As the government contemplates policy options to ensure poor and low-income families benefit from oil revenues, the idea of direct cash transfers has received some attention in the local media. Proposed by Professor Clive Thomas and supported by two other experts, the idea is to give cash to low-income families to improve their standard of living. Indeed, the idea of cutting individuals a check at the end of the month is politically attractive, especially with the next election scheduled at the same time as oil proceeds are expected. While the basic premise of direct cash transfers is sound, and its proponents have cautioned against some of the downsides, little has been proposed on how to guard against those downsides and ensure that the program lifts people out of poverty and put them on a path to prosperity. Program safeguards are more critical for cash transfer programs which are often associated with abuse, corruption, and mismanagement. Not surprisingly, other local and international experts remain skeptical over the effectiveness of a cash transfer program, problems with implementation, and its unintended consequences, specifically the likelihood of creating a dependency and entitlement mindset and worse, discouraging work. Such skepticisms are not without merits as academic and policy research on the success of direct cash transfers have shown mixed results.
Fortunately, there are better options for lawmakers to consider that have been heavily studied and proven to be successful. One of the most successful (if not the most successful) anti-poverty programs is the U.S. Earned Income Tax Credit Program (EITC). The EITC is more successful than any other welfare cash transfer program including direct cash transfers. This is because it is not a cash ‘handout’ program but a ‘hand-up’ program that encourages families to work more. The program targets poor and low-income working individuals and families, whether in formal jobs, self-employment, or piecemeal work (gigs). It allows them to help themselves climb out of poverty and not rely solely on government assistance. It provides a boost to the local economy by reinvesting a portion of income from taxes. It also simultaneously advances other policy goals such as broadening the tax base, reducing inequality and reigning in informal economic activities into the formal economy. The budget cost of administering such a program is also expected to be lower compared to other programs. For these reasons, using a portion of oil and gas revenues to fund an EITC program make good fiscal and economic sense. It is worth noting that the EITC program does not cover individuals that are unemployed or retired. To provide support for these individuals, the government could consider implementing a sperate unemployment assistance program and strengthening the current public assistance program.
Before I elaborate further into what exactly is an EITC program, how it works, and how it addresses much of the concerns associated with direct cash transfers and other liked programs, it is worth emphasizing that there is no substitute for sound fiscal and economic policies for building a strong economic foundation for success. Achieving high and sustained economic growth and creating good paying jobs should remain the government’s top policy priorities. Accordingly, most of the oil revenues should be used to significantly increase public investment to (1) modernize the country’s transport, energy, and communications infrastructures; (2) improve access to and the quality of public education at all levels; (3) address critical access and quality issues in the health sector; (4) invest in technologies to improve the public safety and security including modernizing the legal and justice administrator system; (5) invest in economic opportunities is other non-oil sectors; and (6) invest in making the government itself more efficient and effective. These investments have been proven to build a solid economic foundation, deliver high and sustained growth, and real improvement in standard of living. Legislations that ring-fence portions of the oil revenues to these priorities are an excellent way to ensure revenues actually deliver on these priorities and not get wash into a slush fund that can be used to fund anything under the sun. That said, let’s get back to the EITC.
What is an EITC and how does it work?
An EITC is a refundable tax credit program that provides support to poor, low- and moderate-income working individuals and couples, especially those with children – the target population. The program is designed in such a manner that it allows low-income families to keep more of what they earn to help meet their basic needs and invest in their future. In other words, it reduces the taxes you owe and may also provide a refund. The amount of EITC benefits (refund) depends on an individual or couples’ income and the number of children. More definitively, the target population can be defined as individuals and couples earning up to 250% of the national poverty line (NPL). For the target population, EITC benefits are highest for those at the bottom of the income ladder and slowly phases out as income rises.
Let’s assume for the sake of discussion that the national poverty income for an individual is $80,000 per month – this is likely a realistic estimate since the current poverty income level desperately needs updating. This means that individuals and couples earning up to $200,000 (250%) would be eligible for EITC benefits. Depending on their income level, individuals and couples would be placed into one of three categories with defined benefit levels for each category. For example, individuals and couples with incomes:
- up to 100% of the NPL ($80,000) is eligible for 60% of taxes refunded
- greater than 100% but less than 150% of NPL ($80,000 – $120,000) is eligible for 40% of taxes refunded
- greater than 150% but less than 250% of NPL ($120,000 – $200,000) is eligible for 20% of taxes refunded
For couples with children are eligible for an allowance for each child in addition to the tax refund. The exact amount of allowance for each child should be determined by an analysis that considers the cost of raising a child, sending him or her to school, transportations, health care, and childcare. An allowance between $2000-$5000 per child per month, for example, would help poor and low-income families improve the living conditions for children and invest in their future.
