Reimagining Tax Administration: Social Programs Through the Tax Code – Workshop 4: Eligibility Rules for EITC/CTC and Other Family Benefit/Anti-Poverty Programs, Part 2

Prior blogs in our series giving an advance look at the Center for Taxpayer Rights’ Reimagining Tax Administration workshop briefs have covered the characteristics of the Earned Income Tax Credit/Advance Child Tax Credit population and the impact of administrative burden on that population’s ability to claim and receive those credits.  You can read the first two blogs here and here.

In Part 1 of this workshop’s coverage, we analyzed whether the eligibility rules for tax benefits targeted to low income households actually fit the characteristics of the target population and whether those rules caused some eligible children not to receive the benefits.  Today we explore what are the risks that might arise in using the tax system to deliver these benefits to that population, how other countries have tried to come up with approaches that minimize that risk, and why, even given the risks, we might still want to run such programs through the tax code. All of the workshop sessions are recorded, and the videos are available here on the Center’s website, along with slide decks and other materials.

Avoiding repayment risks in the Child Tax Credit: Lessons from the UK, Australia, New Zealand, and Canada

Presented by Kathleen Bryant, Legal Research Associate & Chye-Ching Huang, Executive Director, The Tax Law Center, New York University

Refundable credits, particularly those with an advance payment feature and eligibility determined retroactively, can pose a “repayment risk.”  Based on evidence from United Kingdom, Australia, and New Zealand, repayment risks can create program instability and financial hardship.  Taxpayers may be required to pay back some or all of the benefit received due to changes in income or family circumstances. While safe harbors can mitigate some of the financial harm, substantial repayment risk can undermine political and public support for the program.

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Generally, there are three approaches to minimizing repayment risk that have been employed internationally (or proposed in the United States). (More information on avoiding repayment risks internationally can be found here.)

  1. The government can require repayment with some protections in place for taxpayers. This is the case in the United Kingdom, Australia, New Zealand, and the United States (for 2021).

In the United Kingdom between 2003 to 2004 and 2005 to 2006, about one-third of all tax credit awards were overpaid, with income fluctuation accounting for 70% of the overpayments and delays in reporting changes in family circumstances accounting for about 30% of repayment obligations. Requiring repayment created financial hardship for families in the UK: as a result, over 25% of overpaid taxpayers owed the government more than £2,500 and 10% owed the government more than £5,000. Seventy-one percent of overpaid taxpayers reported that the obligation to repay the government caused financial difficulty, with some reporting that they went without basic needs so they could make payments back to the government.

In addition to causing financial hardship, credit repayment obligations in the UK discouraged taxpayers from claiming the credit in future years. Credit repayment debt affected the government as well, creating administrative instability with ineffective fixes. Further, while initially UK had large safe harbors to account for income variation from year to year, these safe harbors were reduced over time.

  1. The government can eliminate income-based repayment obligations but can require reconciliation when family circumstances change. This is the option adopted in Canada.

Unlike that in the UK, the Canadian child tax credit is based on prior year income, meaning that changes in circumstances during the current year do not create repayment obligations during that year. However, if a taxpayer fails to immediately report changes in family circumstances, the delay may cause steep repayment obligations and subsequent financial hardship.

  1. The government can create presumptive eligibility rules, implement a grace period for reporting updates, and allow for an income lookback period to protect against all repayment methods.

The repayment structure proposed by the House Ways & Means Committee in the Build Back Better Act provides another approach to repayment obligations. The proposal includes monthly eligibility, an income “lookback,” and presumptive eligibility with a grace period for reporting changes in income and family circumstances.  (Note that under the proposal, the new caregiver has the responsibility to apply for the monthly credit when the care-giving circumstances change.)  Similar to the UK, New Zealand, and Australia, this proposal includes a safe harbor provision that would cover some or all of the excess, meaning a qualifying taxpayer could be protected from repaying any CTC amount overpaid by the government.  However, the safe harbor only applies to changes in the number of qualifying children, and not to other changes such as change in filing status or income.

While repayment risks associated with refundable credits are a concern, the administrative remedies can a high burden on honest/accurate filers.  Refundable tax credits account for 10% of the tax gap, with EITC constituting only 6% of the tax gap and the CTC/Additional CTC comprising only 2%, yet they receive more negative media attention than other contributors, such as underreporting business income tax (25%). Further, as noted earlier, improper refundable credit payments are reported twice – first as part of the tax gap and then as improper payments. This imbalance in scrutiny leads to adoption of more complex rules which can, in turn, result in more mistakes and overclaims, thereby increasing repayment risk.

District of Columbia Earned Income Tax Credit

Presented by Elena Fowlkes, Program Manager, Office of the Taxpayer Advocate, DC Office of Tax and Revenue

The District of Columbia’s Earned Income Tax Credit (DC EITC) provides an alternate approach to refundable credits that the federal government can study to improve its administration of the EITC and other refundable credits. Although the DC EITC piggybacks off of the federal EITC, the program has been greatly expanded and will continue to grow in the future.

For families with qualifying children, the DC EITC started at 10% of the federal credit in 2001 and increased to 40% in 2009 and more than 75% beginning in 2022. The DC EITC for childless workers has been a particular focus of the DC Council, in response to the DC Tax Revision Commission’s 2014 recommendations, and is more generous than the federal credit.  Specifically, in 2015 the DC EITC not only increased the benefit for childless workers (100% of the federal credit as opposed to the prior 40%) but also raised the Adjusted Gross Income (AGI) threshold above the IRS maximum ($25,833 for DC versus $15,820 for IRS, with ongoing inflation adjustments), to account for the higher cost of living in the District of Columbia.  Further, the DC EITC includes a component for non-custodial parents.  In 2015, after the adoption of the changes for eligible childless workers and non-custodial parents, DC saw an increase of 10,000 claims, or nearly 27%.

The DC EITC is scheduled to expand even further in the coming years. Set at 70% of the federal EITC for Tax Year (TY) 2022, the credit is scheduled to increase to 85% for TY 2025 and 100% of the federal EITC by TY 2026. Additionally, beginning in 2022, 40% of the DC credit will be paid up-front, and the remainder of payments, if over $600, will be paid in eleven monthly installments. Beginning in 2023, all DC EITC refunds over $1,200, including those to childless workers, will be paid out in monthly installments. Recently, DC approved the use of Individual Taxpayer Identification Numbers (ITINs) for taxpayers claiming the DC EITC.

One downside to basing the DC EITC on the federal EITC is that it incorporates all the complexity housed in the federal rules. Moreover, if the IRS disallows the federal EITC as a result of a math error or an audit, DC law requires the DC taxpayer to file an amended return reflecting the IRS disallowance of the EITC.  Further, the DC Department of Revenue can independently audit the taxpayer’s DC return and disallow the DC credit.  Thus taxpayers navigating the complex credit eligibility rules can face a significant repayment risk, as well as the potential administrative burden of two audits.

