This year, the Virginia General Assembly introduced a new refundable Earned Income Tax Credit (EITC). The EITC is a federal tax credit that provides tax relief to families based on household size and income. Virginia’s state-level EITC is worth 15% of the federal credit, boosting families’ incomes even further. It joins two existing family credits in Virginia’s tax code: a Low-Income Credit and a 20% nonrefundable EITC. With a new legislative session beginning in January, Virginia can become a leader in family tax policy by extending benefits to even more households and creating a more cohesive tax system. Simplifying the current set of tax credits is the best place to start.
Virginia’s web of credits
There are currently three family tax credits in Virginia (of which families can only claim one):
Families can claim a flat $300 nonrefundable credit for each household member. A nonrefundable credit can only reduce a family’s tax liability to zero. In other words, the credit cannot exceed a family’s tax liability. For example, if someone owes $200 in taxes but claims the $300 Low-Income Credit, they only get $200 to offset their tax liability and lose the remaining $100. Additionally, the household must be below the federal poverty line to claim the benefit. As household size increases, so does the eligible income threshold. For example, a family of two making $20,000 cannot claim the Low-Income Credit, but a family of five earning $35,000 can. The primary rationale behind this policy approach is to ensure families are not taxed into poverty.
20% Nonrefundable EITC
Households can claim a nonrefundable credit equal to 20% of their federal EITC. The EITC phases in based on a family’s income until it is high enough to receive the maximum benefit. After income increases even further, the benefit phases out. Like the Low-Income Credit, it is nonrefundable and cannot exceed what a family owes in taxes.
(NEW) 15% Refundable EITC
Households can claim a refundable credit equal to 15% of their federal EITC. A refundable credit allows families who claim it to receive a tax refund if the credit amount is higher than what they owe in taxes. In this case, the credit can exceed a family’s tax liability. For example, if a family owes $200 in taxes but receives a $300 refundable EITC, $200 of the credit offsets their taxes, and the family gets a $100 check as a tax refund. Therefore, refundable credits are more accessible to households with little or no tax income liabilities.
Figure 1 shows the amount a single parent with one child can claim for each credit.
Figure 1 – Virginia’s Earned Income Tax Credits and Low Income Credit (Head of Household, 1 Child)
The Low-Income Credit and nonrefundable EITC provide the same benefits to families as they phase in since they mirror a household’s tax liability. However, once a household’s income surpasses the poverty line, the Low-Income Credit drops to zero, limiting its reach. Virginia families are likely better off claiming one of the two EITCs instead of the Low-Income Credit. The only exception is for childless adults just below the poverty line.
Of the two EITCs, the 15% refundable EITC supports lower-income families more effectively than the 20% nonrefundable option. Virginia lawmakers increased the state’s standard deduction to $8,000/$16,000 for single and joint filers, respectively, which eliminates any tax liability for Virginians below these thresholds. As a result, they do not benefit from nonrefundable credits. Because the 15% EITC is refundable, families with no tax liability can still receive the benefit as a tax refund.
Households with at least one person working full time at the minimum wage tend to benefit more from the 20% nonrefundable EITC. For example, a single parent with one child is better off claiming the nonrefundable EITC once their income exceeds $23,500 (For context, Virginia’s annualized full-time minimum wage is just under $25,000).
Families can still claim any of the credits, even if they provide smaller payments than others. This makes Virginia’s family tax credits extremely difficult to navigate, especially for people unaware of how they function. Streamlining them into a single policy can remedy this. Two options to improve the current system include: replacing all three credits with either a larger refundable EITC or a fully refundable child tax credit (CTC).
Option 1 – A 20% Refundable EITC
The first approach would establish a 20% refundable EITC to replace the current EITCs and the Low Income Credit. Figure 2 shows how a 20% refundable EITC compares to the existing credits. It exceeds the 15% refundable EITC as it phases in and plateaus. When it phases out, it matches the current 20% nonrefundable EITC.