While under current law, individuals making less than the annual tax-deductible do not pay income taxes, they pay value-added taxes, local taxes, a host of government fees. In fact, with these taxes and fees, low-income families pay a higher share of their income in taxes than everyone else. Thus, in determining tax refunds for individuals in the lowest income category consideration must be given to the amount of value-added taxes, local taxes, and other government fees they pay. In practice, this is generally achieved by establishing official rates for estimating non-income taxes paid based on income levels. Indeed, lots more details have to be worked out in order to implement and manage a successful EITC program, but by now I think you get the broad picture of what exactly an EITC is and how it works. Now let’s address some immediate and critical questions about the benefits of an EITC.
Question 1. How does the EITC encourages work and not discourage it?
As was mentioned earlier, the EITC would benefit only working individuals and couples. Its benefits are tied to their income and taxes paid and the number of children. There is no benefit to not working. The more you work and more taxes you pay the more you tax you get refunded. Further, there is no incentive to limit work to earn income up to 100% of the NPL to benefit from a higher EITC refund rate since on average, 60% of taxes paid on $80,000 is less than 40% of taxes paid $120,000 in dollar terms, other things equal. Research shows that this type of earned benefit structure encourages people to work.
Question 2. How does the EITC expand the tax base?
To receive EITC benefits individuals and couples must file a tax return. This means that eligible persons not currently on the tax roll would be encouraged to get on it by filing their taxes. Even individual who might not be immediately eligible for EITC benefits would be encouraged to get on the tax roll as their family circumstances change, for example getting a child or getting married or divorced.
Question 3. How does the EITC reign in informal economic activities in the formal economy?
Economics activities in the informal economy are not reported largely to evade taxes but also because most informal activities take place in remote and rural areas where formal government systems and public services are weak or simply do not exist. For example, a small livestock farmer living in Mara or a cash crop farmer living in the Pomeroon area. Individuals who operate in the informal economy, especially those that would be immediately eligible for EITC benefits would be encouraged to report their activities and earnings by filing a tax return. Others are likely to follow suit.
Question 4: How does the EITC help close the income inequality gap?
By limiting the benefits of the EITC to those earning up to 250% of the poverty level, the EITC would be directly supporting families at the bottom of the income distribution, living in poverty and struggling to make ends meet. Affording these families an improved way of life and the ability to invest in themselves and their children future, acquire skills and social capital position them for long-term success. This narrows the income and wealth gap over time.
Question 5. What is the budget cost of administering an EITC program and who should administer it?
The cost of administering such a program would have to be determined by a feasibility study. However, the cost is not expected to exceed 10-15% of the overall cost of the program if it is administered by the Guyana Revenue Authority (GRA) which is responsible for processing all tax returns. This is because the EITC can piggyback on existing institutional, regulatory and administrative setup that already exist. No doubt, additional resources will be necessary to enhance and further develop needed capacity to ensure the program is administered efficiently and free from abuse, mismanagement, and corruption. Also, when considering the costs of administering the EITC, consideration must be given to the importance of the program in boosting labour market activities and economic growth, in addition to other benefits the program has been proven to deliver.
Ensuring ordinary Guyanese benefit from oil revenues is not just economically sound, it is a moral imperative. The EITC is the most successful anti-poverty reduction program that has been proven to deliver results while incentivizing work and promote a host of other policy goals. More importantly, the program is less prone to abuse, mismanagement, and corruption. No other anti-poverty reduction program has received bipartisan support and praised from researchers and decision makers. It has been proven to have long-term positive effects on households’ ability to improve their own living standard and even that of future generations. A well-established body of research suggests that families who benefit from the EITC program are better off in several aspects of their lives including; better infancy health, children performance in school, less maternal stress, increased wages, higher odds of children completing high schools and thus going to college, among others. Lawmakers serious about helping families struggling to make ends meet and ensure oil revenues benefit all Guyanese should give serious thought to an EITC program.
About the Author
Dhanraj Singh is a London School of Economics-trained economist. He holds master’s degrees in political economy, finance and investment. He is the founder and executive director of the Guyana Budget Policy Institute – a research and policy think-tank.