How Republicans Could Hike Taxes On The Poor

A key tax credit for working people is being singled out for "fraud."

WASHINGTON ― President Donald Trump says his tax reform plan will help working people, but Republicans are mulling a clampdown on the only part of the tax code that specifically benefits low-income workers.

The earned income tax credit provides a big wage bonus for parents who earn modest incomes, and about 28 million households benefited from the credit in 2015. It was created in 1975 and has been expanded half a dozen times.

But Rep. Kevin Brady (R-Texas), chairman of the House Ways and Means Committee, which oversees taxes, said some households that have received the credit should not have. And his committee wants to make sure they won’t in the future. 

“We’re looking at provisions that reduce or eliminate the fraud in that system, which is unfortunately far too prevalent,” Brady told HuffPost on Wednesday. 

Brady cited the high rate of improper payments on the EITC, which can result if people either deliberately or mistakenly misreported their income. Of the $68 billion claimed in 2015, the IRS has said $15.6 billion of those payments, or about 23 percent, were improper.

Rep. Kevin Brady (R-Texas) announces a tax reform proposal with Republican House and Senate leaders on Sept. 27.
Rep. Kevin Brady (R-Texas) announces a tax reform proposal with Republican House and Senate leaders on Sept. 27.

But the weird thing about singling out improper EITC payments is that they represent a relatively small part of government’s failure to enforce the tax code. The difference between what people owed the IRS and what the agency managed to collect averaged $458 billion a year from 2008 through 2010, or about an 18 percent gap, according to the most recent data available. The single biggest contribution to this “tax gap” was people underreporting business income on their individual returns ― which added up to $125 billion in lost tax revenue each year.

While Republicans want to crack down on the number of people who can claim the earned income tax credit, their tax plan would sharply reduce the tax rate for such “pass-through” business income ― so-called because it passes from a business to an owner’s or partner’s individual return. Reducing the rate would benefit the estimated 38 million households that report pass-through income, and experts say the lower rate would lead to many more pass-through filers, even though the IRS has so much trouble collecting on it already.

HuffPost asked Brady if that was fair.

“We want fraud out of the tax system, period,” he said, adding that the EITC and the child tax credit contribute the “largest fraud amounts.”

An additional problem is that, since the proposed pass-through rate would be lower than the highest marginal rate for regular income, the difference would give high earners a strong incentive to falsely reclassify their wages as business profits. Republicans haven’t said how they’d address this problem, but Brady said they would try to “hold the pass-through rates true to true businesses in that area.”

What makes business-tax avoidance kosher while improper cash refunds to low-income parents a “fraud” basically comes down to ideology. Republicans are very much against the idea of any “welfare” program giving money to people who don’t qualify for it. They consider the EITC to be welfare because it is both a tax break and a cash assistance program that lifts millions of Americans out of poverty every year. (Though a key difference between the EITC and any other welfare program is that people without any work income are categorically ineligible for the EITC.) 

“It’s intended to be a program that supplements parental work effort,” Robert Rector, a policy expert with the conservative Heritage Foundation, said in an interview. “If you have extensive fraud and erroneous payments, that basic idea of rewarding and complementing parental work breaks down.”

A significant portion of the erroneous payments, however, is not intentional. Claiming the credit can be a bit complicated, since the size of the payout rises with income but begins phasing out at different thresholds depending on the number of children in a household. If a married couple with three kids earn less than $23,000, they can get a tax credit payment of $6,318, with the size of the credit falling to zero as the couple’s income approaches $54,000. Past studies cited by the Congressional Research Service have suggested most of the errors result from honest mistakes, such as separated parents both claiming the same dependents. Another source of EITC errors is paid tax preparers, who help file a majority of EITC claims.

People might also be making honest mistakes when they incorrectly report their business income, but members of Congress generally don’t consider avoiding business taxes and receiving an overpayment for earned wages equal.

“There is a strong intuition on the part of a lot of people ― not just Republican members of Congress ― that a person’s receiving a dollar too much from the government is somehow more objectionable than another person’s underpaying his tax by a dollar,” Larry Zelenak, a tax professor at Duke University Law School, said in an email. “Of course, either way the government is out one dollar to which it was entitled, so the intuition flies in the face of the notion that a dollar is a dollar.”

The Republican tax framework released last month didn’t mention the earned income tax credit, but a budget resolution that passed the House last week includes language requiring the IRS to verify the income of all EITC filers. The budget is a key part of the tax process, since passing it allows the Senate to approve accompanying legislation with only 51 yes votes.

The Heritage Foundation has estimated that verifying income and other antifraud provisions could save the government $6.6 billion. But it would also be a huge task ― essentially subjecting any low-income family that applies for it to an audit.

The loss of a tax benefit is often considered a tax increase. That’s why House Speaker Paul Ryan (R-Wis.) and White House economic advisory Gary Cohn have conceded that some middle class Americans could face a tax increase under their plan due to the loss of personal exemptions and itemized deductions. Limiting the number of people who benefit from the EITC would be tantamount to hiking taxes on relatively poor working families.

HuffPost readers: Have you ever been audited over an EITC claim? Tell us about it ― email arthur@huffpost.com. Please include your phone number if you’re willing to be interviewed.

The IRS already devotes a disproportionate amount of effort toward combating EITC errors, with more than 400,000 of the 1.2 million audits last year targeting EITC claims from taxpayers making less than $25,000 a year, according to IRS data. In 2015, Congress directed the agency to delay all refunds for tax returns claiming the credit.

The government doesn’t get a very good return on its investment for all that effort, said Elaine Maag, an expert at the Tax Policy Center. It’s an especially poor investment considering how much more the IRS could recoup by targeting higher-income filers, according to the Government Accountability Office.

“When money goes out the door errantly, it often goes out to other poor families, so it’s very difficult to recover,” Maag said.

Arthur Delaney hosts the HuffPost Politics podcast: