A Simple Fix to Address Income Inequality
Morning commuters walk past tents (Photographer: Brendon Thorne/Bloomberg)  

A Simple Fix to Address Income Inequality


(Bloomberg Opinion) -- For U.S. workers, the tax system acts as an important equalizer. If you earn enough, you pay your share. But if you earn very little, the government gives you money to help make ends meet. The latter feature, known as the Earned Income Tax Credit, has proven extremely effective at reducing poverty while encouraging people to work.

More people can and should use the credit. They’ll need some help.

Politicians on both sides of the aisle recognize the EITC’s success. It benefits more than 25 million households, improving labor force participation, health and education. Without it, the child poverty rate would be more than 7 percentage points higher, at 24 percent. About 80 percent of qualified households claim the credit, compared with take-up rates of between one-third and two-thirds for other targeted programs.

It’s also great value for money. Because it’s administered through the tax system rather than by a separate army of bureaucrats, its expense ratio is just 1 percent — compared with as much as 20 percent for traditional welfare programs. Even better, it offsets about 87 percent of its costs by boosting employment and obviating the need for other programs.

What’s not to like? Well, some Republicans worry that people are claiming benefits for which they don’t really qualify. As far back as 1995, Oklahoma Senator Don Nickles called it “the fastest growing, most fraudulent program that we have in government today.” This is unfair: The EITC accounts for just 6 percent of total noncompliance losses, and payment errors are frequently due to the complexity of the rules or mistakes by unqualified tax preparers, not fraud. Nonetheless, the perception remains, and pressure is growing on the Internal Revenue Service to audit EITC recipients.

The result is a Kafkaesque mess that leaves many struggling to gain earned benefits. Low-income recipients who move relatively frequently — may not receive IRS audit letters. Of those under audit, 25 percent don’t understand they are being audited, and 40 percent don’t understand what is being asked of them. The typical audit requires 30 hours of the subject’s time, and can be delayed by as much as a year due to cutbacks at the IRS. The National Taxpayer Advocate has called it an “unnavigable labyrinth.”

The IRS did 381,000 such audits in 2017, comprising 36 percent of all audits, up from 33 percent in 2011. EITC recipients, who typically earn about $20,000 a year, are twice as likely to be audited as those earning up to 20 times as much.

The burdensome process can be bad news for families counting on the credit to pay bills. Those that give up are barred from receiving the credit for two years — and their capitulation is assumed to be evidence of fraud, perpetuating demands for more audits. A recent study estimates that the process causes 120,000 fewer workers to claim the EITC per year, and 40,000 fewer to claim it even four years after being audited.

Here’s how to fix the problem. First, give people more help in navigating audits. If, for example, the IRS designated an agent to contact, it could avert a lot of erroneous refusals of benefits (about 43 percent of audited EITC recipients helped by an advocacy group won their appeals). The IRS could do this a lot more efficiently if it made better use of technology such as virtual person-to-person support. Currently, nine out of 10 EITC audits occur entirely by mail.

Second, simplify the EITC instructions to prevent the kinds of errors that often trigger audits. The form itself is just a page long, but the explanation of how to determine eligibility goes on for 37 pages. For the growing number of people with complex family situations, figuring it out can be next to impossible.

Granted, improvements require investment — and Congress is doing the opposite. The IRS budget shrank by 18 percent between 2010 and 2017, even as it processed 7 percent more tax returns. Such cuts hinder efforts to use technology to better target fraud — for example, by cross-checking IRS records against other administrative data.

Congress and the IRS must do better. The audit process is damaging one of the most successful programs aimed at addressing income inequality in America. A little help could go a long way.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Pamela Herd is a professor at the McCourt School of Public Policy at Georgetown University. She co-authored the book “Administrative Burden: Policymaking by Other Means.”

Donald P. Moynihan is a professor at the McCourt School of Public Policy at Georgetown University. He co-authored the book “Administrative Burden: Policymaking by Other Means.”

©2019 Bloomberg L.P.

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