The error rate for payments of the earned income tax credit is once again the subject of scrutiny as the Senate Finance Committee is set October 1 to examine the "fragmentation, overlap, and duplication in the federal bureaucracy" it claims is responsible, but the data behind compliance efforts paint a complicated picture for regulating the popular anti-poverty program.
The EITC, along with Medicare and Medicaid, was involved in 76 percent of all improper payments in fiscal 2014, the Finance Committee said in announcing the hearing. The credit's supporters counter that it is a critical but overregulated anti-poverty program. Indeed, a San Francisco Chronicle report points out that "more than one-third of the 1.2 million returns selected for audit [in 2014] were 'selected for examination on the basis of an Earned Income Tax Credit,'" citing the IRS Data Book.
But with such a high audit rate, why the persistently high error rate? Aside from fraud, which National Taxpayer Advocate Nina Olson chalks up partly to overclaims made by unenrolled preparers, the taxpayer advocate offered another significant reason, telling a House Appropriations subcommittee in 2014 that about a third of the taxpayer population eligible for the EITC turns over annually. She said that churning population is a highly mobile one, making correspondence audits -- the chief means by which the IRS conducts audits on that population -- difficult.
To understand the scope of the issue Olson cites, it is worthwhile to examine data on the top U.S. counties in terms of EITC claims in tax year 2012, from the IRS Statistics of Income program, versus population mobility estimates reported in the American Community Survey (ACS) for people changing residence at least once in calendar-year 2013, when many of the audits for the previous tax year were taking place. For instance, in Travis County, Texas -- of which Austin is the chief city -- a full 30.45 percent of the population earning less than $10,000 reported changing residence in the ACS for 2013, twice the 15.53 percent for those reporting more than $75,000 in earnings. For Travis County in tax year 2012, there were 104,930 EITC claims among 599,010 total individual returns filed, according to SOI.
The problem gets to be greater for counties whose populations and EITC claims are higher. In Harris County, Texas -- home to Houston -- 449,460 EITC claims were made in 2012, good for third highest among U.S. counties. The transiency rate for its population reporting $10,000 or less on the ACS was 20.14 percent in 2013; it was just 12.32 percent for those reporting more than $75,000.
There are notable outliers. Los Angeles, highest among counties' EITC claims with 984,640, had a 15.67 percent transiency rate for its lowest earners and 11.73 for its highest, but its residents earning $35,000 to $65,000 moved at a greater rate than those earning $10,000 to $35,000.
Moving 'a Way of Life'
But the ACS data paint only part of the picture. Arloc Sherman of the Center for Budget and Policy Priorities (CBPP) cautioned that the income reporting criteria for the two data sources don't exactly match up. The IRS data, for instance, include people who are counted as making more than $25,000 a year by ACS but are making less than that according to their adjusted gross income, because ACS includes other income sources such as Social Security and dependents' incomes.
Chye-Ching Huang, also of CBPP, pointed out that the ACS doesn't account for childless workers, for whom the EITC phases out at much lower income levels than for those claiming multiple dependents. For 2012, income limits for claiming the credit were $13,980 ($19,190 filing jointly) with no qualifying children, up to $45,060 ($50,270 filing jointly) with three or more children.
But the transiency rate among the likely pool of EITC filers is telling and indeed is perhaps underrepresented, University of Nevada, Las Vegas, Professor Francine Lipman told Tax Analysts. The ACS data likely don't reflect those who are homeless, incarcerated, living with relatives, or in other unstable situations, said Lipman, who does pro bono tax work for low-income taxpayers. She added that they "are quite often rolling stones necessarily having to live where they can find a place. So moving from location to location during the year is a way of life, not an event."
And yet correspondence audits are the go-to method the IRS uses for reaching that population, Olson told the House panel. A look at IRS full-time equivalents (FTEs) -- a measure for staff hours spent -- supports Olson's claim. For 2002, the latest year for which such compliance information is available on the SOI website, the agency's 366.36 FTEs spent on correspondence audits for taxpayers with income up to $25,000 is second only to that spent on field audits for those earning $100,000 or more (593.65 FTEs). For context, third highest are field audits for taxpayers earning $50,000 to $100,000, at 226.88 FTEs.