Issues with Delivering Benefits Through the Tax Code

Presented by Cathy Livingston, Partner, Jones Day

As the foregoing presentations make clear, there are challenges with delivering family benefit and anti-poverty programs through the tax code.  For example:

  • Retrospective filing requirements limit the reach of these programs. Generally, most individuals report their income to the IRS once at the end of each year; thus, the agency must rely on outdated information on income, filing status, and the presence of qualifying children. Moreover, low income individuals are not required to file at all, so the IRS lacks even an annual snapshot of these individuals’ household information. Because these individuals may still be eligible for the credits, they will be forced into an affirmative interaction with the tax agency that would otherwise not be required.
  • Congress and the IRS view the IRS’s primary role as a revenue collector. Many existing definitions and processes reflect this role, which can be difficult to reconcile with benefit administration.
  • The IRS does not have real time information regarding income, marital status, employer health insurance coverage – information that is necessary for targeting benefits more closely to the time of need.
  • Even when a taxpayer may be eligible for a tax refund from a benefit program, the IRS may offset that refund against a past federal tax debt and federal law requires the IRS to offset the refund for certain other outstanding federal and state debts unless a specific exception applies.
  • Finally, there is the culture issue: a lack of resources (or a lack of willingness to dedicate resources) for education and outreach limits the IRS’ ability to reach the most vulnerable taxpayers. Further, the IRS views itself as an enforcement agency; the emphasis on improper payment reporting plays into the IRS enforcement culture.

Given all these challenges, why even attempt to administer social benefits through the tax code?  One answer is found in the U. S. Constitution, Article 1, Section 9, Clause 7, which states that no monies can be drawn on the Treasury except where appropriated.  The impact of this appropriation requirement for discretionary spending is that funds are appropriated on an annual basis and are subject to political winds.  Even with mandatory spending such as appropriated entitlements, they periodically expire (e.g., Children’s Health Insurance Program expired for 114 days between 2017-2018, and is now funded through FY 2023).

To complicate matters further, Congress at times may “disappropriate” funding for provisions it has previously passed.  This happened with the Risk Corridor Payments enacted by the Affordable Care Act (42 USC 18062), which provided for insurers’ net losses attributable to pricing risks to be paid out of program management appropriations.  In 2015, Congress passed a rider to the annual appropriations bill prohibiting use of program management appropriations for this purpose.  In Maine Community Health Options v. United States, 140 S.Ct. 1308 (2020), the U.S. Supreme Court acknowledged the validity of the rider but held that insurers could sue for payment under the Tucker Act and if successful, the obligations would be paid as a debt of the United States.

In recent years, there have been occasions when all or some of the annual appropriations bills have not been enacted by the start of the fiscal year, leading to what is commonly known as a “government shutdown.”  Under 31 USC 1324, certain tax refunds and tax credits are considered “permanent indefinite appropriations” and shall be paid out regardless of a lapse in annual appropriations.   These include credits included in the Internal Revenue Code before 1978 (such as the EITC), as well as the Child Tax Credit and the Premium Tax Credit.

Thus, one motivation for running social benefit programs through the Internal Revenue Code is to avoid the disruptions of the annual appropriations process or disappropriation of entitlement spending.

CONCLUSION: How to Balance the Trade-offs?

As currently structured the IRS is in a difficult position for administering social benefit programs: it is set up to collect the pennies owed.  It is uncomfortable with designing tax procedures that adopt a “rough justice” approach, whereby IRS can show flexibility in administration toward taxpayers who are acting in good faith and are tripped up by the complexity and rigidity of the law.  Moreover, the inflexibility and precise targeting of definitions in current law create repayment risk. 

One way to minimize complexity is to provide a universal benefit.  This approach eliminates gaming. Another approach is utilized in Australia, where the child benefit can be divided between two main carers, with a default set at 50-50, subject to a different division agreed to between the parties.  Such division has the additional benefit of encouraging both parents to be involved with the child.

Canada has adopted a different eligibility rule: the person with primary responsibility for the child’s care is eligible to receive the credit.  This approach maximizes access for families in flux rather than adopting rigid relationship and residency rules.  But it may also require more administrative capacity than the IRS currently allocates to credit administration as well as program navigators. Even without legislative reform, the IRS can learn from other federal agencies and other countries in order to effectively administer social programs.  It needs to increase its administrative capacity, train its staff in social welfare skills, and accept that because it does not have residence or carer information, it must tolerate some improper payments in order to successfully disburse the benefits to the eligible population. (For a discussion of the cultural changes necessary for the IRS to administer social benefit programs, see Workshop VI.)

RECOMMENDATIONS

  1. Eliminate the requirement to include overpayments of the Earned Income Credit and other family-based refundable credits from reporting as improper payments under the IPIA.  (These overpayments are already accounted for in tax gap calculations.)
  2. Absent making the child tax credit universal, Congress should consider adopting a “primary care giver” definition for purposes of determining eligibility for family tax benefits.  Congress should further consider allowing two main carers to receive the tax benefit, to be divided 50-50 unless otherwise agreed to.
  3. If an advance payment mechanism is enacted, Congress should include a reasonable safe harbor provision;  allow a grace period for change-of-circumstances reporting; provide a look-back or income averaging to account for income volatility; authorize the sharing of residency and caring data from state and local agencies; and provide funding for a cross-agency network of navigators that work with beneficiaries of all social benefit programs, including the EITC and CTC.

Reimagining Tax Administration: Social Programs Through the Tax Code – Workshop 4: Eligibility Rules for EITC/CTC and Other Family Benefit/Anti-Poverty Programs, Part I

Prior blogs in our series giving an advance look at the Center for Taxpayer Rights’ Reimagining Tax Administration workshop briefs have covered the characteristics of the Earned Income Tax Credit/Advance Child Tax Credit population and the impact of administrative burden on that population’s ability to claim and receive those credits.  You can read those blogs here and here.

Today’s blog analyzes whether the eligibility rules for tax benefits targeted to low income households actually fit the characteristics of the target population, and whether these eligibility rules leave benefits on the cutting room floor for some otherwise eligible children.  In Part 2 of this workshop brief (to be published tomorrow), we explore the risks that might arise in using the tax system to deliver these benefits to that population, how other countries have tried to come up with approaches that minimize that risk, and why, even given the risks, we might still want to run such programs through the tax code.

All of the workshop sessions are recorded, and the videos are available here on the Center’s website, along with slide decks and other materials. — Nina

Eligibility Rules: Background

Eligibility for the various family benefit and anti-poverty credits is dependent on several factors, including income (e.g., adjusted gross income or earned income), marital and tax filing status, citizenship and residency status, and the number and presence of eligible children. The four-part qualifying child test used for various tax benefit provisions considers the relationship of the child to the taxpayer, where the child resides throughout the year, the age of the child, and (in some cases) the amount of financial support given to the child by the taxpayer. The primary issue regarding tax credit eligibility is whether the adults receiving that benefit have a connection with the child; relationship and residency serve as proxies for determining who cares for and has responsibility for the child.

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Claiming Benefits for a Child

Presented by Elaine Maag, Principal Research Associate, Urban-Brookings Tax Policy Center

Forty percent of all child subsidies come from tax benefits, outstripping traditional benefit programs including Medicaid, Children’s Health Insurance Program (CHIP), and income security programs such as SSI, TANF, Social Security and SNAP.

Chart of federal expenditures on children by category and major programs, 2019.

