between the ages of 18 and 30. Restricting the D.C.-based scenario, for example, to those between 18 and 30 (rather than 18 and older) would reduce the number of noncustodial parents eligible for the credit from 645,000 to 131,000 and would reduce the cost from $1.1 billion to $246 million. This is because most noncustodial parents are over 30 years old and an even higher percentage of noncustodial parents who pay their full child support are over 30. Restricting eligibility to those age 25 to 64 would also reduce eligibility and costs, but by a relatively modest amount (i.e., around 10 to 20 percent).

The NCP EITC policies examined here would increase the annual incomes of eligible noncustodial parents by between $500 and $1,900 on average, depending on the policy and eligible age range. This represents an increase of between 6 and 12 percent in average income after taxes and payment of child support. The highest dollar and percentage increases in income occur under the D.C.-based scenario. The New York–based scenario increases the average dollar amount of income by more than the S. 1626-based scenario, but both have similar effects on the percentage of income. This occurs because the New York–based scenario has a larger eligible income range than the S. 1626-based scenario.

Table 5 shows the distribution of eligible noncustodial parents and NCP EITC benefits by earnings level. Nearly all the noncustodial parents eligible for the S. 1626-based NCP EITC have earnings below $20,000, and most (79 percent) have earnings between $10,000 and $19,999. Table 5:
Distribution of NCP EITC Eligibility and Benefits Under Three Scenarios
(Assuming Eligibility Extends to Noncustodial Parents Aged 18 and Above)   Noncustodial Parents (thousands) Benefits (millions of 2004 dollars) NCP EITC Scenario (Age 18+ Eligible) Twice Expanded Childless EITC ("S.1626") 2/3 EITC Single Filer/One Child       ("NY") Full Qualifying Child EITC ("DC") Twice Expanded Childless EITC ("S.1626") 2/3 EITC Single Filer/One Child       ("NY") Full Qualifying Child EITC ("DC") Total 162 521 645 $87 $466 $1,117 Earnings Level¹ $1 - $9,999 19% 6% 5% 21% 8% 6% $10,000 - $19,999 79% 31% 26% 79% 54% 44% $20,000 - $29,999 2% 56% 51% 0% 37% 45% $30,000 - $39,999 0% 6% 18% 0% 1% 5% Source: TRIM3 Microsimulation Model Using Data from the 2005 ASEC. EITC eligibility is estimated on 2004 income using 2008 rules deflated to 2004 dollars. ¹ Earnings include earnings of a spouse, if present. ² The income to poverty is calculated under the official poverty definition and includes the income of family members with whom the noncustodial parent resides.

The numbers presented here are estimates of eligibility. The number of noncustodial parents claiming the NCP EITC could be substantially smaller. Our estimates do not capture all nuances regarding eligibility,

Our estimates assume that a noncustodial parent would meet the “child support eligibility” requirements for an NCP EITC if he or she pays at least as much child support during the year as accrues during the year. This is the definition of full payment used by New York and Washington, D.C. Under this definition, the noncustodial parent can have arrears that accrued in prior years, as long as an amount equal to the current year’s support has been paid. Payments can include current support and/or arrears—as long as the total equals or exceeds the amount of current support due during the year.

Alternative definitions of full payment—such as requiring that each month’s child support be paid in full and on time—would increase administrative complexity and reduce the number of noncustodial parents eligible for the NCP EITC. Many noncustodial parents who pay child support have arrears, so denying the NCP EITC to noncustodial parents with arrears would also reduce eligibility.http://www.stateeitc.com/basics/index.asp, accessed November 24, 2008.