The Center's work on 'Earned Income Tax Credit' Issues


IRS Funding Cuts Likely Mean More Tax-Credit Errors

December 11, 2014 at 11:00 am

Even as the Treasury Department’s Inspector General noted a significant overpayment rate in the refundable part of the Child Tax Credit (CTC) this week, lawmakers chose — in the pending 2015 government funding agreement — to weaken the IRS’s ability to reduce errors in this credit and other parts of the tax code by once again cutting IRS funding to enforce and ensure compliance with the tax rules.  And, while lawmakers such as Senator Orrin Hatch (R-UT), the Senate Finance Committee’s top Republican, assailed the IRS for failing to address the errors, the Treasury and IRS have recommended a series of measures to Congress to reduce errors in the tax credits and other parts of the tax code — and Congress has failed to act on them (except for one very small measure included in the 2015 funding agreement).

Errors in the CTC and the Earned Income Tax Credit (EITC) — another working-family tax credit — need to be reduced (as do errors related to small businesses and various other groups of tax filers).  But the debate around this issue often is misleading and ignores three significant points:

1. Most overpayments result from unintentional errors, not fraud. IRS studies indicate that the majority of EITC errors stem from the interaction between the credit’s complex rules and complicated family and child-rearing arrangements, not fraud.  The EITC has very strict rules over who can claim a child, for example, which often trip up separated or divorced couples or three-generation families.  The CTC eligibility rules are similar.

Moreover, overclaims in these tax credits account for a small share of the tax compliance gap.  Underreporting of business income alone accounted for $122 billion of the $450 billion tax gap in 2006, the latest year for which such data are available.

2. IRS funding cuts have weakened tax enforcement. The IRS’s budget has taken repeated hits in recent years and will shrink further under the fiscal year 2015 budget agreement, falling to its lowest inflation-adjusted level since 2000.  Funding for IRS enforcement has been hit particularly hard; its 2015 funding level under the agreement is 20 percent below the 2010 level, adjusted for inflation. Yet the number of tax returns filed has grown significantly over the same period, and the IRS received substantial new responsibilities related to the Foreign Account Tax Compliance Act and the Affordable Care Act.

Because of these cuts, the IRS lacks the resources to pursue a substantial share of the questionable EITC and CTC claims that it identifies or to improve enforcement of other parts of the tax code.  For example, the IRS can use data matching and other techniques to identify questionable claims on tax returns related to the tax credits, but it cannot pursue many of those claims further because it lacks the staff resources to do so.  Due to budget cuts, the number of IRS staff devoted to enforcement has dropped by 15 percent since 2010.

3. Congress has failed to act on proposals designed to lower error rates. The year-end funding bill requires people who prepare their own returns to answer due diligence questions when claiming refundable tax credits, a useful but small measure.  But Congress has ignored an array of other, more significant proposals from the Treasury and the IRS (most of which are in the President’s fiscal year 2015 budget) to reduce errors in these credits.  These include:

  • Giving the IRS the statutory authority to require paid tax preparers to demonstrate basic competence in the rules governing these credits and other basic tax matters. The Treasury has found very high EITC error rates among returns filed by certain types of paid preparers (e.g., those who aren’t lawyers, CPAs, enrolled agents, or affiliated with a national tax preparation firm).  These preparers do not need to get any training whatsoever or demonstrate basic competence in the tax rules, a factor that contributes to tax-credit errors.
  • Requiring employers and other third parties to send the IRS information such as W-2’s and 1099’s earlier in the year to help it detect erroneous or fraudulent claims before it pays them.
  • Requiring paid return preparers to follow due diligence requirements in determining eligibility for the CTC, as they already must do for the EITC.

Senator Hatch said this week that “[t]he IRS’s inability to properly administer these refundable tax credits fails American taxpayers.”  In reality, it’s Congress that has failed American taxpayers by not giving the IRS what it needs to enforce the tax code.

