The earned income tax credit (EITC) was

enacted in 1975 to reduce the burden of

social security taxes on low-income

workers, thereby encouraging them to

seek employment rather than welfare

benefits. Program expansions enacted

in 1990 and 1993 made the EITC one of

the largest programs targeted to lowincome individuals. In 1996, the credit

is expected to provide an estimated $25

billion to over 18 million low-income

workers and their families (or over

$1,388 per recipient). Rural residents

are major beneficiaries of the expanded

credit, with low-income rural workers

and their families receiving about a

fourth of all benefits.

The EITC’s rapid expansion since 1990

has heightened concerns about increased

incidents of fraud, imprecise benefit

targeting, and high program costs.

These concerns have triggered efforts

to streamline program administration

and to target benefits better. Other

program changes have also been

proposed that could significantly reduce future benefits.

The earned income taxcredit (EITC) has become

a major source of income

support for low-income rural

workers and their families,

especially in the South, where

the rural poor are concentrated. Program benefits

for rural areas are expected

to total about $6 billion in

1996, nearly double the 1992

amount, providing benefits

to an estimated 4.5 million

low-income rural workers

and their families. Increasing

concerns about escalating

costs and the targeting of

benefits may result in changes

to the EITC program that

would reduce both benefit

levels and the number of

eligible low-income rural

workers. Proposed changes

to improve the targeting of

benefits would exclude many

farmers from the program.

United States

Department of

Agriculture

Agriculture

Information

Bulletin No. 724-02

April 1996

ISSUES IN AGRICULTURAL AND RURAL FINANCE

How Would Changes

to the Earned Income

Tax Credit Affect

Rural Recipients?

How the Earned Income Tax Credit Works

Earned income tax credit, 1996

Earned

Type of Credit income Maximum Phase-out Phase-out Phase-out

recipient rate amount credit rate begins ends

Families w/1 child 34.00% $6,330 $2,152 15.98% $11,610 $25,078

Familes w/2+ children 40.00% $8,890 $3,556 21.06% $11,610 $28,495

Workers w/o children 7.65% $4,220 $323 7.65% $5,280 $9,500

The earned income tax credit (EITC) is a

refundable tax credit available to lowincome workers who satisfy certain income and other eligibility criteria. For

low-income workers with children, the

criteria require that the children satisfy

an age, relationship, and residency test.

For workers without children, the criteria

require that the taxpayer be between

the ages of 25 and 65 and not be claimed

as a dependent of another taxpayer. 

Unlike most other cash-assistance programs for low-income families, the EITC

requires recipients to work. Furthermore,

where other benefit-transfer programs

reduce benefits for higher earnings, the

EITC increases, at least at the lower income levels, for each additional dollar

of earnings until a maximum credit is

reached. This encourages recipients to

work to increase their credit amount.

Like most other programs, once an income threshold is reached, the credit is

reduced as earnings increase.

Most taxpayers receive the EITC in a

lump sum at the end of the year by

claiming it on their Federal income tax

return. Since the credit is refundable,

any amount in excess of Federal income

or other tax liabilities is refunded to the

taxpayer to help offset social security

taxes. Eligible recipients also have an

advance payment option that allows

them to receive a portion of their benefits throughout the year.

Example: Families w/1 child with earned income between $6,330 and $11,610 receive the

maximum benefit of $2,152. For earned incomes between $11,610 and $25,078, the benefit

is reduced at a constant rate of $15.98 per $100 of additional income.
2 Issues in Agricultural and Rural Finance / AIB-724-02 Economic Research Service/USDA

Larger Share of Rural

Workers Receive the EITC

Rural households have historically had

lower incomes and a higher poverty

rate than urban households. In 1992,

rural taxpayers reported average adjusted gross income of $24,742 compared

with $33,884 for urban taxpayers. That

same year, 16.8 percent of rural persons

lived in poverty, compared with 13.9

percent of urban people. One reason

for the higher rural poverty rate is the

preponderance of low-wage jobs found

in rural areas. In 1992, rural areas were

home to 33 percent of full-time, fullyear workers who were poor, but only

about 20 percent of all full-time, fullyear workers.

Given the income differential and the

prevalence of low-wage jobs in rural

areas, rural taxpayers benefit the most

from programs targeted at low-income

workers. In 1992, rural taxpayers received over $3.3 billion in benefits and

represented a quarter of all credit recipients. In the same year, nearly 16 percent

of rural taxpayers received an EITC

(average credit $912) compared with

12 percent of urban taxpayers (average

credit $929). Farmers, however, are

not major beneficiaries of the EITC.

In 1992, only about 8 percent of all

farmers (individuals filing a farm income tax return) received the EITC.

Benefits Are Greatest Where

Rural Poor Are Concentrated

In 1992, about one out of every eight

taxpayers received the EITC. However,

the rate varied widely by State. The

share of taxpayers receiving the credit

in Southern States, where the rural

poor are concentrated, was well above

the national average (fig. 1).

