Audits Endanger Tax Credits for the Working Poor

(AP Photo/Brennan Linsley)

A professional tax preparer views a Form 1040.

In 2017, 27 million families received the Earned Income Tax Credit (EITC), a refundable tax credit available to people with low incomes who work. While the EITC has been described as a subsidy for low-wage employers, the credit still materially puts, on average, $2,445 in the pockets of low-income people.

But a new paper from the National Bureau of Economic Research (NBER) finds that EITC claimants who are audited are less likely to claim the credit in the following years. This is particularly significant because House Republicans recently proposed expanding Internal Revenue Service review of EITC returns.

The NBER researchers looked at the behavior of taxpayers who received the EITC—both those who were audited (through correspondence audit) and those who weren’t. Their study found that, after receiving a correspondence audit, people who claimed the EITC in a particular year were 30 percent less likely to claim it the following year. EITC claimants were also 20 percent less likely in the following year to file taxes at all. Importantly, this effect continued years after the original audit. Four years after an audit, claimants were still 10 percent less likely to claim the credit again.

Last year, the House Budget Committee, in its 2018 budget resolution, proposed “requiring verification of income before [EITC] benefits are paid,” thereby subjecting people who receive the EITC to what the Center on Budget and Policy Priorities called a “quasi-audit.” The proposal seemed to be based on a 2016 Heritage Foundation report that recommended requiring the IRS to “fully verify income through a review of Form W-2, Form 1099, business licensing or registration, and relevant invoices,” to withhold tax refunds until the review is completed, and to subject taxpayers claiming the EITC to a $2,000 penalty if income is misreported. Returns filed by wealthier households who aren’t eligible for the EITC would be subject to the traditional audit test; for low- and medium-risk filers, audits are random.

Congress had already introduced an additional hurdle for EITC claimants in 2015, holding EITC refunds until the IRS could match W-2s and 1099s to reported income, which delayed refund receipt until at least February 15 (the policy was implemented last year). But even before the 2015 legislation and the 2018 House budget resolution, taxpayers claiming the EITC were more likely to be audited than the average, non-EITC-claiming taxpayer.

Further verification requirements and audits could limit the effectiveness of the EITC, which in 2015 pushed 6.5 million people out of poverty.

Although the House Budget Committee’s proposal was not made into law, that doesn’t mean it won’t return, or that something similar won’t be on the horizon. Last week, the Trump administration unveiled a package of suggested (and draconian) reforms to anti-poverty programs, with one of the stated intentions being to combat “fraud, waste, and abuse.” It requires no imaginative leap to anticipate that reforms to the EITC could be proposed in the near future.

While the IRS reports that the incidents of EITC payment errors are indeed high, the IRS also indicates that this is much less likely due to intentional fraud than to the complexity and minutiae of EITC rules. In fact, the majority of errors are found on commercially prepared returns. Tax preparers often target low-income taxpayers, charging exorbitant prices for their services—about 60 percent of EITC returns are completed by commercial preparers. In lieu of further regulating the lives of the poor, better options to reduce discrepancies could be to require better training of tax preparers and also to simplify the credit itself, making the confusing rules easier to understand.

An Obama-era IRS move to require that tax preparers take competency exams was struck down in 2014 as overstepping regulatory authority, meaning that Congress would need to approve such an initiative (a similar proposal was included in President Trump’s budget for next year). And a number of suggestions from both the Obama and George W. Bush administrations (like simplifying how to treat parents who are separated) could help make claiming the credit more straightforward, especially for families that have complex situations to report on their tax returns.

The EITC, which encourages work while getting more money to the poor, is frequently hailed as one of the few generally bipartisan anti-poverty programs. But as the NBER paper suggests, imposing mandatory reviews on workers who receive the EITC could threaten the success of the tax credit—which already largely excludes childless workers and completely excludes the nonworking in deep poverty.

Considering that the GOP’s tax reform was a giveaway to the wealthy, it would be cruel—if, alas, not all that unusual—to target the small, but critical, tax refunds of the working poor.

Tax Cuts for the rich. Deregulation for the powerful. Wage suppression for everyone else. These are the tenets of trickle-down economics, the conservatives’ age-old strategy for advantaging the interests of the rich and powerful over those of the middle class and poor. The articles in Trickle-Downers are devoted, first, to exposing and refuting these lies, but equally, to reminding Americans that these claims aren’t made because they are true. Rather, they are made because they are the most effective way elites have found to bully, confuse and intimidate middle- and working-class voters. Trickle-down claims are not real economics. They are negotiating strategies. Here at the Prospect, we hope to help you win that negotiation.

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