“Tax Extenders” Package Even Worse Than First Appeared

December 1, 2014 at 3:34 pm

12-1-14taxWe’ve explained that the package that emerged last week to permanently extend several temporary tax breaks (“tax extenders”) and enlarge some of them would raise deficits — thereby putting more pressure on domestic programs for cost-saving cuts — while favoring large corporations and leaving out millions of working families. Following a presidential veto threat, the package now appears dead; but as lawmakers continue to consider options for what to do about the extenders, they should recognize another serious flaw in that package: nearly a quarter of its roughly $400 billion cost would have come from expanding tax cuts for businesses, not just extending them (see chart).

In particular, the package doubled the tax credit for research and experimentation, raising its ten-year cost from $75 billion to $151 billion. Making this and other extenders permanent without paying for them would be fiscally irresponsible; expanding some of them while doing so would be even more egregious.

Our report detailed the package’s main flaws:

  • It would have given back more than half of the revenue raised by the 2012 “fiscal cliff” legislation. If it had become law, more than 85 percent of the deficit reduction achieved since 2010 would have come from budget cuts rather than new revenues.
  • Congressional Republicans insist that future congressional budget plans balance the budget in ten years with no new revenues, cuts in Social Security benefits for current retirees, or defense cuts. Such a plan would already demand deep cuts in important areas; the extenders package would require even deeper cuts. As incoming House Budget Committee Chairman Tom Price (R-GA) said recently, “anything that’s made permanent now makes it more difficult to get to [budget] balance.”
  • While permanently extending and expanding tax benefits mostly for businesses, the package failed to extend temporary tax provisions for low-income working families with children. Those provisions — in the Earned Income Tax Credit and the low-income piece of the Child Tax Credit — lift more than 16 million people out of poverty or closer to the poverty line each year, including nearly 8 million children. Their omission would make it less likely they will continue beyond 2017, when they are slated to expire.
  • If policymakers make a number of extenders permanent now, without paying for them, they won’t have to offset the cost of making them permanent as part of tax reform. That would enable them to produce a tax reform bill that cuts the top tax rate more deeply, curbs fewer special-interest tax breaks, or both — and yet still is labeled “revenue neutral.”

4 Reasons Why the House Has the Wrong Approach to Tax Extenders

November 20, 2014 at 4:09 pm

Congress is expected during the lame-duck session to address “tax extenders,” a set of tax provisions (mostly for corporations) that policymakers routinely extend for a year or two at a time.  While the Senate has pursued temporary extensions, the House has taken a far different approach that’s flawed on both policy and priorities grounds, as our updated paper explains.

The House has: made a number of extenders permanent; permanently expanded one of the biggest extenders, the research and experimentation credit; and permanently extended some temporary tax breaks that aren’t extenders — such as “bonus depreciation,” which lets businesses take larger upfront tax deductions for purchases like machinery.  (A temporary measure to help revive a weak economy, bonus depreciation is largely ineffective.)   But it hasn’t offset any of the considerable costs.

The House approach would:

  1. Undo a sizeable share of the savings from recent deficit-reduction legislation. At a combined ten-year cost of $312 billion, the nine extenders provisions that the House Ways and Means Committee has passed this year would give back two-fifths of the $770 billion in revenue raised by the 2012 “fiscal cliff” legislation.  (The full House has already approved seven of these, costing $235 billion.)  House Republicans also are pushing to make permanent an expanded version of bonus depreciation in an extenders package; adding this to the nine Ways and Means provisions pushes the total ten-year cost to $588 billion, or roughly three-quarters of the revenue raised in the “fiscal cliff” legislation.
  2. Constitute a fiscal double standard. Failure to pay for making the extenders permanent would contrast sharply with congressional demands to pay for other budget initiatives, from easing the sequestration budget cuts to extending emergency unemployment benefits for long-term unemployed workers.  While demanding that spending measures be paid for, the House is pushing for permanent, unfinanced tax cuts that would cost much more.
  3. Bias tax reform against reducing deficits. If policymakers make the extenders permanent before they enact tax reform, a tax reform plan wouldn’t have to offset their cost to be revenue neutral.  This would free up hundreds of billions of dollars in tax-related offsets over the decade that policymakers could then channel toward lowering the top tax rate.  The resulting package would lock in substantially larger deficits than under revenue-neutral tax reform that paid for the extenders or let them expire.
  4. Place corporate tax provisions ahead of other, more important tax provisions scheduled to expire. Most notably, key elements of the Earned Income Tax Credit and Child Tax Credit will die at the end of 2017 unless policymakers act, pushing more than 16 million people in low-income working families, including 8 million children into — or deeper into — poverty.  When policymakers consider which expiring tax provisions to continue, they should give top priority to making those key low-income provisions permanent.

