Is There Anything to Learn From the Earned Income Tax Credit for Germany?
By Waltraut Peter

The United States and Germany have created very different welfare systems. Pundits call one mean, the other cradle-to-grave. The former is rooted in the work ethic and the promise that anyone who strives hard will get ahead, the other in societal solidarity and the promise that everyone is given the means to live with dignity. Putting work and personal responsibility first, "America's cowboy capitalism" has created abundant employment opportunities and wealth for citizens and millions of immigrants but also high poverty and inequality. The Rhineland capitalism, on the other hand, has been wrapped in a tight safety net that prevents American-style poverty but propels mass unemployment. Statistics reflect how vigorously each country has pursued its course: total poverty in the United States is 12 percent; Germany's unemployment rate is 11 percent. There is an essential difference, however. Because the United States radically shifted its anti-poverty policies to "welfare to work" and "make work pay" in the 1990s, the poverty rate of those most at risk of being poor decreased by 10 percentage points and their employment rate rose by 9 percentage points. Welfare caseloads shrunk by more than half. During the same period, unemployment in Germany continued its upward trend, in particular among low-qualified adults, and job creation stagnated except for subsidized minimal hours jobs.

Germany began to acknowledge the unemployment trap it had created through its high guaranteed income level in the late 1990s. Last year Hartz IV was enacted, which tightens work requirements and enhances work incentives for employable, needy adults. However, while transforming the former social assistance into welfare-to-work, the new means-tested program (ALG II) provides no exit strategy for those who leave welfare but do not have the earning power to become self-sufficient. Without a "make work pay" complement, Hartz IV leaves workers who earn "poor" wages welfare dependent -- when they move from welfare to work -- or working poor -- if they work without asking for "help and hassle." It also unfairly pits subsidized against unsubsidized workers and encourages employers to displace the latter instead of creating new jobs, which then forces governments to compensate for the lack of employment opportunities with cost-intensive community jobs.

If Germany seriously strives to tackle its unemployment problem and give low-skilled workers the opportunity to take responsibility for their lives, there is no alternative to more wage differentiation, which will pull the wage floor below the needs level. The ALG II, therefore, has to be complemented with an earnings subsidy that is conditioned on work, but not tied to the strings and stigma of welfare benefits. The U.S. Earned Income Tax Credit (EITC) is one such possibility.

Implemented in 1975 as a mere tax relief, the EITC has matured into the central anti-poverty program while the welfare reform in 1996 ended "welfare as we know it." The tax credit is available to working taxpayers whose earned income and assets are below certain thresholds during a tax year. The amount varies by income, number of children and filing status. The credit phases in and out at different rates until it reaches its maximum, then remains unchanged until the beginning of the phase-out range. In tax year 2003, a married couple with two children filing jointly was eligible for the EITC if their combined income was below $34,692. For earnings below or equal to $10,510 the credit amount was 40 percent of gross earnings. If earnings were between $10,511 and $14,730, the couple received the maximum amount of $4,204. Once their earnings moved into the phase range the maximum credit was reduced by 21 cents for every dollar earned in excess of the income at which the phase-out begins. (The chart below plots the amounts for different households and includes the Child Tax Credit for a married couple with two children.) The income thresholds and the maximum benefit are indexed to inflation. The credit is refundable, which means that recipients either receive the full credit, if their federal income tax liability is zero, or the amount in excess of their tax liability. Under an advance payment option, workers who expect to be eligible for an EITC during the year and have at least one qualifying child may opt to receive a portion of their expected credit in their monthly paycheck. However, only one percent of filers choose this option. It is estimated that roughly 85 percent of eligible taxpayers file for the credit, far above the participation rates for TANF or food stamps.

A wide body of research shows that the EITC is well targeted to the working poor and has had significant positive effects on the labor market participation and poverty rate, in particular among single mothers who are most at risk of being poor and welfare dependent. It, therefore, remains widely popular in the United States.

Whether the EITC could be a model for Germany as it moves beyond Hartz IV, depends on its seriousness about wanting to give all workers the opportunity to work, not just those whose earning power makes them self-sufficient.

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The complete paper will be available on the AICGS website on September 15. Waltraut Peter will present her paper on September 13, 2004, at an AICGS event entitled: "Traps and Tradeoffs in Welfare Policies: could the U.S. Earned Income Tax Credit be a possible solution for Germany's unemployment trap?" for more information on this event, please click here.
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Waltraut Peter is a welfare policy analyst for the Institut der deutschen Wirtschaft (IW) in Cologne, Germany and currently a DAAD/AICGS Fellow.
This essay appeared in the September 9, 2004 AICGS Advisor. ...................................................................................................
The views expressed in this article are those of the author(s) alone. They do not necessarily reflect the views of the American Institute for Contemporary German Studies.