TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy wonks often advocate for increases in refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit. s (e.g., Child Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. , CTC and Earned Income Tax Credit, EITC) and nonrefundable tax credits (Child and Dependent Care Tax Credit, CDCTC) as one solution to help low-income Americans. Arguments in favor of expanding these tax credits appear during economic expansions and contractions alike.
Last Tuesday, the Aspen Institute published a white paper arguing in support of an expanded “Pandemic” Earned Income Tax Credit as a way to help workers cope through the COVID-19 outbreak. This plan would double a household’s refundable EITC based on their earnings in the 2020 tax year.
Two days later, the House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. hosted a virtual hearing focused on tax relief to support workers and families during the COVID-19 recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. , which included testimony and policy suggestions from tax scholars and academics, some arguing for expansions to the EITC and CDCTC.
Increasing the CTC, EITC, and CDCTC as a short-term economic policy response measure would not be the best use of forgone federal revenue. The debate over reforming credits should come in the context of longer-run policy discussions separate from the public policy response to the pandemic and subsequent economic fallout. Creating new or expanding already-enacted workforce and dependent-related credits would be an ill-timed way of providing economic support to families working paycheck to paycheck and caring for dependents.
Instead, if policymakers think more relief for households is necessary in the next round of legislation, Congress should consider improving upon the direct rebates provided in the CARES Act. While not perfect, rebates are preferable to temporarily increasing or tinkering with credits, which are less timely, administratively cumbersome, and overly-narrow in delivering economic relief.
“Response” Credits are not Timely, Especially During A Pandemic
Tax credits offer taxpayers dollar-for-dollar reduction in their tax liability at the end of the tax filing process. Whether someone claims the EITC, CTC, or CDCTC, any eligible tax relief comes in a lump sum. Additionally, only the EITC and CTC can be claimed as refunds if their value is greater than the total liability owed.
While proponents argue that the EITC could be doubled and the CDCTC made refundable to provide additional relief to families with childcare expenses, such changes would result in a one-time cash transfer on an annual basis. The HEROES Act—released in the spring and including “advanced” credits that could be claimed before the 2020 tax filing season—partially addressed this shortcoming. However, an advanced credit still requires households to provide the IRS with additional information and may create more confusion for these households as they learn about the advanced credit.
Any relief which would result from a change in credits, whether the “Pandemic EITC” or the fully-refundable CDCTC, would not be seen until taxpayers next file their taxes, likely in 2021. As policymakers discuss the likelihood of a “V-shaped” or “L-shaped” recovery, it is essential that taxpayers are not forced to wait until 2021 to receive liquidity. Economic theory tells us that the value of one dollar of relief today is greater than it will be next June.
“Response” Credits are Administratively Cumbersome & Less Efficient at Providing Relief
In an earlier post, I argued that certain credits are prone to administrative complexity, logistical difficulties, and fraud, which may blunt their effectiveness. That drawback remains true today. Trying to create a new “Pandemic EITC” or expand the CDCTC to be fully refundable simply adds more complexity to the code and more compliance hoops for the taxpayer to jump through to obtain economic relief. Take the EITC: the Treasury Department recently found that 25 percent of all payments continue to be sent out incorrectly.
Increased compliance costs means that taxpayers will be less likely to claim eligible relief. This was demonstrated in the administration of the CARES Act recovery rebates. Many filers expressed confusion about how they would receive their benefits, for example, if they had not already filed a 2019 tax return or had changed addresses since they had last filed. This is in addition to the many questions taxpayers had about what the rebates were and how receiving a rebate would affect each person’s tax liability.
While proponents of refundable credits argue that they increase disposable income for vulnerable households, there are far more efficient ways to accomplish such a policy goal, especially if time is of the essence in response to a pandemic or economic contraction.
Furthermore, the Treasury Department and the Internal Revenue Service (IRS)The Internal Revenue Service (IRS) is part of the U.S. Department of the Treasury and is responsible for enforcing and administering federal tax laws, processing tax returns, performing audits, and offering assistance for American taxpayers. have already learned a great deal from the first round of rebates. This makes the prospect of a second-round rebate much easier than starting from scratch or changing credits for the 2020 tax year.
“Response” Credits Favor Certain Filers Over Others and Narrow Economic Relief
Additionally, the CTC, EITC, and CDCTC explicitly favor taxpayers with a greater number of dependents. While the CARES Act rebates provided $500 for each dependent claimed, this was a noticeable supplement to the total benefit rather than the essential criterion. If the federal government is going to increase the deficit and spend taxpayer dollars, it should be delivered in a method which increases liquidity through a rebate which is straightforward to understand, directly delivered, and well-targeted to the policy objective at hand.
Curtailing relief to those who happen to claim certain types of dependents via means-tested tax credits narrows the relative effect of those payments. Simply put, the next round of rebates—if considered by Congress in the next phase of federal legislation—should be universal in their eligibility. Any rebate check should not bias relief on types of dependents (e.g., children, elderly, or disabled) or ages (e.g., additional amounts for younger children).
Treasury and the IRS can and should incorporate the lessons learned from issuing the first round of rebates. Doing so would likely administer relief more smoothly than expanding credits such as the EITC and CTC and service the goal of increasing disposable income much more quickly.
Some might argue that sending more money via means-tested credits is the more targeted method of relief for lower-income families. But consider the CDCTC, a provision which primarily benefits upper-income filers who can afford childcare, not those struggling to live paycheck to paycheck. A universal rebate helps both lower- and upper-income filers and is better-targeted to providing liquidity for all households, including those with no dependents.
Even the CTC, which for some filers may result in a refund of $1,400, has its drawbacks. Issuing a second round of direct payments is preferable to filing more forms with the IRS and navigating the maze of eligibility requirements, which still differ from the EITC and CDCTC.
Simplicity, administrability, and transparency should be the goal for the next stage of relief. Policymakers should resist the urge to stuff more money into means-tested credits. While reforming these credits may make sense, there are far better ways to provide individuals and families with more liquidity during this crisis.
Policymakers should not get wrapped up trying to tinker with refundable tax credits at this time. Doing so would mean more money going out the door in a less-efficient way with more administrative complexity and delayed relief.
Instead, giving individuals more liquidity and letting them make decisions about which purchases to make and expenses to pay was—and remains—the better course.
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