Letting Tax-Credit Provisions Expire Would Push Millions Into Poverty

November 12, 2014 at 1:55 pm

As Republicans and Democrats look for areas where they can work together, they should be able to agree to make permanent three key provisions of two pro-work tax credits:  the Child Tax Credit (CTC) and Earned Income Tax Credit (EITC).  More than 16 million people in low- and modest-income working families, including 8 million children, would fall into — or deeper into — poverty in 2018 if these three provisions expire as they are currently scheduled to do after 2017, our new paper (with state-by-state data) shows.  Some 50 million Americans, including 31 million children, would lose part or all of their credits.

The EITC and CTC encourage and reward work, and there is growing evidence that income from these credits leads to improved school performance, higher college enrollment, and increased work effort and earnings in adulthood.

Both credits have enjoyed bipartisan support, and their underlying provisions are permanent parts of the tax code.  But several key features of the credits will expire at the end of 2017 unless lawmakers act.

The stakes are high for millions of workers in low-wage jobs, from custodians to health care workers.  If these provisions expire:

  • Not one penny of earnings of a full-time, minimum-wage worker would count toward the CTC. For example, a single mother working full time at the minimum wage and earning $14,500 would thus lose her entire $1,725 CTC.  That’s because the earnings needed to qualify for even a tiny CTC would jump from $3,000 to $14,700.  The earnings needed to qualify for the full CTC (of $1,000 per child) would jump from $16,330 to more than $28,000 for a married couple with two children, so many low-income working families that would still qualify for the CTC would see their credit cut dramatically.
  • Many married couples would face higher tax-related marriage penalties due to a cut in their EITC. To reduce marriage penalties, the income level at which the EITC begins to phase out is now set $5,000 higher for married couples than for single filers.  After 2017, it would be set $3,000 higher, which would shrink the EITC for many low-income married filers and increase the marriage penalty for many two-earner families.
  • Larger families would face a cut in their EITC. After 2017, the maximum EITC for families with more than two children would fall more than $700 to match the maximum for families with two children.

Some 65 percent of the families that would lose part or all of their credits include at least one full-time, year-round worker.  About 450,000 veteran and armed forces families with children would lose all or part of their CTC in 2018; a similar number would lose all or part of their EITC.  Also, 15 percent of the families that would lose all or part of their credits include at least one member with a disability.

For more on the impact on specific types of families if the provisions expire, see this interactive calculator.

New Poverty Figures Show Impact of Working-Family Tax Credits

October 17, 2014 at 2:05 pm

The Child Tax Credit (CTC) and Earned Income Tax Credit (EITC) together lifted 9.4 million people out of poverty in 2013 and made 22.2 million others less poor, our analysis of Census data released yesterday show (see first graph).

Using Census’ Supplemental Poverty Measure (SPM), which includes taxes and non-cash benefits as well as cash income, our analysis shows how critical these tax credits are for low-income families.  It also highlights the impact if policymakers let key provisions of the credits expire, as I explain below.

Each credit plays an important antipoverty role.  The EITC lifted 6.2 million people out of poverty in 2013, including 3.2 million children.  The CTC lifted 3.1 million people out of poverty, including 1.7 million children.  Both credits acting together lifted some additional people out of poverty.

The EITC and CTC combined lift more children out of poverty than any other antipoverty program.

Unfortunately, critical provisions of the EITC and CTC are set to expire at the end of 2017.  If that happens, 16.4 million people — including 7.7 million children — will fall into or deeper into poverty, we estimate based on the Census data.  (See second graph.)  Our interactive calculator lets you explore what’s at stake for low-income families if policymakers don’t act.