The federal earned income tax credit (EITC) was initially passed during the Ford Administration in 1975, and its subsequent support and expansion have been popular with both Republicans and Democrats. Experts describe the EITC as one of the most effective anti-poverty programs ever implemented. It has lifted millions of low-income working families out of poverty, and research shows that it has helped to increase participation in the workforce by single parents, reduce dependence on public benefits, lower the number of low-birthweight babies, and produce better and lasting educational achievements.
The federal EITC works by reducing the tax liability of eligible families. It is a refundable tax credit. This means it not only decreases the taxes that eligible workers pay, but also gives them a refund if their tax debt is less than the tax credit they’ve earned.
The federal EITC has been so effective that many states and territories have established parallel EITC programs to further reduce taxes for low-income families. In 2017, Hawai‘i joined 28 other states, Washington D.C., Guam and Puerto Rico when it passed our state EITC. A crucial difference, though, is that Hawai‘i’s EITC is not refundable. That means Hawai‘i’s program can only reduce eligible families’ tax liability to zero, even if the full credit amount they are entitled to is larger. They cannot receive a refund and, therefore, cannot benefit from the program’s full potential.
The 2017 bill that created our new state EITC also increased the individual income tax rates paid by Hawai‘i’s wealthiest residents. These two actions were put together so that the effect of the tax credit, which would decrease state funds, would be offset with new tax revenues. The non-refundable EITC, as passed, was expected to cost $12.7 million in 2018 and $16.7 million in 2019. Making the tax credit refundable was estimated to cost an additional $30 million a year, on average, over the first six years.
At the end of May, the State Council on Revenues recently reported on the state’s income status, and the results of the effects of that 2017 legislation couldn’t be more clear: Individual income tax revenue increased by $334 million in 2018 and is projected to increase by another $152 million in 2019. A refundable EITC, in comparison, was projected to cost just $49 million and $50.2 million for each of those years.
Over the first two years since the EITC legislation was passed, the state collected almost five times more than a refundable tax credit was expected to cost.
Toward a Progressive Tax System
Hawai‘i’s lowest-income working families pay nearly 15 percent of their income toward taxes, much more than the 9 percent paid by the wealthiest residents. The EITC is one of the best ways to help reverse this inequity.
The Council on Revenue’s report predicts some other interesting revenue trends for Hawai‘i for the current year through 2025. The following is a summary of general fund revenue projections by source, which we’ve listed by order of magnitude:
The council’s projections seem to be optimistic compared with estimates for overall economic and personal income growth coming from others (for instance, the Department of Business, Economic Development and Tourism’s “Population and Economic Projections for the State of Hawaii to 2045” and UHERO’s May 3rd state forecast through 2021).
Accordingly, we reviewed the council’s projections from May 2014, five years ago, to see how well they matched actual performance between 2014 and 2018. We found that, although there was a lot of variability in what happened within categories of taxes, the council’s predictions were pretty accurate, overall. For 2014 through 2018, the difference between projected and actual general fund revenues averaged just 0.2 percent.
One of the notable—and positive—trends from 2012 to 2019 is that our reliance on GET is waning slightly, while individual income tax collections are increasing. The GET once accounted for 54 percent of all general fund revenues, but is projected to drop to 49 percent in 2019. State income taxes are making up the difference. They’re projected to rise from 31 percent to 36 percent of the total.
This is a good thing because the GET is a regressive tax: it takes a greater proportion of the gross earnings from lower income workers than from more wealthy taxpayers. Our state’s progressive individual income tax has the opposite effect. Increasing tax credits for lower income families can do a lot to offset the GET burden. And that brings us back to the EITC: making it refundable would make Hawai‘i a more progressive tax state and help working families make ends meet.