Like Food Stamps and Supplemental

Security Income, but unlike Aid to

Families with Dependent Children

(AFDC), the eligibility criteria and rate

of the EITC are the same nationwide.

This is especially important for the

rural poor, since 53 percent of them

live in Southern States, where AFDC

benefit amounts are well below the

national average.

Recent Changes 

Increased Rural Benefits

The Omnibus Budget Reconciliation

Act of 1990 and the Revenue Reconciliation Act of 1993 broadened EITC

coverage and increased its benefit

levels. The 1990 act broadened EITC

coverage by simplifying eligibility rules

and by reducing interactions between

the EITC and other low-income assistance programs. The 1993 act extended

the coverage to an additional 4 million

workers (rural and urban) by offering

the credit to low-income workers

without children. The combined effects

of these acts increased the credit rate

from 14 to 36 percent of earned income

for workers with one child and from

14 to 40 percent for workers with two

or more children. These rate increases,

combined with an increase in the maximum income level on which the credit

is calculated, have more than doubled

the maximum credit for workers with

one child and have nearly quadrupled

the maximum credit for workers with

two or more children.

Both the number of beneficiaries and

the level of benefits will increase because of the expanded credit provisions in the 1990 and 1993 acts. Compared with 1992, benefits to rural recipients are expected to nearly double

to an estimated $6 billion. Most of

these increased benefits will go to

low-income workers with two or more

children. Their average benefit will

increase from $911 in 1992 to an estimated $2,154 in 1996; the average benefit for low-income workers with

only one child will increase from

$912 to an estimated $1,399. 

The extension of the credit to low-income workers with no children will

benefit an estimated 900,000 low-income rural workers. However, since

the average benefit in 1996 for these

workers is much lower ($168), the

aggregate benefit is estimated at less

than 3 percent of the total EITC for

rural workers (fig. 2).
Economic Research Service/USDA Issues in Agricultural and Rural Finance / AIB-724-02

Targeting and Other Concerns

Prompt Program Changes

Even before the 1993 expansion of the

EITC became fully effective, concerns

about the targeting of benefits, rapidly

escalating costs, and increasing evidence

of fraud prompted efforts to target

benefits better, reduce fraudulent claims,

and reduce future benefit levels. Since

the EITC is administered through the

tax system, participation rates have

been high. However, fraud and error

rates have also been high, with some

Internal Revenue Service (IRS) studies

suggesting that as many as a third of

EITC recipients were not eligible for

all or a portion of the benefits received.

The IRS has taken steps to detect fraudulent claims and to make other changes

to improve program administration.

Targeting Proposals Can Increase

Benefits Provided to the Poor

Until 1991, the combined employeeemployer social security tax rate had

always exceeded the EITC rate. However,

the current credit rate (40 percent) for

workers with two or more children is

2.5 times the combined social security

tax rate. In fact, only about half of the

current credit amount going to rural

recipients with adjusted gross income

below $10,000 is needed to offset all

Federal income and payroll taxes. This

indicates that the credit has expanded

well beyond a payroll tax offset to

become a means of lifting low-income

working families above the poverty line.

This expanded role and the escalating

costs of the program have heightened

concerns regarding the targeting of

benefits. The current EITC does not

consider a taxpayer’s assets or certain

sources of income, such as interest,

dividend, rent, or royalty income, unless

adjusted gross income exceeds earned

income (in which case adjusted gross

income is used to phase out EITC

benefits). Various nontaxable sources

of income, including tax-exempt interest, social security benefits, and

child support payments, are also not

considered in determining eligibility.

Under a broader measure of income

that includes nontaxable income sources,

over 1 million recipients (both rural

and urban) have over $30,000 in income. Many of the recipients in this

group are clearly outside the intended

group targeted for benefits.

Legislation enacted in early 1995 addressed some of these concerns. Beginning in 1996, individuals will no longer

be eligible for the EITC if their interest,

dividend, rent, or royalty income

(disqualified income) exceeds $2,350.

The primary purpose of this change

was to improve the targeting of benefits by denying eligibility to individuals

with a level of asset-based income

that suggests some wealth, regardless

of their level of earned income. This

change could remove from eligibility

between 1 and 2 percent of all EITC

recipients. While the effect on rural

recipients is expected to be slightly

less, up to 10 percent of farmers currently receiving the credit will be ineligible in 1996, primarily due to

their relatively high level of interest

income reported.

Other asset-based income sources, such

as net capital gains, could be added to

the disqualifying income list. If net

capital gains were added, the number

of farmers removed from eligibility

would double, primarily because sales

of certain farming assets qualify as a

capital gain. 

Another alternative for improved targeting is to expand the definition of adjusted gross income for purposes of

phasing out the credit. Under one proposal, adjusted gross income would

include certain nontaxable income

items, including nontaxable social security benefits, tax-exempt interest,

nontaxable pension distributions, and

child support payments in excess of

$6,000. Certain losses, including farm

losses, would also be disallowed, affecting benefits for about 10 percent

of current recipients. Again, farmers

would be disproportionately affected

(primarily due to the disallowance of

farm losses) since nearly half of all

farmers receiving the EITC reported

farm losses, with the average loss

about $10,500.

