The recent brouhaha over the suggestion to spread out payment of the earned income tax credit (EITC) over twelve months rather than to pay it in a lump sum says more about business as usual in our political sector and the way it gets reported than it does about "balancing the budget on the backs of the poor." Sound bites are more important than reasoned analysis. Purposefully misleading half truths are voiced and repeated without being critically analyzed. Democrats and Republicans (and Republicans and Republicans) stage a visible battle over what is essentially a nonissue in order to distract the attention of the American public from what is really going on. Let me explain.
Congressional Republicans have suggested that payment of the EITC, a cash payment to low income families who work, be spread out in twelve payments instead of being paid in a lump sum, like an income tax refund, as they currently are. In real terms, what is at stake is the time value of money. Instead of receiving a one time lump sum of, say, $2400, a family would receive monthly payments of $200 each. While the politicians can (and do) say with straight faces that each recipient will still receive the full amount of the credit, this is only a half-truth because waiting eleven months to get the last payment is not as good as getting it today. The government keeps the money longer and the recipient loses the interest. But what is the magnitude of this effect? Readily available financial formulas exist to calculate the magnitude. The number depends on the interest rate that the money would have earned if saved, or the interest rate that the recipient would pay to borrow money. For example, at 10% interest, the monthly payments are actually worth only $2293.86, for a savings of about 4.4% of the total amount of the program. The lower the interest rate, the lower the savings to the federal budget and the lower the lost income to recipients.
The 4.4% (or less) of the total EITC program is the true economic impact of the proposal but it is not the real issue. Accusations about balancing the budget on the backs of the poor notwithstanding, this drop in the bucket would hardly have a measurable effect on the federal deficit. Nevertheless, the Democrats (and George W. Bush) have decided to politically hype the negative effect on the recipient's income, and proclaim themselves against the project in order to sound compassionate and in order to distract attention from the real reason why spreading the payments looks good to Congress. The real reason is that it allows a simple accounting trick. By spreading the payments out into the future, a portion of them will fall in the next fiscal year. For example, depending on the timing of the lump sum payment and the end of the current fiscal year, only part of this year's obligation to pay the EITC will fall in this year. Suppose that proportion is one-half. If so, then the apparent effect of the spreading is a one-time, current year savings of over 50% of the total EITC program. The effect is only for one year. Next year the treasury will have to pay the last half of this year's payments and the first half of next year's payments.
Saving 50% of the EITC program in the current budgeting cycle would be significant. It would allow both the Democrats and the Republicans to spend more without seeming to violate their own deficit reduction plan. Congress will continue to try such accounting flim-flam, accelerating revenues to the current year and pushing costs into the next one, as long as they, with the press's active or tacit assistance, can continue to fool the public. But they don't fool me.
In the current case the proposal seems dead in the water, but watch out. Clinton and the Democrats will propose simultaneously spreading the payments and raising the EITC by the lost 4.4%. The Democrats will take credit for increasing the program (conveniently forgetting the time value of money argument this time). The Republicans will appear non-compassionate for the original proposal. But the Republicans will go along with it, because although they talk the talk of fiscal responsibility and decreased government, they rarely walk the walk. The one year brightening of the budget will be more significant to them than the infinite future of higher payments. The press by and large will paint the Democrats and Clinton as compassionate, as the champions of the EITC and poor working families, and the Republicans as stingy foes of the poor. The truth is, both the Democrats and Republicans, with the press as witting or unwitting allies, intend simply to spend more tax dollars without appearing to do so. Poxes all around.
I say shame on the Republicans for proposing the accounting slight of hand in the first place. Shame also on the Democrats and the press for not calling the Republicans on the carpet for the blatant accounting chicanery and for, instead, attempting to demagogue the issue by harping on the relatively minor effect the change would have on recipients or tax payers.
Steve Shmanske is a Professor of Economics at California State University, Hayward