Due to the difficulty that comes with delivering benefits directly to children, there are several ways in which agencies try to deliver benefits to adults most closely connected to the child:

  • Medicaid and the Children’s Health Insurance Program (CHIP) follows the tax filing relationship;
  • Social Security survivor benefits are provided to the legal representative or designated payee, which may be different from the Medicaid adult;
  • Temporary Assistance for Needy Families (TANF) gives benefits to families regardless of marital status, so the adult can be an unmarried partner living in the household with the child;
  • Supplemental Nutrition Assistance Program (SNAP) grants benefits to those who share meals with the child, which may be the TANF unit or the tax unit; and
  • the Child Tax Credit (CTC) adopts the qualifying child test applied to the dependency exemption (IRC § 151-152).  Unlike the EITC, the CTC/dependency exemption includes a support test.

These different eligibility tests raise the question, in awarding benefits, what criteria should policymakers care about so long as we know the child actually exists?  For example, one goal would be to minimize overlapping claims.  Going beyond the taxable unit so that the benefit can follow the child as the child moves throughout the year could increase duplicate claims, but if the definition is intuitive – e.g., by focusing on providing the benefit to the taxpayer who provides care for the child regardless of the taxpayer’s relationship to the child – overlapping may not be a significant issue.

The existing piecemeal system creates problems for both the applicants and agencies administering the benefits. Confusion arises when the benefit units don’t match.  For example, if an individual is denied benefits under one program’s eligibility rules, that person may be less likely to apply for benefits under another program despite being eligible. Conversely, an individual eligible for benefits under one program might incorrectly claim benefits another program. These mismatches create compliance costs for the agencies.  Further, requiring multiple agencies to determine eligibility for the same households increases administrative costs and applicant burden.

Although there are problems associated with having different eligibility rules for each program, there are also costs associated with creating a uniform eligibility test across all family benefit and anti-poverty programs. First, a uniform definition would create winners and losers – if an individual is ineligible for one program, that individual is ineligible for all programs. Second, while each of these programs is designed to reduce poverty and provide benefits to children, their methods and goals are different. A uniform definition might not coincide with each program’s individual goals.

As discussed in Workshop 2, the tax system’s current test for whether individuals can receive benefits on behalf of children does not adapt to the changing structure of the American family, and thus excludes children and families from receiving much-needed cash benefits. One potential area of focus for policy makers should be to try to determine with whom the child lives and deliver benefits to that household, which could bring a degree of uniformity between the various programs and reduce compliance and learning costs for the taxpayer and administrative costs for the agencies.  (See Workshop 3 for a discussion of administrative burden.)

Social Welfare Considerations of EITC Qualifying Child Noncompliance

Presented by Emily Lin, Financial Economist, Office of Tax Analysis, Department of the Treasury

In Fiscal Year (FY) 2020, according to the IRS, nearly one quarter (24%) of EITC payments, or $16 billion, were made to taxpayers completely or partially ineligible for the credit, with 30% (and half of the dollar amount) of these errors attributable to nonqualifying children. This aggregate data, however, doesn’t provide insight into how to improve administration of the credit or the social welfare loss of noncompliance.  For example, what is the value of an improperly paid EITC dollar, and what is the cost of reducing those errors?  EITC noncompliance is also subject to duplicative reporting, because EITC overclaims are considered elements of the IRS tax gap as well as “improper payments” under Office of Management and Budget (OMB) guidance for the Improper Payments Information Act of 2002 (IPIA).

A summary of EITC errors on Tax Year (TY) 2006 to 2008 returns is shown in the table below.

As shown above, failure to meet the qualifying child test constitutes 30% of returns with EITC errors and over half of dollars incorrectly claimed.  What this data does not provide is answers to the following research questions:

  • Who are the taxpayers incorrectly claiming the EITC?
  • Do they live with the child at all during the year?
  • Do they have a relationship with the child?
  • Why did the correct person not claim the child?
  • What is the social welfare loss and the net revenue loss of the wrong person claiming the credit?

To understand the nature, extent, and impact of EITC errors, the Treasury Department’s Office of Tax Analysis (Treasury) analyzed the IRS National Research Program (NRP) results of a random sample of over 12,000 returns claiming the EITC between 2006 and 2011.  (You can find the study here.) Together with the returns, Treasury analyzed Social Security records and information returns. From the study, Treasury was able to determine the number of improper payments and the amount of money associated with those payments in connection with qualifying child errors.

The charts below summarize the type of qualifying child error in returns incorrectly claiming children for EITC purposes as well as who is making the ineligible claims.

Of the 31.4 million children claimed each year, on average, 4.8 million were claimed in error (based on annual average data above).  Of that 4.8 million children, 3.4 million met the rules relating to children (e.g., the age test).  Thus, 71% of the children claimed in error could be claimed by someone else. This constitutes 38% of all EITC overclaims.

The study further found that in the vast majority of cases, these children met the EITC relationship test with the person incorrectly claiming them on the return.

  • 47% of the children were a son or daughter of the taxpayer;
  • 37% of the children were an other qualifying relative;
  • 15% of the children had lived with the taxpayer at some point during the year; and
  • Only about 12% of the children failed to meet the residency and relationship test.

The researchers then matched the children claimed in error to their non-claiming parents, as follows:

  1. Use Social Security records to identify the non-claiming/non-audited parents of children claimed in error.
  2. Search for the tax and information returns of the non-audited parent. Did this parent file a tax return? Did this parent claim the EITC?
  3. Determine whether the non-audited parent could have claimed the EITC with respect to this child based on income.

Treasury found that for 21% of the children, they could not find Social Security Numbers (SSNs) for any parent (they were deceased, had an ITIN, or were foster parents).  For 20% of the children, the parent on the NRP return was the only parent on record with SSA, and for 19% of the children, they identified one non-audited parent who was not on any return.  Of these latter parents, only 27% had earned income and those who did had very low income.  Thus, 36% or 1.2 million of the children were not claimed by the other parent on a return.  (Only 4% of the children were claimed by both parents – i.e., duplicate claims.)  But could the other parent have claimed the child for EITC?

For Tax Years 2006 through 2011, it appears that 47% (or 0.5 million) of non-claiming parents appeared eligible to claim 0.6 million children.  Of the non-claiming parents who were ineligible to claim the child, in many cases they had already claimed the maximum number of children for EITC purposes, or their income was above the phase-out range for EITC.  Thus, they may have allowed another family member to claim the child.

Treasury then determined the amount of EITC forgone for the sample of 0.6 million children associated with incorrect EITC claims.  The study found that 39% of the $1.449 billion in EITC overclaims could have been claimed by another parent, resulting in $561 million in foregone EITC payments.

Based on this study, the researchers were able to make several conclusions about the nature of improper EITC payments. First, the official EITC improper payment rates overstate the revenue loss to the government because they do not take account of forgone claims. Second, most improperly claimed children are claimed by a relative, not by a stranger or a friend. About 11% of these children are claimed by a relative they live with for all or part of the year, meaning this taxpayer would be eligible to claim the child but for their relationship to the child. Third, the research indicated that while some errors appear to be accidental, most improper payments reflect a credit-maximizing motive. Finally, about 2 million of the 3.4 million children claimed in error could not have been claimed by a tax-filing parent under the current eligibility rules. While some of these children may not be the intended beneficiaries of the credit, more research is necessary to determine the social welfare loss associated with the exclusion of these children.