While these benefit-targeting proposals

would substantially reduce benefits to

farmers, possibly halving the number

of farmers eligible for the credit, these

changes would primarily reduce benefits to higher income recipients, increasing the share of benefits going to

the working poor. However, both the

disqualified income test and an expanded adjusted gross income definition would impose additional burdens

on taxpayers in determining eligibility

and on the IRS in ensuring compliance.

Broader Changes Could

Greatly Reduce Future Benefits

Concerns regarding the escalating costs

and the expanded role of the EITC

have led to proposals that would make

much broader changes to the credit.

These proposals include eliminating

the EITC for low-income workers

without children and reducing the

credit for higher income workers

with children, especially those with

two or more children. These changes

would have a much greater effect

than targeting proposals on future recipients and benefit levels.

Eliminating the EITC for Workers

Without Children. Before 1993, the

EITC was available only to low-income

workers with children. This restriction

effectively excluded a large segment

3

0

20

40

60

80

Share of recipients

Share of benefits

Worker

without

children

Family

with one

child

Family

with two

or more

children

 Source: Economic Research Service estimated

from Internal Revenue Service data.

Figure 2

Distribution of Earned Income Tax Credit

benefits, by type of rural recipient

Percent
4 Issues in Agricultural and Rural Finance / AIB-724-02 Economic Research Service/USDA

of the working poor from receiving

benefits under the credit. Providing

benefits to low-income workers

without children, especially at a rate

equal to the employee’s share of social security taxes, is consistent with

the original objectives of the credit. 

Eliminating the EITC for childless

low-income workers would remove

benefits for an estimated 900,000 rural

workers. While the estimate of total

benefits lost to these workers is less

than 3 percent of the total EITC for

all rural workers, the great majority

losing benefits would be poor or have

total income just above the poverty

level. The poverty level for a twoperson household is about $10,000.

For childless taxpayers, the credit is

only available if the greater of earned

income or adjusted gross income is less

than $9,500. Most affected workers have

total income below $20,000, and about

75 percent have income below $10,000.

Reducing the Credit for Higher

Income Recipients With Children.

As the credit rate has increased, the EITC

has been extended to taxpayers with

income well above the poverty level,

leading legislators to propose reductions

in future benefits to such recipients.

One proposal that was incorporated

into recent budget reconciliation legislation is to combine a credit rate reduction with an earned income enhancement factor at the lower income levels.

This proposed change would reduce

from 40 percent to 36 percent the credit

rate for workers with two or more

children and maintain the credit amount

at essentially the same level for lower

income recipients. The proposal would

also increase the phase-out rate for all

recipients with children, reducing the

level of income that taxpayers could

earn and still receive some benefits.

This proposal maintains the credit

level for lower income recipients and

reduces it for higher income recipients.

However, the proposal also would make

EITC calculations more complex, and

the more rapid reduction of benefits

as income increases would reduce the

incentive to work for recipients in the

phase-out range.

The combined effect of eliminating the

EITC for workers without children and

reducing benefits to higher-income

recipients with children would reduce

or eliminate benefits for about half of

all rural credit recipients. Rural recipients would lose nearly 10 percent of

their estimated benefits in 1996. 

Conclusions 

The earned income tax credit has become a major source of income support

for low-income rural workers and

their families, over 4.5 million of whom

(about 20 percent of rural taxpayers)

will receive an estimated $6 billion in

benefits in 1996. This assistance is

especially important in the South where

the rural poor are concentrated and

where benefit levels of other incomesupport programs are below those in

other regions. Recent proposals to

improve targeting of benefits, prevent

fraud, and reduce future benefits, if

enacted, would increase the share of

benefits going to the poor but would

also significantly reduce future benefits

to rural taxpayers, especially farmers.

Contacting the Author

Ron Durst

(202) 219-0896 (voice) 

(202) 219-0908 (fax) 

e-mail: RDURST@ECON.AG.GOV

Further Readings

U.S. Congress, Joint Committee on

Taxation. Description of Present Law

and Discussion of Issues Relating to

the Earned Income Tax Credit. JCX-27-

95, June 14, 1995.

U.S. General Accounting Office.

Earned Income Tax Credit: Targeting

the Working Poor. Washington, DC,

Mar. 1995.

About the Data

Data for this article are based on

special tabulations from the 1992

Internal Revenue Service Individual

Tax Model File. For additional detail

concerning the data, contact the author.

Finding Reports in This Series

These reports are available electronically through the ERS Home Page

at http://www.econ.ag.gov/ and

through the ERS AutoFAX. To use

the AutoFAX, call (202) 219-1107 on

your fax machine’s handset. Enter

41100 for a directory of available reports. This document is no. 41102.

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