Earned Income Tax Credit Still Plagued with High Error Rate

May 14, 2014

This week, the Treasury Inspector General for Tax Administration (TIGTA) released their annual report on the EITC improper payments.

TIGTA found that in fiscal year 2013, the Earned Income Tax Credit suffered from an improper payment rate of 22 to 26 percent. They found that these payments cost between $13.3 billion and $15.6 billion.

This places the EITC in non-compliance with Executive Order 13520, which set guidelines to reduce “waste, fraud and abuse in Federal programs.”

As a social welfare program that helps low income individuals while encouraging workforce participation, the EITC has been historically supported by those on the left and the right. However, the continued high level of improper payments show that it is not a perfect program. It is in need of reform.

What is an Improper Payment?

From the TIGTA report: “an improper payment is defined as a payment that should not have been made or that was made in an incorrect amount or to an ineligible recipient.” These payments of incorrect amounts can be either overpayments, or underpayments by the IRS to taxpayers.

Improper payments are linked both to taxpayer fraud and taxpayer error. On one hand, there is a significant reward for misreporting income or claiming additional dependents you are not eligible to claim. On the other hand, the complexity of the EITC program (a handbook of over 90 pages) and the tax code in general could lead to honest errors on the part of EITC recipients.

Research by economist Jeffery Liebman has suggested that it is likely a mix of both. His research looked at the rate of improper payments and how they increased or decreased when the size of the credit increased. His hypothesis was if the reward for fraud increases (holding risk constant) the level of improper payments should increase. Looking at the 1996 expansion, he found that for every dollar spent on the EITC, 24 cents went to ineligible taxpayers. Of the 24 cents, 45 percent went to taxpayers who wrongly claimed children due to the larger EITC (fraud) while 55 percent went to those who would have wrongly claimed children in the absence of the expansion (taxpayer error).

Improper Payment Rate is Lower Than it Was 10 Years Ago, but costs about the same

The TIGTA report also shows the improper payment rate for the EITC from fiscal year 2003 to fiscal year 2013. According to their estimates, the improper payment rate was highest in 2003, a rate between 25 and 30 percent. This cost the government between $12 and $14.6 billion (2013 dollars).

After the expansion of the EITC in 2009, the error rate and cost began to climb, peaking in 2010 with a rate between 24 and 29 percent and a cost between $16 and $19 billion (2013 dollars). This is the most improper payments have cost in the past decade.

Most recent data shows a rate lower than the 10-year average (26 percent) with a cost between $13.3 and $15.6 billion.

Estimated EITC Improper Payments for Fiscal Years 2003 Through 2013

Year

Minimum Improper Payments Percentage

Maximum Improper Payments Percentage

Minimum Improper Payments, 2013 Dollars (Billions)

Maximum Improper Payments, 2013 Dollars (Billions)

2003

25%

30%

$12.07

$14.61

2004

22%

27%

$10.58

$13.16

2005

23%

28%

$11.42

$13.57

2006

23%

28%

$11.37

$13.46

2007

23%

28%

$11.65

$13.78

2008

23%

28%

$11.99

$14.15

2009

23%

28%

$12.21

$14.50

2010

24%

29%

$16.37

$19.69

2011

21%

26%

$14.25

$17.37

2012

21%

25%

$11.72

$13.74

2013

22%

26%

$13.30

$15.60

 

How Would the IRS Reduce Improper Payments?

The TIGTA report did not have any specific recommendations to reduce EITC payment error. They did mention that the IRS’s proposed regulation of paid tax preparers could have helped. However, the D.C. Federal Court rightly struck down these rules.

On the congressional side, there have been a few recent pushes to reduce the EITC error rate. Most recently, Senator Patty Murray (D-WA) with her “21st Century Worker Tax Cut Act” doubled the penalty for preparers (who prepare about 70 percent of all EITC claims) making the expected cost of fraud much higher. Before that, Chairman Camp’s tax reform bill, which reformed the structure of the EITC, aimed to reduce payment error by simplifying the program and matching it more closely to the payroll tax.

Of course, it may be the case that wage subsidies through the tax code are predisposed to high rates of error, making any marginal reform effort futile. Rather than trying to reform a broken program, Congress could replace the EITC with a spending-side wage subsidy. Although administrative costs are generally higher for spending programs, the huge reduction in payment errors may be worth it.

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