Reimagining Tax Administration: Social Programs Through the Tax Code – Workshop 3: Design Theory and Administrative Burden

Today we continue our series giving an advance look at the Center for Taxpayer Rights’ Reimagining Tax Administration workshop briefs. An earlier post here explored the social safety net, including the role of refundable tax credits in lifting children out of poverty, and the characteristics of the population claiming the Earned Income Tax Credit (EITC) and Advance Child Tax Credit (CTC).

In the brief today, we explore the impact of program design and administrative burden on that population’s ability to understand and navigate application procedures and other bureaucratic apparatus, and how that apparatus might deter the targeted population from receiving benefits for which they are eligible.  We also learn about some interesting experiments in trying to communicate complex administrative requirements and legal issues to program beneficiaries.

All of the workshop sessions are recorded, and the videos are available here on the Center’s website, along with slide decks and other materials.

Administrative Burden: Policymaking by Other Means

Presented by Pamela Herd & Donald Moynihan, Professors, McCord School of Public Policy, Georgetown University

Administrative burdens occur when an individual’s experience with policy implementation is onerous. Administrative burden can occur in any context where the state regulates private behavior or structures access to services, and it can apply to either a consumer of government services or a government employee. Administrative burdens are distributive in that certain groups experience more benefits or burdens than others. In the context of the tax system, lower income groups often experience the most disadvantages. These burdens are also constructed, as they reflect the preferences of political actors and their constituents regarding policy. As the product of administrative or political choices, these burdens are often presented as technical fixes or aspects of broad concerns, such as reducing fraud.  Note, however, that just as administrative burdens can be designed into a program, they can also be designed out.

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Administrative burden reflects people’s experience of the state. That experience includes three categories of costs – learning, compliance, and psychological. Learning costs are the costs people face when searching for information about government-provided services. Compliance costs are those encountered when trying to comply with a program’s rules and regulations. Psychological costs are related to the stress, lack of autonomy, or stigma experienced when learning about a program or complying with its requirements.

The table below provides examples of each cost and how they operate in the context of the Advance Child Tax Credit (Advance CTC):

Cost:Learning CostsCompliance CostsPsychological Costs
Description & Examples:– Engaging in the search process to collect information about public services, as this knowledge is not innate.
– Evaluating how services are relevant to the individual.
– Examples: learning a program exists, determining eligibility, considering the benefit, researching how to apply.
– Following administrative rules or requirements
– Examples: submitting forms, providing documentation, completing recertification process, hiring legal help.
– Stigma associated with applying for or participating in a program with negative perceptions.
– Loss of personal power or autonomy in interactions with the state.
– Stress of dealing with administrative processes or potential loss of benefit.
Advance CTC Context:– Mitigated by automatic enrollment, via previously filed returns or nonfiler information provided through a portal, and outreach efforts.
– Information about enrollment not clear on IRS website.
– Significant portion of nonfiler population not familiar with tax system.
– Requires large outreach effort, which is not a core IRS skill.
– Low compliance costs for those automatically enrolled.
– Early versions of nonfiler portal not available in mobile-friendly version.
– Early versions of nonfiler portal not available in non-English languages.
– Limited ability to modify eligibility information via portal.
– Applications through nonfiler portal do not always result in receipt of credit, and no explanation provided or resources to remedy.
– Low psychological costs due to broad eligibility across income groups.
– No need to apply for the benefit in person.
– Benefit was provided in cash (rather than voucher or card).

These burdens will likely change as taxpayers are required to reconcile the Child Tax Credit and receive the remaining credit during the 2022 filing season. Individuals with limited or no experience with the tax system must file a return to receive the remainder of the credit, and easy to use filing portals will not be available until after April 15th. Measures instituted to protect against improper payments may raise impose significant administrative burden.  Additionally, the nature and extent of burdens in future years is still unclear, as the existence of the Advance Child Tax Credit is uncertain beyond the 2021 tax year. The addition of a work requirement will increase burden, both in terms of accessibility of the credit and the challenge of documenting work status.

Applying Behavioral Economics to Human services

Presented by Emily Schmitt, Office of Planning, Research, and Evaluation, Administration for Children and Families, U.S. Department of Health and Human Services

Administrative burdens can be mitigated or eliminated by applying modern understandings of human behavior to the administration of social services, including those administered by the IRS. Under traditional theories of human decision-making, consumers are treated as rational decision-makers who use all available information to make decisions that maximize their well-being. Under this approach, where the benefit outweighs the cost of applying or compliance with requirements, people will apply for the benefit.

However, behavioral economics and psychology have brought additional insights into how humans interact with systems and make decisions.  These insights include the following observations, which can be applied to reduce administrative burden:

  • People can only pay attention to and understand a limited amount of information at a time;
  • People give more weight to the present than to the future;
  • People may place more importance on smaller factors, giving them an outsized influence;
  • People are influenced by how they see themselves and others; and
  • People are more motivated by loss than they are by gain.

In 2010 the Administration for Children and Families of the U.S. Department of Health and Human Services launched the Behavioral Interventions to Advance Self-Sufficiency (BIAS) initiative, to determine whether applying behavioral economics principles to programs under its purview can have a large impact with small, low cost changes. (In Fiscal Year 2021 ACF provided grants totaling $120 billion in 60 programs, including child care, Head Start, Temporary Assistance to Needy Families (TANF), refugee resettlement, and child support enforcement.)  Under the BIAS approach, human services should be redesigned based on the characteristics of decision-making using the following steps:

  1. Define: Identify problems of interest with a program or agency.
  2. Diagnose: Gather data, create a process map, identify drop-off points, and hypothesize bottlenecks.
  3. Design: Propose behavioral interventions to address these bottlenecks.
  4. Test: Ideally, conduct Rapid Cycle Evaluation using random assignment.

The BIAS portfolio applied this approach in three domains (work support, child support, and child care), seven states, and 15 tests.  In these tests the agency was trying to zoom in on specific places where people drop out of the application or recertification process and identify particular design interventions, mostly in the way agencies communicated with people.  Using this system, administrative burdens have been reduced by taking the following actions:

  • Simplifying messaging so it is more easily and quickly understood, including consolidating important information on the first page;
  • Including information about how people can plan how they will interact with the system, for example by providing information about how to get to a meeting via public transportation;
  • Adding personalization to materials, for example by adding sticky notes from case workers to agency letters;
  • Making deadlines and other important dates prominent; and
  • Experimenting with highlighting the potential loss or gain that comes with the consumer’s choices.

Through randomized tests and demonstration projects, BIAS identified very low cost and scalable small changes that improved program administration. In one such program, BIAS redesigned communication sent to New York City residents who may be eligible for an EITC-like payment. To receive the payment, residents were required to attend a meeting and provide information in the year before the payment was administered. To increase awareness of the payment and of the steps required to guarantee eligibility, BIAS designed a postcard and text messages sent to residents by the city. In the modified postcards, steps for eligibility were simplified and the information was condensed to make the process as simple and clear as possible for recipients. BIAS found that residents who received both the simplified postcard and the text message were more likely to attend the meeting required for eligibility. (For more information about “the power of prompts,” see the ACF report here.) For the next round of projects, ACF will focus on changing program and staff level processes and practices in small but important ways.  Ultimately, adapting messaging based on human behavior is low cost and increases participation in important social programs because consumers experience fewer burdens as they navigate the complex processes.

