D. Dowd Muska


The Tax Credit None Dare Call Welfare

October 22, 2015

It’s the policy-analysis equivalent of questioning the cuteness of puppies.

Veronique de Rugy, of the Mercatus Center, and Chris Edwards, of the Cato Institute, have dared to doubt the efficacy and morality of the earned income tax credit (EITC). Their brief-but-brave takedown of a program adored by left and right, Democrats and Republicans, exposes one of the ugliest methods fedpols use to meddle with the economy.

The EITC was enacted in 1975 as a “temporary” measure. The IRS describes it as “a benefit for working people with low to moderate income. To qualify, you must meet certain requirements and file a tax return, even if you do not owe any tax or are not required to file. EITC reduces the amount of tax you owe and may give you a refund.”

Scholar Laurence M. Vance noted that “Senators Russell Long and Lloyd Bentsen made [the EITC] their ‘signature initiative.’ … Ronald Reagan heralded it as ‘the best anti-poverty, the best pro-family, the best job creation measure to come out of Congress.’ Clinton’s Labor Secretary Robert Reich advocated its expansion, along with the minimum wage, to give everyone in the bottom half of society ‘a chance to get on the escalator.’”

In “Earned Income Tax Credit: Small Benefits, Large Cost,” de Rugy and Edwards contrast the majestic rhetoric with several inescapable realities. To start, the EITC “is a huge program,” providing 28 million tax filers about $69 billion worth of goodies. Some of the value represents revenue not poured into Washington’s coffers, but most -- 88 percent -- is spending. In all, the credit is “the largest federal cash transfer program for low-income households.”

The EITC got so expensive because Congress expanded its “size and scope … in numerous laws over the decades.” Recipients have more than doubled since 1990. (Population growth was just 30 percent.) Its current maximum value is $6,242 -- no small sum for workers in the cellar of the pay scale.

EITC proponents, de Rugy and Edwards write, “implicitly favor cutting market wages for low earners” by encouraging greater labor force participation. “The labor-supply effect … also means that the program acts partly as a subsidy to businesses that hire lower-skilled workers because they are able to pay reduced market wages.”

Wage-earners qualifying for the EITC progress along a path in which the credit phases in, remains flat, and phases out. Employees “have an incentive to reduce hours worked in both the flat and phase-out ranges of the credit” -- and 75 percent of EITC claimers “are in those two ranges where the work incentives are negative.” Econ 101 dictates that the effect is a reduction in “overall U.S. output and employment.”

“A major weakness of the EITC,” de Rugy and Edwards argue, “is the program’s high rate of overpayments, which are caused by math errors, misunderstanding of the the rules, and fraud.” A 2013 audit of the program by the Treasury Inspector General for Tax Administration found that the IRS had not “made … significant improvement in reducing improper [EITC] payments.” The service’s claim that somewhere between 21 to 25 percent of payments were improper in 2012 wasn’t credible, auditors concluded, because “the laws extending increases in the EITC were not factored into the estimates.”

Incomprehensible architecture is another EITC sin: “Benefits change as income rises, with four phase-in rates and three phase-out rates. It is adjusted by filing status and number of children. The rules regarding child eligibility are complex due to issues such as separation and divorce. There are rules and calculations regarding earned income, investment income, and adjusted gross income.”

Complexity invites “dishonest filers,” motivated by a share of the refundable cash. “[U]nscrupulous tax preparation firms prey on unsuspecting workers, including many immigrants who have poor English skills. For a fee, firms help workers file claims, and they also provide loans in anticipation of EITC refunds. Typically, half of the EITC tax returns completed by paid preparers overclaim the credit.”

The EITC, de Rugy and Edwards recommend, should be scrapped, and replaced with “policies to boost wages and increase job growth.” The authors suggest cutting the corporate income tax, but a privatized pension system -- funded with a much-lower payroll tax -- deserves to be on the list of alternatives. So should cuts/repeals of Washington’s levies on tobacco, alcohol, and transportation fuels, which disproportionately burden households of modest means.

The EITC is marked by “errors and fraud, disincentives to increase earnings … and deadweight losses.” It’s no exemplar of enlightened, bipartisan government. It’s an unaffordable and failed tool for social engineering.

D. Dowd Muska (www.dowdmuska.com) writes about government, economics, and technology. Follow him on Twitter @dowdmuska.

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