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Illustrating the Earned Income Tax Credit’s Complexity

3 min readBy: Amir El-Sibaie

The Earned Income 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. (EITC) is one of the United States’ most important social programs, yet happens to be bogged down with some of the most complicated eligibility requirements in the 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. code. The excessive complexity has commonly led to it being considered a “high-risk tax program” in need of reform by some governmental agencies.

The EITC provides benefits to millions of low-income taxpayers. It is intended to supplement existing social and welfare programs while at the same time encouraging those receiving benefits to work. In addition, the credits are refundable in the sense that if they total more than you owe in taxes, the IRS will give you any excess in a payment when you file for taxes. In 2013 taxpayers claimed about $68.1 billion in credit, of which $59 billion was directly refunded. For comparison, SNAP (sometimes referred to as food stamps) costs $79 billion a year.

The Government Accountability Office (GAO) published a report in May of this year. It found that the program suffers from a high improper payment rate. For the fiscal year 2015, they found that $15.6 billion of the EITC’s $68.1 billion in total payments were considered improper, meaning the filer over claimed or wasn’t eligible. That’s almost a fourth of the entire program’s payments.

The GAO says that the program’s high payment error is a result of the program’s complex eligibility requirements.

In order to illustrate just how complicated figuring out if you’re eligible for the EITC can be, we made a flowchart:

The flowchart above isn’t able to capture every intricate possibility associated with claiming the EITC. For example, the GAO report includes a number of scenarios in which eligibility can be incredibly ambiguous. Imagine a young man working to support his girlfriend and her two kids; they used to be married, then got divorced, but are still living together. In this scenario, he is likely eligible for the EITC as the children are his stepchildren. However, if the couple were never married, then he is likely ineligble because then the children are not related to him.

For such reasons, it’s no wonder why the GAO discovered significant noncompliance. The eligibility rules for the EITC can be confusing for some people, and the IRS needs better ways to check the accuracy of tax returns. The GAO recommended many ways in which the IRS can use additional data from other agencies to reduce levels of noncompliance. However, the IRS then subsequently raised concerns about the increasing cost of studying collections data.

Policymakers will nevertheless argue that the program needs more regulation and oversight in order to enforce compliance and eligibility. However, with the burdensome task levied on the IRS and taxpayer, this can lead to more inefficiency. With almost a fourth of the EITC currently being misappropriated, perhaps alternative solutions should be investigated. Instead of adding on more eligibility requirements or red tape, simplifying the credit program itself might lead to a more effective program and less enforcement costs.