Case Study: Cancellation of debt self-help materials

Presented by Jim Greiner, Honorable S. William Green Professor of Public Law, Faculty Director, Access to Justice Lab, Harvard Law School

Experiments with materials distributed to taxpayers with cancelled debt illustrate the benefits – and the disadvantages – of designing benefit administration in accordance with the principles of behavioral economics. The goal of these experiments was to get people to show up to court to contest credit card debts.  The proceedings involve legal terms and procedures that can increase administrative burden. In this experiment, researchers designed educational materials intended to increase participation in administrative proceedings relating to cancelled debt. Drawing on adult education literature and techniques used by junk mail purveyors and working with the Access to Justice Lab, these materials relied heavily on cartoons and other images, and characters were designed to convey certain messages to the consumer.

For example, the taxpayer character, named Blob, is intended to be “everyperson” — raceless, genderless, and shapeless to remove any potential bias. The attorney character is designed to be friendly and inviting to encourage participants to seek legal help when self-help is not enough.

Although participation rates after publication of these materials are still low, the addition of these materials resulted in a tripling of the participation rate for these proceedings. Additionally, producing material like this is low-cost, and it proved beneficial where an individual might be hesitant to retain legal help or where legal assistance is not scalable. Especially where data sharing among agencies is limited (meaning individuals must participate more to provide information the agency does gather itself), more self-help materials are necessary to help individuals navigate complex procedures.

Although the benefits are clear, there remain some challenges to producing self-help materials like this. First, because the law and processes covered are so complex, the materials are quite lengthy (in the credit card sits, the paper-based self-help document was 91 pages long). Additionally, determining when self-help is not enough and an individual should seek legal help is problematic, as the benefits of self-help and of free legal assistance can vary based on the nature and extent of the proceeding.  One promising approach is that of blended self-help, such as that used by upsolve.org to help people get through the bankruptcy process.  This tool uses online guided interviews to gather information that will then be presented to a bankruptcy lawyer in the proper format to prepare documents for filing.

CONCLUSION

How the agency approaches its role as benefits administrator can have significant impact on administrative burden.  For example, one state unemployment agency tried to make the claims filing and hearing process less burdensome by requiring the claims adjuster to obtain the employment file directly from the employer rather than requiring the claimant to submit it.  In this way, the agency conducts its own discovery and the adjudicator asks questions.  This approach to the proceeding is inquisitorial rather than adversarial, which reduces the learning, compliance, and psychological costs of the proceeding.

Further, interventions differ depending on one’s goal.  Is the goal to increase participation by 5 percent or to get to universal participation?  The latter goal may require policy simplification, or better collaboration by data-sharing between state and federal agencies or between federal agencies.  And where data-sharing doesn’t achieve the desired improvements, intensive outreach may be required – not just by the agency but on-the-ground third parties assisting individuals.  Further, the type of intervention depends on where you are in the policy process and also on the nature of the problem.  For example, information nudges work well where the key problem is learning costs.

To bring about changes in the organizational culture, which can result in larger scale reduction of administrative burden, agencies must be willing to experiment and work on institutionalizing these values by creating an ethic of experimentalism and continuous learning.  Nudging can be a gateway to cultural change – it shows how difficult it is for people to navigate existing processes and opens the door to systemic change.

RECOMMENDATIONS

In attempting to minimize administrative burden in programs that benefit low income and historically under-represented populations, policy makers and administrative agencies should consider the following design elements when making policy choices:

  • Design programs that incorporate automatic enrollment and default elections;
  • Incorporate data-sharing among state and federal agencies into program design to determine eligibility and further auto-enrollment, subject to necessary protections on use and disclosure of data;
  • Draft eligibility rules that are able to be expressed in non-legal common parlance and do not create barriers to participation by the eligible population;
  • Establish programs of on-the-ground personal assistance, including partnerships with stakeholders trusted by the eligible population;
  • Articulate explicitly the costs and benefits of improper payment/fraud detection protections, including the impact of these measures on the eligible population by deterring them from participating in the program.
  • Establish inquisitorial, non-adversarial dispute resolution processes; and
  • Establish an agency culture of experimentation and continuous learning that considers design and administrative burden at all stages of administration.

Reimagining Tax Administration: Social Programs Through the Tax Code – Characteristics of the EITC/Advance CTC Population

In the fall of 2021, the Center for Taxpayer Rights held an online workshop series titled Reimagining Tax Administration: Social Programs Through the Tax Code.  The goal of the series, funded by the Rockefeller Foundation, was to bring together tax professionals, researchers, and administrators not only to understand the current federal tax administration approach to administering social benefits through the tax system but also to explore and discuss alternative approaches.  The Center will be publishing a report based on these workshops, but we thought readers of PT would like to get a preview of this work.

All of the workshop sessions are recorded, and the videos are available here on the Center’s website, along with slide decks and other materials.

Today we are sharing with you the brief from the second workshop in the series.  In 2021, the EITC, Advance CTC and Economic Impact Payments (EIPs) combined were the largest federal program lifting children out of poverty.  This session explores the characteristics of the EITC/CTC population and the implications of those characteristics for administering such major social benefits by the Internal Revenue Service.  Later sessions build on this fundamental information to “reimagine” eligibility rules, administrative burden and due process protections, agency culture and, ultimately, proposals for change.  We’ll be sharing these briefs with PT readers over the rest of this week and beginning of the next, so stay tuned! 

THE SOCIAL SAFETY NET

Presented by Hilary Hoynes, Professor of Economic & Public Policy, Haas Distinguished Chair of Economic Disparities, University of California, Berkeley

Both the Earned Income Tax Credit (EITC) and the Advance Child Tax Credit (Advance CTC) fall within the United States’ social safety net. Programs in the social safety net can be divided into two categories: social insurance programs and public assistance programs. Eligibility for social insurance programs is determined by work history and amounts paid in while working, not on current income. Conversely, eligibility for public assistance programs is determined based on income and, in some instances, assets. Benefits from programs in each category can be given in cash, tax credits or refunds, or in kind, such as health insurance or vouchers. These programs can be administered through a number of systems, including by the Internal Revenue Service through the tax system.

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Who are the disadvantaged and how are social safety net programs helping?

In the United States, children under 18 experience the highest poverty rate at 9.7%, followed closely by older Americans at 9.5% (reduced significantly by Social Security). These rates are higher among Black and Hispanic Americans, female heads of household, and foreign-born non-citizens.

A chart of monthly and annual social safety net participation by program. Medicare, Medicaid, and Social Security are highest.

The largest programs in the social safety net – in terms of participation – are Medicare/Medicaid, Supplemental Nutritional Assistance Program (SNAP), Social Security, and refundable tax credits. Although Social Security pulls more Americans out of poverty than any other anti-poverty program, its effect on children is not as drastic. Refundable tax credits and SNAP are the largest anti-poverty programs for American children. The charts below show this distinction.

