This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: addressing poverty through tax.

Since its enactment in 1975, the earned income tax credit has played a crucial role in U.S. policy for alleviating poverty. While numerous studies have linked the EITC with a reduction in poverty, concerns have been raised over the structure of the program and how the IRS handles claims.

So how should we assess the effectiveness of the EITC, and what are some of the possible solutions to address concerns over fraud, audit practices, and the exclusion of certain groups from the benefits of the program?

Joining me now to talk more about this is Tax Notes reporter Alexander Rifaat. Alex, welcome back to the podcast.

Alexander Rifaat: Hi, Dave. Good to be back.

David D. Stewart: Why don't we start off with, in basic terms, what is the earned income tax credit?

Alexander Rifaat: So the earned income tax credit is a subsidy directed towards low- and middle-income households and provides crucially an incentive to work, at least up to a certain threshold.

David D. Stewart: Now I understand you recently did an interview on this subject. Who did you talk to?

Alexander Rifaat: So I talked to a trio of professors from Marshall University, Susan Lanham, Amanda Thompson-Abbott, and Tom Norton, who recently did research on the EITC and its effect on poverty rates. So I spoke with them, we weighed up the pros, the cons of the credit and delved into possible solutions to make the credit work better for working families.

David D. Stewart: All right, let's go to that interview.

Alexander Rifaat: Thank you all for being here.

Thomas A. Norton: Thank you.

Susan W. Lanham: Thank you.

Amanda Thompson-Abbott: It's a pleasure to be on your program.

Alexander Rifaat: Tom, I'll start with you. Could you provide a brief overview of the EITC program and its importance in alleviating poverty?

Thomas A. Norton: Absolutely, I would love to. So for starters, the EITC stands for earned income tax credit, and it was originally envisioned in 1975. At that point in our history, we had some sort of, what we call them, welfare programs, but at the time, there was a lot of talk about a negative income tax or what we would probably call today a universal basic income. The thought at that time or the proposal was everybody would have some sort of universal basic income, and some people disagreed with that, particularly Senator Russell Long. And he proposed what was known at the time as the work bonus program.

So the work bonus program wanted to incentivize people to actually work because under the negative income tax situation, the people who got the largest credit would be people who did not work at all, and he wanted to incentivize work. So he proposed the work bonus program. And under that program, 10 percent of the first $4,000 of earnings would be credited back to the taxpayer, and then you would start a phaseout period between $4,000 and $8,000. So you could earn up to $8,000 and still earn the credit. And eventually that passed as a temporary measure, and then once it passed as a full-on measure that had some weight, it actually got changed to the earned income tax credit, which is what it's known as today, or EITC for short.

So it started in 1975. And from 1975 until 1990, the credit itself increased, but it did not increase based upon the number of children you had. So it was just a credit that, it wasn't indexed to inflation at the time, but they increased it several times over that time period. In the 1990s, we saw it undergo quite a bit of different modifications.

The credit was limited or modified to include single people, and then you also got more credits for the more children you had. We also saw a lot of changes in the 1990s. So one of the things that becomes an issue is that you could have somebody who has a relatively high amount of income, but that income would be unearned income. So it essentially eliminated those people out of the applicant pool or tried to. It made the applicants have a valid Social Security number and work in the U.S., and then they started out with the antiabuse rules in the 1990s.

Of course, it's important to note at the outset that my introduction's not going to cover every single thing that's happened since 1975, but these are the main things that have happened. In the 2000s, we saw the credit expand again and that three or more children — and we saw a reduction in, and we'll talk about this later, what is known as the marriage penalty. So it works out in certain situations where it makes more sense to not be married because you'll get a higher credit than if you do get married. So they call that the marriage penalty or the marriage cliff.

And then in the late 2010s, we added more antiabuse provisions to the law because some people perceive the EITC as one that's highly abused. And now the current iteration of the credit, we give single people and up to three children, and that works into the favor of the credit. So the credit starts out as single then one child, two child, three child, and it also depends upon filing status. So if you're single, head of household, all of that is under one bracket, and then there's another bracket for married filing joint.

It is a refundable credit, so you can get money back even if you owe no taxes, and of course, it is phased out. There's a maximum credit amount. So if you're a single person and you have no children, your maximum credit is $600. So you'll earn income until you reach that maximum credit. And then once you earn too much income, it'll sharply decline off until you get no credit at all. So there is a sweet spot there that people like to be in because you get the most credit. The other thing is that it's also age dependent.

