Where the EITC Goes: A Qualitative Examination of EITC Allocation

The Earned Income Tax Credit (EITC) subsidizes the earnings of low-wage workers through a sizable, annual tax refund. As a result, this lump-sum credit plays a unique role in the budgets of low-income families. Many presume this large amount of money usually goes to a big-ticket consumption item, such as a laundry machine, a computer, or furniture. However, a new working paper suggests this may not always be the case. Ruby Mendenhall, Kathryn Edin, Susan Crowley, Jennifer Sykes, Laura Tach, Katrin Kriz, and Jeffery R. Kling examine families’ allocation of the EITC in their working paper, “The Role of Earned Income Tax Credit in the Budgets of Low-income Families.”

The study obtained information on the EITC allocation of 194 households with dependent children during the 2006 tax season. The study was performed in the Boston, Massachusetts and the Champaign-Urbana, Illinois metropolitan areas with the intent of representing the range of living costs that EITC recipients may encounter.  After gathering initial survey data, a stratified random subsample of families receiving at least $1,000 in EITC were selected for in-depth interviews. The $1,000 threshold was used to ensure the study only included families who had an opportunity for meaningful savings and asset building. Six months after receipt of the EITC, the same families were interviewed again to observe how they actually used their EITC refund.

The authors found that 82 percent of households in their study hoped to use part of their refund to pay off debts. In addition, 25 percent planned on using the refund on shopping for clothing and household items and 22 percent of families reported that they intended to use the refund on groceries. Fifty-seven percent of the participants planned to save some of their refund, with 15 percent stating that they would like to spend a portion of their refund on a down payment for a home, while another 15 percent of families hoped to save for school.  However, when a household’s EITC funds were actually allocated, only 39 percent of surveyed families saved part of their EITC, eight percent saved for homeownership, and three percent paid or saved for school with their EITC.

The authors report that two-thirds of funds initially saved were spent on unexpected shortfalls in monthly income or unanticipated monthly expenses. Many respondents prioritized debt repayment over asset accumulation, and as a result, cited debt as a barrier to saving. Nevertheless, it is notable that the stated purpose of debt repayment for many households was often related to asset-building goals.

The authors also examine household allocation of the EITC toward non-necessity expenditures, referred to in the study as “treats.” Although only seven percent of a family’s refund dollars were spent on “treats,” nearly every household in the study reported spending in this category. While many middle-income families would take a computer game or a plush toy for granted, such items might be a rare once-a-year luxury for low-income children. One example, provided in the study, highlights a family that spent $240 dollars on an overnight birthday excursion to Red Lobster for her child. The authors contend that the “treats” expenditure has a two-fold effect: a boost in confidence to parents in their role as providers, and the luxury of experiencing freedom from financial worry, even if only for a few weeks.

Findings from the study suggest households viewed the EITC as a form of savings in and of itself and even viewed eligibility for the program as engaging in saving behavior due to the lump-sum nature of the payment. The authors found that most participants voiced a strong preference for receiving a lump-sum payment, as opposed to monthly disbursements. Furthermore, most families preferred that the government hold the money until tax season, because it allowed for an accumulation of a large sum of money that could be used for large purchases. With many families already expressing a desire to save their EITC refund, programs that educate families on various savings strategies and budgeting may also help families become successful in meeting savings goals through the EITC.

Feature Photo: cc/Images_of_Money