Change in number of people in poverty after including each element of public assistance, 2020.
Source: U.S. Census Bureau, Supplemental Poverty Survey 2020, Figure 8
"what if" child poverty rates with the elimination of selected federal programs.
Source: National Academy of Sciences, A Roadmap to Reducing Child Poverty (2019)

Despite the success of these programs in reducing poverty from 11.4% to 9.1% in 2020, child poverty in the United States is higher than the OECD average, and higher than in similarly situated countries after taxes and government benefits. This disparity is due to the following problems:

  • Benefits are not universal. Adults without children and undocumented immigrants are often excluded.
  • Cash is the most useful form of assistance, but many programs provide benefits in non-cash forms.
  • Many programs in the social safety net are conditioned on work, which can be a difficult requirement to meet.
  • The United States spends less as a percentage of GDP on social safety net programs compared to OECD countries, and the child poverty rate remains high after taking into account tax and transfer programs compared to economically similar countries. Taxes and government benefit programs reduced child poverty by only 7% in 2015 (from 27% to 20%). The charts below show the comparison.

Expanding the EITC to include more childfree adults, as well as permanently implementing the Advance CTC, can begin to address these gaps.

CHARACTERISTICS OF THE EITC/CTC POPULATION

Presented by Margot Crandall-Hollick, Specialist in Public Finance, The Congressional Research Service

Background: Why Benefits Are Administered by the Internal Revenue Service

Traditionally, the IRS is a revenue collector. However, because the agency has access to most income and personal information, it is also in the best position to administer benefits to the public. With each tax return, the IRS gains access to the financial and personal information of the filer and any individuals associated with that taxpayer’s return, such as a spouse or any dependents. Additionally, because filing requirements are determined without regard to immigration status, the IRS can collect information on non-citizens and other residents. From tax returns and third party information reporting, the IRS receives information for 86 percent of Americans.  Given this breadth of information, Congress has placed administration of two significant anti-poverty programs, the EITC and the CTC, within the IRS.

There are limits to the IRS’ reach, as some populations have no reason to interact with the IRS and its data collection procedures. The Tax Reform Act of 1986 limited the contact IRS has with the very low-income population by eliminating the need for many in this population to file tax returns. While this measure eliminated a burden, it created challenges for administering benefits to this population, as demonstrated when Congress chose the IRS to administer Economic Impact Payments (EIPs) during the COVID-19 pandemic. Of the 14% of Americans whose information is not available from tax returns, many are older Americans earning only Social Security income. For these individuals, the IRS was able to partner with the Social Security Administration to gather the data it needed to administer EIPs.

To administer benefits to the individuals who do not file tax returns or who are not known to the Social Security Administration (or another federal agency), the IRS has created a series of temporary portals through which nonfilers can provide their information, discussed in workshops 1 and 6.

The Earned Income Tax Credit

Created in 1975, the Earned Income Tax Credit (EITC) has always been conditioned on work, although its eligibility rules have been expanded to consider filing status, number of qualifying children, and income.

The EITC phases in and out based on these factors. The chart below shows the credit amount for 2021, both with and without the expansion for childfree workers under the American Rescue Plan Act:

According to the Congressional Research Service, (CRS) the highest participation, both in terms of percentage of eligible claims made and dollars received, is among taxpayers with more than one qualifying child. In terms of household adjusted gross income, the highest participation rates come from households with AGI between $10,000 and $15,000, and the highest credit amounts are received by families with AGI between $15,000 and $20,000.

Among childless workers, only 65% of eligible taxpayers claim the EITC. This disparity may be because the taxpayer is below the filing threshold discussed in Workshop 1, and the cost of preparing the return is high compared to the amount of the credit – the highest amount a childless worker could receive before the enactment of the American Relief Plan Act (ARPA) was $543, compared to several thousand dollars potentially available for those with children. ARPA expanded the childless worker EITC to $1,502 for Tax Year 2021.

To satisfy the earned-income requirement, a majority of taxpayers reported W-2 income, with some also reporting self-employment income. Regardless of the type of job, about 60% of EITC claimants work multiple jobs throughout the year.

The Child Tax Credit

Like the EITC, eligibility for the Child Tax Credit (CTC) is dependent on number of qualifying children and income. However, the CTC differs from the EITC in that it is not dependent on filing status and, at least for 2021, eligibility does not require earned income – extending eligibility to the 5% of children who live in a household without earned income. The American Rescue Plan Act (ARPA), which eliminated the earned income requirement, also made the credit fully refundable for 2021 and increased the maximum amount an individual can receive — $3,600 for each qualifying child under six and $3,000 for each qualifying child under 17, with half of the credit paid in monthly installments in advance in 2021. The chart below from CRS summarizes the credit for 2021 (and for years not covered by ARPA’s expansion):

Although the exact impact of ARPA is not yet known, CRS has estimated the reach of the Child Tax Credit as well as its effect on the child poverty rate. The graphs below show the estimated increase in the number of families with children benefitting from the credit, both overall and for those in poverty:

In addition to reaching more families and children generally, CRS estimates that the ARPA expansion of the Child Tax Credit will result in a higher credit amount for all families, but especially for families living below the federal poverty line. CRS estimates that nearly 20 million children live in households below 200% of the federal poverty line, 4.7 million of whom live below the poverty line. A detailed breakdown of the expected credit increase by income level is below:

CRS has also predicted the ARPA expansion’s impact across races and ethnicities, with black and Hispanic children experiencing the largest decrease in poverty. For all children, the ARPA expansion is predicted to nearly halve the child poverty rate. Predicted reductions in child poverty rates by race and ethnicity are shown below:

EVOLVING HOUSEHOLD COMPOSITION & IMPLICATIONS FOR CREDIT ADMINISTRATION  

Presented by Elaine Maag, Principal Research Associate, Urban-Brookings Tax Policy Center 

As a result of the COVID-19 pandemic, families already struggling financially faced increased income volatility and food insecurity, missed or delayed healthcare, childcare problems, and an inability to meet basic needs. Both existing programs and new COVID relief programs provide cash or in-kind benefits to address these problems. Historically, the tax system has been taxed with redistributing income through these programs – through taxation of high-income individuals as well as through delivery of safety net benefits. Although there are benefits to using the tax system to administer certain benefits, IRS procedures have not kept up with changing family structures.

Advantages of Using the Tax System to Administer Benefits

 About 40% of benefits for children is administered through the tax system. As discussed above, the IRS has access to information needed to determine eligibility for benefits based on tax returns. Because benefits are claimed when a tax return is filed, there is no additional administrative step necessary – individuals do not need to schedule an appointment or fill out another application to claim tax benefits. Perhaps because these benefits are claimed via a tax return, there is little or no stigma associated with receiving tax benefits, which can serve as a barrier to claiming benefits administered by other agencies.

Disadvantages of Using the Tax System to Administer Benefits

Despite these advantages, there are problems with administering benefits through the tax system. Aid can be administered as transfer benefits or as taxes. Transfer benefits consider the household, can change throughout the year, and are based on need at the time of eligibility determination. Conversely, taxes are based on taxable unit (legal relationships), are usually constant throughout the year, and eligibility is determined after the tax year ends. Benefits as taxes do not always provide assistance directly to the individual who needs it most and when it is needed most.