A 20% refundable EITC would elevate the incomes of lower-income families and ensure middle-income households are not harmed. Families could also navigate this system more easily since only one credit would exist. According to the Joint Legislative Audit and Review Commission, increasing the refundable EITC to 20% would cost an additional $36 million per year. For context, Virginia’s total spending in FY2022 was $74.9 billion. This option would consolidate the maze of current benefits by establishing a single credit at a relatively low cost.
Figure 2 – 20% Refundable Earned Income Tax Credit (Head of Household, 1 Child)
While this policy would help many families and simplify the system considerably, some complexity issues still stem from the EITC. Because the value of the EITC depends on a household’s size and income, changes in family structure and income from one year to the next can lead to fluctuations in a family’s refund.
At the federal level, these changes make administering the benefit extremely difficult. Many families receive underpayments or overpayments, sometimes by hundreds of dollars. Additionally, the program’s complexity contributes to the fact that only 80% of eligible recipients actually receive the benefit. Those who receive their payments do so in the next year, when their circumstances may differ widely. For example, a parent with income just above the threshold to receive EITC benefits could lose their job at the start of the following year. At the exact time they need additional assistance, they receive nothing from the EITC based on the previous year’s earnings.
Option 2 – A Fully Refundable Child Tax Credit
The second approach would consolidate the three current credits into a fully refundable Child Tax Credit (CTC). As a fully refundable credit, families with low or no income can still receive the full benefit. After the temporary, fully refundable federal CTC expired, state lawmakers across the country introduced their own state-level CTCs to fill the void. By 2024, there will be 11 states with fully refundable CTCs.
This year, Del. Kathy Tran introduced the Commonwealth Kids Credit, a fully refundable CTC worth $500 per child to households making less than $100,000. Because it minimizes variation based on income, the Commonwealth Kids Credit would eliminate many complexity issues associated with the current set of credits. Furthermore, while the new credit would be incredibly beneficial to lower-income households, it also fully supports middle-income families that receive a reduced (or no) benefit under the current system.
The Commonwealth Kids Credit, however, does not provide any benefits to households, single or married, with incomes above $100,000. Having a hard cutoff would hurt families with incomes just above $100,000 – the median for families with children in Virginia – and could reduce upward mobility. Instead, the credit could phase out at 2%, beginning at $100,000 for single filers and $200,000 for joint filers. This would effectively eliminate the income cliff and marriage penalty.
Additionally, the Commonwealth Kids Credit could consolidate the current set of credits and ensure lower-income families are not made worse by the simplification. Currently, a family with one child can receive $599 from the 15% refundable EITC. Raising the credit to $600 per child would ensure no families are made worse under the proposed reform. Families with multiple children would receive a higher payment with the Commonwealth Kids Credit even if they currently get the maximum EITC. Furthermore, the childless portion of the 15% refundable EITC could remain so adults without children retain their benefits under the new system. With diligent policymaking, families claiming the 15% refundable EITC would break even or see an increase in their payments (Figure 3).
Figure 3 – $600 Commonwealth Kids Credit (Head of Household, 1 Child)
Consolidating the current credits also lowers the cost of the revised Commonwealth Kids Credit. For FY2022, before Virginia established the 15% refundable EITC, the Low-Income Credit and 20% Nonrefundable EITC cost approximately $124 million. The projected impact of the 15% refundable EITC for FY2023 is $159 million in reduced revenue.
Altogether, the estimated cost of existing credits is roughly $283 million. If kept, the childless section of the EITC pays the smallest benefits to a relatively low number of people, so the cost is modest. Therefore, the net cost of a $600 Commonwealth Kids Credit is around $600 million a year. The Virginia General Assembly could appropriate the remaining cost in the best way it sees fit.
The Virginia General Assembly has the opportunity to create a cohesive and effective family tax policy. Replacing the current web of credits is an excellent place to start in the upcoming legislative session. A 20% refundable EITC is a relatively low-cost option to consolidate the system, while a fully refundable CTC would expand benefits to thousands of families and make Virginia a leader in family tax policy.