If you're under 25 or you're over 65, you are ineligible for the credit. And over the course of the credit, the two main drivers are the amount of the credit and what eligibility rules you have to meet in order to get it.

Alexander Rifaat: Susan, turning to your research and to the report that you all published, what were the main takeaways from that research? And second, why was it important to focus on that particular time frame of 1999 to 2021?

Susan W. Lanham: The data was absolutely fantastic. To have a period of data with that range was great, and we wanted to look at economic downturns and upturns in relation to the EITC payments being made to see if there was any kind of trend. And so you need multiple years worth of data in order to do that. So I was glad they provide that easily online. And we looked at 1999 to 2021 data, and it did show that the yearly EITC payments made do match the ups and the downs of the economy. And so this does show that the EITC is a tool that supports those in need.

We also looked at trends in the average payments made to each person. And the trend is that the average is increasing at a rate above inflation, which means that the program is becoming more generous as time passes. And we looked at 2020 though [it] was an anomaly year; it was unusual. It stood out from all of the other years probably because of the pandemic. But in that particular year, you saw earned income tax credits drop sharply, and the child poverty rate actually increased during that time period.

So there were other new relief measures that were in place during then that probably did — it'd be an interesting study though, just to look at what happened in 2020, but no doubt the pandemic had some effects regarding that. Our study looked at, we used regression to look at the relationship between the earned income tax credit payments and poverty rates, specifically those in deep poverty, which would be defined as that we're using consumer price or we're using the CPS, Current Population Survey, data and definitions to define deep poverty and near-poor.

And the deep poverty would be if you have a threshold for poverty, which is going to be based on your age, based on the number of children you have, the number of family members you have, and your annual earnings, if you're 50 percent of that rate, 50 percent of your threshold for being in poverty, you're considered deep poverty. And so we looked at the relationship between the payments made and those in deep poverty, and there was a significant relationship between the two showing that the payments are supporting those in that category of deep poverty.

When you look at the near-poor, and so that would be defined as anybody earning 25 percent above the threshold for poverty, you're not underneath or at the threshold for poverty, but you are close. You're within 25 percent of it.

And the relationship wasn't significant. It was very, very weak. That was interesting as well. So that tells us that there are other factors involved that's affecting those in the near term and that the EITC payments, it doesn't look like it's affecting those individuals nearly as much. And so it is obviously an incredibly important program to support those in need. The overall net positive versus [net negative] is a good question and one that's very, very difficult to answer because there are so many different factors that you would need to consider.

And we'll be getting into that probably a little bit later on when we talk about the fraud and just overall errors within the program. But that was the gist of what our research study found.

Alexander Rifaat: Amanda, the EITC program appears to be in the news for all the wrong reasons these days. The Government Accountability Office found roughly 33 percent of EITC payments made by the IRS last year totaling $22 billion were made in error. A study by Stanford University found non-white taxpayers have a greater chance of having their EITC claims audited. And another report alleges storefront tax preparation companies deliberately targeted low-income earners in part to arrange advanced loans on their EITC claims. What do you see as the main factors driving these concerns?

Amanda Thompson-Abbott: Well, I think it's like with any tax policy, there are always going to be things that maybe you don't anticipate. There are groups that are impacted in very different ways. When I look at the structure of the earned income tax credit, there are a couple of things that come to mind, to me at least, even beyond what you have already mentioned. One of the things that I think stands out about the earned income tax credit, if we look at the age range. So our age range for the earned income tax credit is between 25 and 65. That leaves out some people that are in poverty.

So we have individuals that may be 19 to 24 that have started families young and yet they are not eligible to take advantage of the earned income tax credit. So I think that is one area that's definitely a problem, maybe doesn't make the news probably like it should. And the other side of it, if you look at the age range, is that people over 65 technically are not entitled to take advantage of the credit. And the problem with that, quite truthfully, is we have a lot of grandparents now that are raising kids and that are working and going back into the workforce. [Correction, June 12, 2024: Individuals 19 to 24 and over 65 can claim the earned income tax credit if they have an eligible child.]

But sadly, they're not able to take advantage of this credit that could really help them when you look at Social Security not maybe being enough for them to make ends meet. So I think that if you look at discrimination and some of these populations that maybe are not being able to take full advantage of the credit, definitely age plays a factor. Another thing that I think plays a factor is you could argue that the structure discriminates against families that have a lot of children. If you look at the structure of it, basically you get to three kids and there's no additional benefit.