The rigidity of the tax system prevents some from receiving benefits when needed – both in terms of timing and eligibility. With the exception of the Advance Child Tax Credit in 2021, the IRS provides cash assistance in one lump sum several months after the eligibility period ends. This approach does not help individuals who lose or change their jobs throughout the year, as aid is delivered after the hardship is experienced. Additionally, Congress has provided strict and unrealistic eligibility based on legal relationship. Despite a changing social landscape, the IRS uses a traditional family model when determining eligibility for tax credits. These rules prevent 300,000 children from receiving benefits from the IRS because the households in which they live do not reflect the legal definitions required for credit eligibility.

The current tax code is based on a traditional familiy composition of childbearing/rearing within marriage, married parents, and low divorce rates.  Yet relationships of families and children in the United States are changing — married parents are becoming less common, increasingly children are born outside of marriage and couples are cohabiting, children are moving between households throughout the year, and multigenerational households are becoming more common. The charts below, excerpted from an important Tax Policy Center report, summarize how familial structure has changed in the United States:

Household income is also changing throughout the year. Income volatility is not considered when the IRS administers yearly tax credit payments. Forty percent of families living under 200% of the federal poverty line experience a 25% change in income for six months throughout the year. The chart below, from another TPC report, summarizes income volatility for all households and for those with incomes below 200% of the federal poverty line:

Yearly lump sum payments have certain advantages, but providing periodic payments in advance of the close of the tax year (the period for determining eligibility) can lessen the burden for families experiencing repeated income volatility throughout the year.

Conclusion

The IRS is a natural choice for administering benefits to families – it has access to information from tax returns and other agencies, and it is equipped to provide billions of dollars to Americans. Additionally, administration through the IRS is easier for individuals and comes with a decreased social stigma. However, using the IRS comes with challenges.  First, the tax system has not fully embraced the adjustments necessary to administer advance, periodic payments rather than lump sum payments at year end.

Second, a significant population of low income households do not interact with the tax agency, including the lowest-income individuals with no obligation to file a tax return and children living in households that do not meet the rigid relationship tests currently in place. Although safeguards against fraud and misuse must be in place, using data from external sources (states and other administrative agencies), the IRS can incorporate these individuals without creating too great a burden on itself or these individuals. For example, SNAP has information regarding family composition of some households not currently part of the tax system.  With these improvements, the IRS can decrease the effects of child poverty on American children and their families.

RECOMMENDATIONS

  1.  Retain the Tax Year 2021 dollar and age expansion of the childless worker EITC for future years.
  2. Amend EITC eligibility rules and revise administrative procedures to be more responsive to the structure of today’s families.
  3. With appropriate safeguards, utilize state and other agency data to identify non-filer households that are potentially eligible for the EITC and CTC.
  4. Increase the capacity of IRS systems to issue monthly or periodic advance payments, building on the EIP and Advance Child Tax Credit experience.
  5. Quantify the long-term effects on child welfare and labor participation of benefits administered through the tax system.

Join the Center for Taxpayer Rights for a Celebration of Keith Fogg’s Career on the Occasion of his Retirement

Readers of Procedurally Taxing know how vital Keith Fogg’s analyses and commentary is to improving the state of tax procedure and administration in the United States.  One only has to read his most recent series of posts about the Boechler case here and here and here and here and here to realize that Keith is a tireless advocate who does not rest on his laurels.  He is always thinking about how to build on victories and how to work around losses.  And those readers who know Keith personally know how generous and unstinting he is with support, friendship, and humor. 

So it may come as a surprise for readers to learn that Keith is retiring from the Harvard Federal Tax Clinic on June 30th of this year.  We didn’t want this occasion to pass unnoticed.  The Center for Taxpayer Rights, of which Keith serves as President, is hosting a virtual celebration of Keith’s career.  Now you can share your appreciation by raising a toast to Keith and sharing some reflections about what his support and friendship mean to you.

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The celebration will be held on Tuesday, May 10th, 2022, from 5 pm to 7pm EDT via zoom.  You can register for celebration and receive the Zoom invite here.

If you can’t attend, you can still share your reflections by registering.  We will then send you a link to a drop box location where you can upload a short (2 to 3 minute) video of your comments which we will share with Keith during our celebration.

I can personally attest to the impact Keith has had on my life, starting with a conversation I had with him in January 1993, shortly after I incorporated The Community Tax Law Project (CTLP), the first independent low income taxpayer clinic in the country.  CTLP was just a vision in my mind; I was working on my LLM at Georgetown, and one of the deans there mentioned that I should speak with Keith Fogg, who taught the bankruptcy and insolvency class in the LLM program and who was the district counsel for the Virginia-West Virginia district.  So I cold-called Keith.  He didn’t know me at all, but he took my call, listened to me talk about my ideas for the clinic, and agreed completely about the need for representation of low income taxpayers before the IRS and in the courts.  The only doubt he raised was, where would the funding come from?  (Note, as the Center’s president, he still asks that question; we did address that concern, somewhat – see IRC § 7526.)

Fast forward a week or two, and Keith had finagled an invitation for me to meet with the VA-WVA IRS district leadership – the District Director, the Deputy District Director, the chief of exam, the chief of collection, the district chief of appeals, the customer service director and education director, even the chief of criminal investigation.  The District Director committed to putting posters up about CTLP in the walk-in office (when it was truly open for walk-ins) as well as including stuffer letters in appeals initial letters.  All that from one phone call!

I can truly say that had Keith hung up on me that first day, or been too busy to take a call from an unknown person, or just failed to see the need, a lot of things would have happened differently in my life.  Or at least at a more slow pace, and we all know that timing is everything.  Lucky for all of us, Keith not only did listen, but he actively supported CTLP and the concept of clinics writ large.  The tax system is much improved because of that one simple act in early 1993 and all the other acts of generosity and integrity Keith has done over the years.  On top of all that, I’m fortunate to have had Keith’s friendship over the years.

So, if you’d like to share your “Keith stories,” join us in our celebration of Keith Fogg on May 10th.

Keith has asked that folks wanting to recognize his career make a contribution to the Center for Taxpayer Rights.   You can donate to the Center here. Hope to see you on May 10th to raise a glass to Keith!

The 7th International Conference on Taxpayer Rights: Tax Collection & Taxpayer Rights in the Post-COVID World

On May 18-20, 2022, the Center for Taxpayer Rights will be convening the 7th International Conference on Taxpayer Rights, once again in a virtual online format.  We are very excited about this year’s conference, which will focus on an under-studied area of tax administration, namely the actual collection of tax.  I have always believed that for many taxpayers, especially low- and moderate-income individuals and small businesses, the audit process and assessment of additional tax liabilities is theoretical.  It is when the tax agency starts levying on one’s bank account, or garnishing one’s paycheck, that taxes become real.

That’s where taxpayer rights have an important role to play.  And that is what we will explore during the 7th International Conference on Taxpayer Rights: Tax Collection & Taxpayer Rights in the Post-COVID World.  You can see the full agenda and register for the conference here.

