Tax filing and Inequality

The Earned Income Tax Credit (EITC) is America’s most successful poverty alleviation program, but too few families are actually claiming this benefit.

Many low-income families refer to tax season as “Second Christmas.” Although tax refunds are certainly not gifts that appear whether you’ve been naughty or nice, these refunds are often the salvation that millions of families look forward to every year.

The Earned Income Tax Credit (EITC) lifted 5.8 million people out of poverty in 2018, 3 million of those were children. The policy has been around since 1975 and has been expanded by both Republicans and Democrats alike — Obama expanded the EITC after the 2008 financial crisis to support families hurt by the economic downturn, and Trump expanded it in 2016 to focus on helping low-income families with children.

However, the EITC remains highly underutilized. More than 20% of people who are eligible for the EITC fail to claim it. The average family will get $3,191 in EITC benefits, effectively boosting wages by $266 per month. When families fail to claim, billions of dollars are left on the table every year which just get recycled back into the government’s budget.

While the chart above shows us where the most people in the US are filing for the EITC, it does not tell us where people should be filing.

Source: Center on Budget and Policy Priorities

Taxes are complicated, and taxes once you have children are even more complicated. If you are a single mother making $20,000 and just had your first child, you are eligible to receive $5,900 in EITC credits, or 30% of your total annual income. This means that tax time can be a tremendous boost for low-income families.

Challenges to claiming the EITC

Why don’t people claim the EITC if it is so helpful? The answer to this question is tied up in several factors.

First, researchers at Stanford Law School suggest that take-up of the EITC is actually higher amongst those families who have the most to gain from it. In other words, households that may only get a-few-hundred-dollars from the EITC are more likely to skip over it than those families who would be getting thousands-of-dollars.

source: https://fas.org/sgp/crs/misc/R43805.pdf
Source: Congress

Second, the requirements are complicated. While the IRS has tried to outline the various qualifications, many families are unsure who qualifies as a ‘dependent’ for the EITC. If a teenage mom lives with her parents to help with childcare needs, is her baby the dependent or is she the dependent?

Third, many families lack proper tax support. Predatory tax filers often take advantage of low-income families who don’t know where to turn — a GAO study found that between 89%-94% of EITC tax returns filed with paid-prepares in 2015 had errors. Vulnerable communities need extra tax support and must be funneled toward the right resources.

The Path Forward

The 16th amendment was passed in 1913 and gave Congress the power to collect federal taxes. Since then, individuals, businesses, and policymakers alike have all lamented how complex the tax code can be. While this post cannot go in depth on how to reduce tax code complexity, two possible solutions exist to reduce inequality in our tax filing system. First, automatic tax filing would be a more radical change to the system, which would entail sending out pre-filled-out 1040s to households based on information that the IRS already has. Second, free-filing information could be more easily provided so that low-income families in particular can avoid predatory filers and exorbitant fees.

Automatic tax filing — The American system of tax filing can reduce the burden placed on individuals for filing their taxes. When the IRS checks if you have filed taxes correctly, they validate this information against the information that your employer, your bank, and other sources have already sent to them. If you say that you had $45,000 in income from your manufacturing job at Ford, the IRS checks the form that Ford also sent along to make sure this is correct. Instead of putting the burden on you to also send along the right information, the IRS can send you a pre-filled-out form based on the information they are already receiving and ask you to validate if it is accurate. While this would likely only work for people with simple tax situations, Austin Goolsbee at Brookings estimates that 40% of Americans would qualify for this ‘Simple Return’ process, saving 225 million hours each year, reducing $2 billion in tax fees, and improving tax collection by $36 million each year. This is already the practice in Spain, Sweden, and Denmark and California ran a pilot of this in 2005–2006 with great success. Unfortunately, Grover Norquist and tax lobbyists have made it nearly impossible to pass such legislation since it would disrupt the multi-billion dollar tax filing industry. Intuit spends more on lobbying each year than Apple or Amazon.

Free Tax Filing

70% of Americans qualify for free tax filing, but only 3% of them actually take advantage of this. The use of free tax preparers can actually be more accurate than paid prepares, with studies showing that paid preparers make errors 49% of the time, compared to volunteers which only make errors 11% of the time. The average cost of paying taxes is $242, but this can be far lower if more people took advantage of the paid options. Many Americans don’t know that free filing exists, and this is often done intentionally. In 2019, TurboTax hid its free file site by unindexing it from Google — this meant that if you searched for “TurboTax Free File” or similar, nothing would come up. Even fewer Americans know about the Volunteer Income Tax Assistance (VITA) program administered by the IRS. 5 million Americans relied on VITA last year to help them file tax their tax returns, but far more are eligible.

More Americans should be filing taxes for free and using VITA services to accurately complete their taxes. If the IRS will not send people with ‘Simple Returns’ their pre-filled-out tax returns, then at least the IRS can do more to ensure that people can file their taxes for free. The IRS Free File page is a good place to start to learn more about options, the VITA locator is even better, but the best is going to Let’s Get Set to find the best match for you.

Any household making less than 72,000 is eligible to file taxes for free. While the US tax code may take decades to overhaul, steps can be made to improve access to the Earned Income Tax Credit, to make it easier to avoid predatory tax preparers, and to get volunteer support that ensures every family gets the credit they deserve.

MIT Grad Speaker 2020, now writing about inequality || follow along @ bit.ly/SubstackAmericanInequality

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