And I get why that was probably put into the law; obviously we don't want to encourage certain behaviors. But people that do have large families, it seems like there should be something that would help them take more advantage of that credit. I think another area that I feel structure-wise with the earned income tax credit that maybe needs some adjustment is if you look at single individuals. Tom, I think, shared in the first part, the maximum credit for somebody that is single that has zero kids is $600.

Well, that's great, but that $600 probably really doesn't provide the safety net that somebody that is single and also in poverty might need. And if the goal of earned income tax credit is to encourage people to work, I'm not sure that the $600 maximum credit really goes a long way to encouraging what it was set out to do, which was obviously make people think about work.

Alexander Rifaat: And looking specifically at the claims of fraud within the EITC program, what do you see as sort of the main issues there?

Amanda Thompson-Abbott: I think probably one of the big issues with the earned income tax credit — there's a couple, but if I were going to look at where it could be manipulated — probably would be with self-employed individuals because self-employed individuals do have quite a bit of control over the income that they're earning and the expenses that they're reporting. The government has tried to rein that in a little bit by really cracking down and making people file 1099s. But I'm not sure that it's still to the level where it would prevent fraud with regards to that area.

Other areas of fraud, there is a provision in [the] tax code that will allow married individuals if they are separated [for] a certain period of time to file as head of household. And I think that that is definitely an area where there is some fraud. It would be hard as a tax preparer to really drill down and see if an individual has lived apart however long they're supposed to live apart in order to file head of household. I think that's one that would be particularly hard to crack down on.

My suggestion to combating that particular type of fraud with earned income tax credit is I think that there should be limits on how often people can take advantage of head of household if they are truly married. I think the government might need to think about saying you've got a year or maybe two years and after that you have to make a decision. You're either going to stay together or you're going to get a divorce. So I think that's definitely an area where we see some abuse.

Alexander Rifaat: So in looking at other solutions, you mentioned one, taking a step back and looking at the program in general. What are y'all's thoughts on just sort of solutions, other solutions that can be taken into consideration to either fix the EITC program, maybe there's an alternative model solution. What are your thoughts there?

Susan W. Lanham: Anytime you have a social service program, there are going to be issues with it. There's going to be fraud. We know that stat of 33 percent of the payments are made in error, which is mind-blowing because that's every year. It may not be at 33 percent, but it's been in excess of 20 percent for many, many years since its existence. When you look at the total volume of dollars over these years, it's just mind-blowing. But the EITC program, it's really interesting. It's very similar to the size of our supplemental security income program, our SSI.

And so you have welfare programs and SSI programs like that that are heavily reviewed. There's a lot of oversight associated with those programs that we don't have with EITC. And so roughly $64 billion is paid out for EITC. Same for SSI. The cost of administering these programs, it's interesting as well. SSI, because it has all of this additional oversight, is a lot more expensive. The estimates of that are around 10 percent of the payout. With EITC, it's probably less than 1 percent would be the estimate of the administrative costs of that program.

But then you have to look at the error rate. And some of the error is fraud. But some of it's just the complex nature of the program itself and who qualifies, and educating the taxpayer is critical. Educating tax preparers is critical in order to reduce those, but the error rate under SSI programs is only around 8 percent. They estimate it in the literature at around 8 percent. And so when you're considering the net positive, net negative, while the cost to administer programs like SSI is much higher than the cost of EITC, the error rate of EITC would put that in a negative.

Much, much higher than the error rate, or the overpayment, they call it, for SSI income. So it's interesting to see that. It would be difficult to take the EITC program away. It does support those in need.

Thomas A. Norton: Yes, this is Tom. I agree with everything that she said. Some other things that I think might make the credit a little bit better is to simplify the eligibility criteria. So if we had unified income thresholds and consistent definitions about what a qualifying child is and what earned income means, I think that we could make it easier to know if you're eligible or not. If we could simplify the filing process. So I know that people who get the earned income tax credit are also receiving other credits and assistance programs. If we could have a one-stop documentation shop, that could definitely be helpful.

And I know Amanda and I do some work with VITA (Volunteer Income Tax Assistance), but having an IRS support and assistance and enhanced tools to help educate people on that they would be eligible for the earned income tax credit and helping them get their tax return forms filled out properly and accurately. That would definitely help. So that's more communication and outreach and just the structure of the benefit itself. From looking at it, it seems that people who are single kind of face a bad burden because if you're single, you're at $600 maximum credit and you have no children.

