[Tax Story] A Reexamination of the Earned Income Tax Credit System

There is great interest in raising the minimum wage and introducing a basic income. Recently, the Ministry of Employment and Labor announced the 2022 minimum wage as 9,160 won. This is about a 40% increase over five years from the 2017 minimum wage of 6,470 won. Although the minimum wage has risen significantly, the earned income of the lower-income groups has actually decreased. This is because the increase in the minimum wage has had a negative impact on employment among youth and vulnerable groups, and workers earning below the minimum wage are not necessarily directly linked to poverty. Discussions on introducing a basic income that provides 1 million won annually to all citizens are also underway. A true basic income that ensures a minimum standard of living would be around 10 million won per year, but providing just 10% of that to all citizens would require a fiscal burden exceeding 50 trillion won, comparable to this year’s defense budget, highlighting the serious challenge of securing funding.

While the intentions behind raising the minimum wage and introducing basic income are understandable, there is a growing voice that selective support targeting the poor or those without jobs is more desirable in terms of effectiveness and funding than universal welfare. Amid criticism of the Achilles’ heel of minimum wage and basic income, the existing Earned Income Tax Credit (EITC) system is gaining renewed attention as an alternative. Introduced in 2006, the EITC is a work-linked income support system that provides incentives to workers with low household income by granting earned income credits calculated based on household members and total wages. As of 2020, 4.33 million households received payments totaling 4.5 trillion won, representing an 8.5-fold increase in recipient households and an 11.4-fold increase in payment amounts compared to 2008, showing remarkable growth. The EITC encourages labor participation among low-income groups by providing earned income credits, while guaranteeing a certain level of income, thus reflecting the intentions of both minimum wage and basic income as an economic social safety net. For workers, the earned income credit boosts motivation to work, and for companies, it acts as a kind of ‘matching fund’ for labor costs, creating a win-win effect. The EITC eligibility criteria include total income thresholds of less than 20 million won for single-person households, less than 30 million won for single-earner households, and less than 36 million won for dual-earner households. Additionally, households are excluded if their total assets exceed 200 million won, and if assets are above 140 million won, only 50% of the calculated amount is paid. The maximum annual EITC payment is 1.5 million won for single-person households, 2.6 million won for single-earner households, and 3 million won for dual-earner households, with amounts gradually reduced based on annual income.

The EITC originated from the Earned Income Tax Credit system introduced during the Nixon administration in the United States in 1975 amid intense debates on income and employment security. It was inspired by American economist Milton Friedman’s Negative Income Tax concept and is similarly operated in the UK, France, Canada, and New Zealand. South Korea modeled its EITC after this, introducing it in 2006 and making the first payments in September 2009. Legal amendments in 2018 aimed at expanding eligibility, increasing benefits, and speeding up payments relaxed income and asset requirements. Payment amounts were increased, and a so-called ‘semi-annual payment system’ was implemented, providing earned income credits twice a year.

The EITC serves as a tailored support linked to work, boosting motivation and acting as a pillar for hardworking low-income households. It also performs a multifunctional role by promoting and revitalizing employment for companies. While introducing a new basic income or significantly raising the minimum wage to reform welfare systems has its merits, before full-scale implementation, the existing EITC system, which can reduce transaction and administrative costs, can be proposed as a policy alternative. However, for the EITC to successfully achieve both income and employment security, it must harmonize with a reasonable level of minimum wage. Above all, an excessively low minimum wage imposes an undue burden on national finances. The OECD also recognizes that a system combining an appropriate minimum wage with EITC is effective. This is an important consideration to avoid repeating the painful experience of Spinhamland over 200 years ago. The Spinhamland system in England was introduced in 1795 by justices of the peace in Berkshire, southern England, as an out-of-poverty relief measure under the Poor Law, in response to worsening poverty among low-income groups caused by continuous crop failures and inflation in the late 18th century. It set minimum living standards based on bread prices and family size, providing supplementary wages to low-wage workers. However, workers, receiving the same income through poor relief regardless of effort, began to work less diligently, employers lowered wages excessively and overemployed workers, and the government paid subsidies based on the number of workers. The resulting costs were imposed on the middle class striving for self-sufficiency without relying on poor relief, creating a problematic situation.

Administratively, it is crucial to improve income reporting rates for the effective enforcement of the EITC. The National Tax Service of Korea oversees EITC support through its Income Support Bureau under the main office and maintains a high-level management organization and system for earned income credits. However, since the EITC plays a central role in income and employment security, it needs to be further strengthened. Enhancing transparency in tax bases and fiscal expenditures benefits not only EITC payments but also the selection of beneficiaries for other social security programs and the calculation of social insurance premiums. Furthermore, as the EITC also functions as a form of basic income, if similar systems are refined, it is necessary to proactively consider providing meaningful amounts within fiscal capacity. As the EITC turns 15 this year, we look forward to its new role as a next-generation welfare model that firmly supports low-income households, warmly illuminates welfare blind spots, and prevents moral hazard that may arise during the support process.

Baek Jeheum, Lawyer at Kim & Chang