"Because the IRS depends upon mailing addresses, I often work very hard to get my clients to identify a reliable/dependable mailing address," Lipman said in an e-mail. "This often is not where the taxpayer is living (full-time in the traditional sense), but rather someone who will get mail for them on a more regular basis than they could do it for themselves." She said those who use those addresses for mailing purposes may say they haven't moved, despite their transiency. "'Moving' means nothing to them because they are always moving and do not have the luxury of having a place/space/home in the traditional sense," she said.
Olson also said in her testimony that correspondence audits don't offer as strong of an opportunity to study the sources of errors, citing the agency's 2006-2008 National Research Program Compliance Study, which found that 30 percent of total possible overclaim returns and 41 percent of possible overclaim dollars result from unknown errors mostly because of audit nonparticipation.
Correspondence audits in a way are cost effective for the IRS compared with other types of examinations, according to Villanova University Professor Leslie Book, but they provide "significant downstream costs" that may be less apparent, such as the potential for some taxpayers who fail to respond, or who are unable to provide the documents that the IRS requests, actually being partially or totally eligible for the credit and getting caught in an audit reconsideration or similar system.
"In addition, there is some concern that the correspondence examination, even among taxpayers who are noncompliant, is not an effective way of educating those taxpayers about the reason why they are noncompliant," Book told Tax Analysts. He said later, "This is especially so given language, literacy and transiency issues, as well as the dynamic nature of the population claiming and in fact potentially eligible for the credit."
Taken together, Olson said, the EITC's complex rules and the taxpayers' lack of a home base to store documents or the skills needed to read and understand them frequently result in a lack of documentation.
The EITC's incorrect payment rate is one shortcoming H&R Block recently cited as justification for its controversial lobbying effort to increase the credit's information reporting requirements.
The Senate Appropriations Committee included language in its fiscal 2016 budget bill to expand what the CBPP called an already complicated Schedule EIC, used to claim the credit. H&R Block "lobbied heavily" for the provision, the CBPP said in an August 20 release, saying the "onerous" new four- or five-page form would create "substantial new burdens and costs, as well as confusion," for EITC filers and would lead to decreased participation rates among deserving taxpayers.
For its part, H&R Block said the move would reduce fraud and protect the "future of the EITC," a program it said had $16 billion to $19 billion in improper payments in 2014. It rejected claims it was motivated beyond anything other than preventing fraud, saying, "Anyone who says differently is not really committed to fixing a gaping hole in EITC eligibility or to reducing the billions of dollars in improper EITC payments that occur every year."
Olson, however, has made the point that EITC noncompliance makes up only a fraction of the tax gap, saying in her Appropriations subcommittee testimony that credit overclaims account for only 6 percent of gross individual income tax noncompliance. Business income that individuals underreport makes up about 52 percent of the tax gap, she said.
Also, in testimony before a House Oversight and Government Reform subcommittee hearing in April, Olson challenged the truism that EITC noncompliance is getting worse. Citing IRS figures, she said that while the improper payment rate is "often presented as a worsening problem, it may actually be less severe than in tax year" 1999.
Olson also noted the higher participation rate and different administrative approach behind the earned income credit compared with "traditional anti-poverty and welfare programs." The design of the EITC, allowing people to claim it on their tax return, doesn't require an infrastructure of caseworkers and local agencies, which leads to significantly lower administrative costs, Olson said. And adopting a "front-end application process" wouldn't eliminate improper payments, she said. Olson's testimony included a chart showing overhead costs plus improper payments as a percentage of total expenditures. That figure for the EITC was lower than for the school lunch, for children's healthcare, and for the supplemental nutrition program for women and children.
And setting aside Huang and Sherman's point about the limitations of the ACS data when it comes to EITC eligibility based on income, some argue that those in the bottom brackets should qualify for a greater credit amount, children or no. Republican presidential candidate Jeb Bush, for one, announced a tax reform plan that calls for expanding the credit for childless workers and for those under age 25. And President Obama in his fiscal 2016 budget proposal called for a secondary earner deduction to supplement the EITC for joint earners.
So despite its apparent flaws -- whose true extent is debated and indeed unknown thanks partly to the IRS's means of ensuring compliance -- the program remains popular. And whatever is next for the EITC, be it compliance method reforms or proposed changes to the program itself, the Finance Committee's hearing October 1 could set the stage.