But if you have just one child, your credit jumps up 566 percent, up to almost $4,000 of eligible credit. So maybe help those sort of people who don't have children. And then it seems to me at least when the phaseout period starts, it should be a more gradual phaseout; it seems like the phaseout is almost like a cliff instead of a phaseout. Especially today, if you think about some of the people who are using the earned income tax credit, they live in inner-city places, and the cost of living is fairly high. So having such a devastating cliff at the end of the tax credit, I don't think makes sense in our current climate.

And then one of the big things is just nontraditional families in general. So you might not be related to the person who you are taking care of. And if you're still taking care of that person and you're impoverished, it would make sense for you to be eligible for the credit. But some people miss out on that completely. So I think that those are all things that we can look at as to maybe help the program. As far as fraud prevention, it seems like in today's society, with as much AI and advanced analytics as we have, that the IRS could make use of that to weed out more of the abusive.

When we come up with a 33 percent, we got to realize that some of that is an error and some of that is fraudulent. So really target the fraudulent people because I can see where it would make sense from a business model perspective as a tax preparer to move into an inner city and churn out a lot of earned income tax credit returns. And you could probably charge a pretty high fee for doing that. But we need to target the people who are truly abusing it and the people who — there's also language barriers that come with people who have the earned income tax credit.

So we don't necessarily want to punish somebody for maybe making a mistake, but if it's a willful thing, then we need probably stronger penalties than we currently have. And I don't think we talked about it yet, but there is currently a due diligence process for people who are filling out tax returns. So they have sort of a checklist that they go through, and they're supposed to fill out that checklist and make sure that the client seems like they're telling the truth or should be eligible. And you can have penalties as a paid preparer.

I think it begins at about $600 and goes up to $2,400 per violation. So those are definitely in place. And maybe modifying those to where it targets the abusive behavior better would help out the credit.

Amanda Thompson-Abbott: I agree with what Tom and Susan have proposed. One thing that I would add to what Tom has just shared with us is that I've always felt with that checklist, maybe some additional documentation should be uploaded and provided before the tax return is e-filed. So things like copy of Social Security card that could be provided by the taxpayer, school records, anything that they have in terms of daycare invoices, just to prove that they are providing for that child and it is a legitimate dependent.

And those are things that for the caretaker really shouldn't be too hard for them to produce, especially medical card, Social Security card, and even the school records. I think that would go a long way towards improving the current due diligence checklist that we currently have for tax preparers.

Alexander Rifaat: Well, it's been a fascinating discussion, and it will certainly be interesting to see how the EITC evolves going forward. Thank you all for your time today.

Susan W. Lanham: Thank you.

Amanda Thompson-Abbott: Thank you.

Thomas A. Norton: Thank you. It's been great.

David D. Stewart: And now, coming attractions. Each week, we highlight new and interesting commentary in our magazines. Joining me now is Senior Executive Editor for Commentary Jasper Smith. Jasper, what will you have for us?

Jasper B. Smith: Thanks, Dave. In Tax Notes Federal, PJ Cline explains what limited partners should know about Soroban. Louis Mazawey and Catherine Ferguson examine proposed regulations on the stock buyback tax that clarify some benefits issues.

In Tax Notes State, Brett Carter outlines Tennessee’s recently approved franchise tax refund opportunity. Joel Busch considers how states define professional athletes for state income tax purposes.

In Tax Notes International, Ryan Finley explains why the Irish Tax Appeals Commission's first published transfer pricing decision is based on a flawed analysis of the employee stock option issue. Reuven Avi-Yonah examines the tax treatment of crypto-to-crypto exchanges in the first of a two-part series.

And finally, in featured analysis, Joe Thorndike examines public reactions to the first federal income tax’s failure to generate as much revenue as the government had predicted during the Civil War.

David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. And be sure to follow @taxnotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

Tax Analysts Inc. does not provide tax advice or tax preparation services. The information you have seen and heard today represents the views of the presenters, which may not be the same as those of Tax Analysts Inc. It may include information obtained from third parties, and Tax Analysts Inc. makes no warranties or representations of any kind and is not responsible for any inaccuracies. Nothing in the podcast constitutes legal, accounting, or tax advice. The tax laws change frequently, and neither Tax Analysts Inc. nor the presenters can guarantee that any information seen or heard is accurate. Also, due to changing tax laws, any information broadcast or downloaded after its original air date may no longer represent the current views of the presenters. If you have any specific questions about any legal or tax matter, you should always consult with your attorney or tax professional.

All content in this broadcast is protected under U.S. and international laws. Copyright © 2024 Tax Analysts Inc. Unauthorized recording, downloading, copying, retransmitting, or distributing of any part of the podcast is strictly prohibited. All rights reserved.