Suppose the government decided to place bushel baskets full of cash at every street corner, with the following note: "Please read the attached instructions and take the appropriate amount, if any, from the basket. Write your name, address, and the amount you took on the sign-in sheet. WARNING! We will check one out of every 50 names, and anyone we find taking too much will have to give the money back."
Would the feds really do something like this? Well, not exactly. But it's not all that far from how the government runs what has become its biggest cash transfer program for low-income families: the Earned Income Tax Credit (EITC). The good news is that half of the people who take money out of the EITC basket do so honestly. The bad news is that the other half take more than they should.
The EITC is a low-income wage supplement for families with children, run by the IRS as a "refundable" tax credit. (There's also a tiny credit for childless singles with very low income.) Almost all of the EITC is paid out in checks to families who don't owe income taxes because their reported incomes are so low.
A decade ago, the U.S. government spent about $14 billion a year on cash welfare payments and only about $6 billion or $7 billion a year on the EITC. But this year, federal welfare outlays will be about $22 billion, while EITC benefits will be up to $34 billion.
Overall, the EITC is extremely successful in putting some needed cash into the pockets of low-wage workers -- and doing so in a way that both Democrats and Republicans can support. There are, however, some flaws in the way the EITC is structured. Because the credit depends on a person's wages, it's often touted as "rewarding work." That's true up to a point. For minimum-wage parents (those who earn up to $10,350 in wages this year), the EITC can add as much as 40 cents to each dollar earned. On the other hand, one might also note that once the EITC starts to phase out, it "punishes work" by imposing a 21 percent added tax on earnings between about $14,000 and $34,000. The EITC also creates some horrific marriage penalties that no one has found an affordable way to solve.
But the biggest problem is how poorly the EITC is policed. Because it has become so big -- maxing out this year at $4,140 for a family with two children -- lots of people are cheating to get it. Last year, under pressure from Congress to crack down on these abuses, the IRS actually audited a higher number of EITC claimants than the combined total of all other audited individual taxpayers. Even so, that meant an EITC audit rate of only 2 percent.
A just-released Treasury study, based on in-depth audits of about 3,500 people who claimed the EITC in 1999, finds that only half of the people who took the credit were fully entitled to what they claimed -- including about 7 percent who mistakenly took too little. The other half of EITC recipients claimed, in total, $11 billion more than they should have. Apparently, about 2.8 million of the 9.3 million people who took too much merely overstated their credits a bit. But most of the cheating was by 6.5 million people who shouldn't have gotten a penny of what they claimed -- a rip-off of $10 billion. In other words, a third of the total benefits of a program designed to help low-income families with children went to people who either didn't have eligible children or made too much money -- or both.
Antipoverty groups have challenged the Treasury's findings (which, by the way, are similar to what a Clinton Treasury study found a few years ago), but their objections amount to quibbles. Their only suggested "solution" is to change the EITC rules so that some of the ineligible become eligible -- an odd approach and, in any event, one that's been tried several times before with little success.
Of course, the EITC isn't the only part of our tax code where cheating is endemic. Many well-off small-business owners routinely understate their profits by large amounts. Capital gains often go unreported. Unscrupulous big corporations use abusive offshore tax shelters to evade tens of billions of dollars a year in taxes. No doubt, this style of tax cheating dwarfs the EITC's compliance problems. But if we want the IRS to crack down on tax-evading corporations and rich people, we should worry about all the resources the IRS diverts to (poorly) monitoring the EITC.
There's no doubt that the EITC is worth preserving and improving. But that goal isn't furthered if the program is perceived as rife with cheating. Unfortunately, the kinds of cheating involved -- parents claiming children who didn't actually live with them, ignoring the earnings of a child's other parent (spouses as well as cohabiting partners), and so forth -- are extremely difficult to detect through the necessarily limited scrutiny that the IRS can apply.
I don't have the answer to the EITC compliance problem. Perhaps there's a government agency that could do a better job running the program -- although making such a change could risk losing Republican support. In any event, liberals need to go beyond denial and come up with some better ideas to stem cheating if this important program is to be effective at reaching those who need it most.
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