Should We Pay the EITC All at Once?
The New York Times has a great article in today’s A section that discusses the EITC. It is a fair story. The author managed to see the program without rose-colored glasses. She gives the EITC credit for alleviating poverty, but she acknowledges that it is mainly a patch to help low-income filers get through hard times, rather than a program that lifts those families out of poverty.
The Earned Income Tax Credit amplifies the wages paid to low-income families. It provides a refundable credit on a formula that expands for the number of dependents carried by a filer and shrinks as a person’s income approaches a need-based ceiling. For households filing “married filing jointly with three or more children, the maximum income is $50,270 in 2012. A single person filing with no dependents must have less than $13,980 in earned income.
Use of the EITC is fairly widespread, but its use is usually not permanent: According to a study reference in the story, three in five filers that get the EITC stop claiming it after two years, but one in two families claimed the credit as some point in time between 1989 and 2006.
Economists love the EITC because it manages to combat poverty without impacting employment. Many people argue that raising the minimum wage reduces the demand for employees. There is some logic to that argument, because it will make it that much more attractive for employers to find ways to substitute the use of labor for the use of equipment. Other places in the tax code already make that an attractive solution – you can depreciate your investments but not your wage costs.
In New York, a minimum wage worker makes $7.25 per hour. Factored over the course of the year, this amounts to $15,080 per year. For a single parent with two children, though, the state and federal EITC raise his or her hourly wage to $10.56 per hour or to an annual pay package of $21,726.
The EITC does not impact how firms make employment decisions.
The New York Times built their report around the personal experience of Karen Spain, a seasonal employee with the Reinvestment Partners‘ Voluntary Income Tax Assistance Clinic in Durham. Spain was once employed in IT at Nortel where she earned $85,000 per year. But until she received her EITC payment, she was driving on old brakes, late on rent for three months, and going without car insurance.
The author frames her finances in the context of an economy where the notion of full employment is gradually shrinking. But she draws a careful line on just how much she extols its virtue by emphasizing that only about ten percent of all EITC payments are ever set aside for savings. The two concepts contribute to the same picture of an economy that is gradually leaving more people behind but where current government tax policy contributes to ameliorating the situation year by year.
It is always a legitimate question to ask “how could this be done better?” One idea could be to find a way to break up the payments. Spain received one-third of her total after-tax income in just one check. The whole idea undermines the likelihood that the EITC will provide a real cushion. Instead, it becomes a once-a-year boom. Pawn shops, furniture stores, used car lots acknowledge that their revenues are seasonal. Here is an excerpt for the annual report filed this year by Rent-a-Center:
Our revenue mix is moderately seasonal, with the first quarter of each fiscal year generally providing higher merchandise sales that any other quarter during a fiscal year, primarily related to federal income tax refunds.
It is not unusual to see a buy-here-pay-her car dealer put a tax preparation shop inside their store during the first two months of tax season. The preparers do not stay much longer because the overwhelming number of EITC recipients file before March 1st. Today is tax day, but it is certainly not much of an EITC day. January 28th is national EITC day.
The rush to get a refund creates the opening for businesses that charge too much to file simple returns. No tax prep firm can lobby for their filings to come back more quickly, but all kinds of shops make this claim. The only way to hurry up a return is to e-file. With that comes the demand for the refund anticipation loan. Although banks will effectively be prohibited from making RALs after this week, it has been a practice that has added between $50 and $150 to the ultimate cost of a return. A RAL allowed a filer to get their money in about a day, as opposed to the norm of as many as fifteen days. This year the IRS has been especially slow. Last year, Spain paid $550 to have her taxes prepared. Given that she has worked as a manager in an auto parts store until her recent stint at the VITA site, it is likely that she had a relatively simple return. She says she paid extra to get her refund back sooner. How much is not said.
One significant take-away from her story is that she must have also paid quite a lot to get her return prepared. It is hard to imagine why someone would pay more than $400 for a standard return by a filer that did not itemize, but that is probably what happened to Spain last year.
Taken together, the next step in reforming the EITC seems relatively clear: the payments should be spread out over the course of the year rather than in one enormous lump sum.
LongTimer
April 19, 2012
I see the point of the author and I applaud the accuracy and perception obviously shown as you noted. IRS tried this and simply dropped it because no one would do it. Why? Perhaps because the one-time EITC big refund is the only time in their lives they have a lump sum of that amount. How else short of a winning lottery ticket would a low incomer ever have that much at one time – to get out from under the cash advance payments, the car title loans, buy a vehicle, pay property tax for those those who are struggling to keep the home (not always but frequently a mobile home) on a small lot. The problem is the unscrupulous in our midst. As always, the bad apples cause problems. My concern is the denial of that one-time, lump sum for all those desperately-needed reasons. Must we always hurt the innocent to stop the bad actors? I believe all the bad actors use e-file. The IRS could demand that fees be deducted in an itemized list. A long list of “bully pulpit” speeches could highlight the variation in tax prep fees from the “average” charges…for every charge on the list. An even less freedom/free enterprise encroachment solution could be to require every tax preparation firm to pay all associated expenses from the fee that preparer charges the taxpayer. I guarantee that every taxpayer would know every fee charged by third parties if the preparer had to pay it out of the fee the preparer collected. All of this seems preferable to the current EITC funding. Because almost no elibigle person wanted the “paycheck dribble” benefit (thousands and thousands said a resounding “NO”), other actions seem more likely to address the problems with the minimal encroachment on individual choice. But that’s just my opinion.
sdoggie
April 23, 2012
Long Timer —
That is a great comment. You are right…there are many factors contributing to the current dilemma. There are unscrupulous people out there and there are plenty of refund recipients that do not budget their sudden windfall very well. I am not sure if a quarterly payment plan would make a difference. People would still go to high cost buy-here-pay-here \”we finance anyone\” car dealers. Yet, not being sure if it would work is not a reason to reject a quarterly payment plan. It could be rolled out with an opt-in feature.
Joenik
April 23, 2012
Paying the EITC over the course of the year sounds like a good idea, but it doesn’t work. You need to overcome a lot of problems. Whose money is used? It’s hard to get employers to front the money. Do you pay in advance or in arrears? If its in advance what do you do if the person turns out to be not eligible or should receive less then they already got? How much information does a person need to give their employer? Number of kids? The fact that they work a second job?
The only way to do this would be to move the credit from the tax system to a welfare system, which would drive up the costs.
Mike Perkins EA
April 30, 2012
I agree with most of the comments here, but would like to add a few of my own. Our current tax system is already a welfare system for the less fortunate or the lazy system players. I have been preparing tax returns for 25 years. My firm prepares about 4000 returns per year. I am on my third generation of families. For 3 generations the same families have benefited from EITC, food stamps, free school lunches, welfare, paid state medical insurance, and an whole host of other entitlement programs you and I are not even aware of. They come in my office with 3 or 4 kids, who all have new top of the line sneakers, cell phones and complain they are broke and need their refund as fast as possible. This is a one time personal choice. We do not pressure to do a Refund Anticipation Loan. Most of the people I see that legitimately need help can’t get it, but let someone breed like rabbits and we send monthly checks without question. There’s a Tax Gap for you.