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We will also be holding a free workshop on The Role of Tax Clinics and Taxpayer Ombuds/Advocates in Protecting Taxpayer Rights in Collection Matters.  This free online workshop will be held on May 16, 2022 and will include clinics and taxpayer advocates and ombuds from around the world.  Anyone interested in starting a clinic or encouraging one’s country or state to create a taxpayer ombuds/advocate will find this workshop helpful and interesting.  It’s also a great forum for sharing experiences and learning from one another.  You can register for the free workshop here.

As noted above, while an audit may result in a tax liability, it is still theoretical until the tax bill actually arrives and payment is expected (or extracted).  And while tax policy attempts to take into account taxpayers’ ability to pay in the form of living allowances and household or child exemptions or credits, individual financial circumstances are often not addressed by either policy or administrative procedures.  Requirements such as pay first, resolve later can seriously impair taxpayers’ access to administrative and judicial review of agency determinations. 

The COVID-19 pandemic has brought to the forefront the challenge of balancing the state’s collective need for tax revenue to fulfill its responsibility to provide for its citizens with the need to recognize the “slings and arrows of outrageous fortune” that might affect an individual’s ability to contribute to that collective need.  This balancing also applies to business entities where the added factor of competitive advantage or disadvantage comes into play.  A further challenge is addressing the imbalance between tax collection from taxpayers who have limited assets or income that nevertheless are easy to identify and levy, and taxpayers who have significant assets and the means to hide those assets or put them beyond the reach of tax authorities.

At the conference we will explore how agencies can address these challenges while respecting taxpayer rights.  We will cover various aspects of tax collection, including the state’s authority to collect, the statutory periods of limitation for collection, the exemption of income and assets from collection, the availability of alternatives to full payment of tax, the use of amnesties, settlements, and bankruptcy, and the availability of judicial review of agency collection actions.  We will also look at the tools available for international collection, the use of artificial intelligence and data mining to identify both those who are at risk of not affording basic living expenses and those who have the ability to pay.  Finally, we will discuss the impact of enforced collection actions and other approaches to collection on taxpayers’ willingness to pay and on tax morale.  The framework for these analyses will be the application of taxpayer and human rights principles to the collection of tax.

The 7th International Conference on Taxpayer Rights (ICTR) is part of a series in which we covered taxpayer protections in the audit process at the 5th ICTR in May 2021 and taxpayer rights as human rights at the 6th ICTR in October 2021, and will cover access to judicial review at the 8th ICTR in May 2023.  We have a number of really interesting videos of panel discussions from the 5th ICTR and 6th ICTR posted on our website and YouTube channel.  You really should check them out.

So, click here to see the agenda and register.  We’ve kept the registration fees very low and have discounts for JD/LLM/PhD students as well as for attendees from non-OECD countries.  The ICTR is a unique experience – people from all over the world attend to discuss taxpayer rights.  I hope to “see” you there! 

How Did We Get Here? Correspondence Exams and the Erosion of Fundamental Taxpayer Rights – Part 2

In my last post, I reviewed compelling IRS data, including from the National Taxpayer Advocate’s 2021 Annual Report to Congress, that show the IRS Automated Correspondence Exam (ACE) system disproportionately harms low income taxpayers and is desperately in need of a fix.  The IRS maintains the batch processing approach to correspondence (corr) examinations is efficient.  But the long-term goal of an audit should be to educate the taxpayer about what they did wrong (or for the IRS to learn what it got wrong), so the taxpayer (or IRS) does not repeat the mistake.  If the taxpayer never responds, or does not understand why additional tax is assessed, then the audit may result in more tax dollars, but from a voluntary compliance and taxpayer rights perspective the audit is a failure.  Correspondence exam, with its batch processing, assembly-line approach, may result in a high number of audits and assessments, but it does not promote understanding and in some cases has a negative compliance effect.  Moreover, researchers report that taxpayers who experience a correspondence audit report relatively low perceived levels of procedural, informational, interpersonal, and distributive justice.

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If the IRS were truly taxpayer-centric and designed its compliance programs from a taxpayer-rights foundation, it would look at the data presented by the Taxpayer Advocate Service in this year’s report, as well as all the past reports, and conclude that the process isn’t working for the lowest income taxpayers.  It would ask itself how it could improve the audit process so that taxpayers engage with the auditor and learn what, if any, error they made and how to avoid it going forward.  That engagement and education is at the heart of voluntary compliance, and while it appears to require more upfront resources, it is way more cost effective in the long run than current correspondence exams, which have little educational value.  For example, in a 2007 TAS survey of taxpayers who experienced correspondence examinations for EITC claims, 45% did not understand how the documents requested by the IRS related to the questions the IRS had.  One study found that only 39.7% of Schedule C taxpayers audited by correspondence recalled being audited at all, as compared to 72% of field audited taxpayers and nearly 80% of office audited taxpayers.

The IRS doesn’t need to look far or use much more in the form of resources to be both more effective and in greater compliance with taxpayer rights.  In this post I will set several recommendations for improving the correspondence exam process.  All of these can be accomplished with a modicum of resources, and you can pay for the rest by minimizing, if not eliminating, the expensive downstream work caused by poorly handled correspondence exams (for a sense of this downstream cost, see Figure 2.9.7, page 156 of the 2021 Most Serious Problems for a chart of average pay of downstream employees).

First, the IRS should rename correspondence exam as “virtual office exam.”  Specifically, the IRS should reap the benefits of the pandemic-spurred “zoom” revolution by designing a virtual correspondence exam process that more closely follows in-person office exam procedures.  With this approach the IRS would still send the taxpayer an audit initiation letter, with a suggested date and time for a virtual audit appointment.  Behavioral researchers have found that people are more likely to respond when an appointment time is set, even if the response is to request a different appointment time. 

Second, the audit initiation letter should set out – in common parlance/plain language — the issue that is being examined (since IRS insists correspondence exams are “single issue” exams) and describe the types of documentation that may be helpful to establish eligibility for a credit or deduction.  Here’s an excerpt of an actual Notice CP-75 (correspondence exam audit initiation letter) sent to a low income taxpayer in February 2022:

Notice how vague the letter is about what, precisely, the IRS is auditing; the letter lists 5 different possible issues, each of which have different eligibility criteria.  This sure doesn’t look like a single-issue audit to me.

This notice goes on to identify the “audit items that require documentation” to be: EIC, Dependents, Filing Status, AOC, CDC Credit.  The notice helpfully includes the following enclosures:

According to the 2021 Annual Report to Congress, only 3% of taxpayers with Total Positive Income under $50,000 were represented in individual correspondence exams.  For unrepresented taxpayers, the above enclosures will be overwhelming and the sheer volume of them could lead an unrepresented taxpayer to just give up.  It is no wonder that the no-response rate for correspondence exam is higher than any other form of exam.  The inability to reach a live assistor to ask questions increases the administrative burden exponentially.  (In FY 2019, IRS answered the correspondence exam phone line 40% of the time.) 

Third, the IRS should completely trash its current notice system and use some of the IT funding it is getting for FY 2022 to replace it with a 21st century system that is flexible and graphically robust in terms of layout, type, and design.  IRS letter format is currently dictated by an aged, obsolete correspondence system that is completely inflexible.  Trying to get a change in wording to an IRS letter can take more than a year of endless reviews and negotiations, and even then you have to wait for the programming to be complete.  There is lots of good research, some conducted by IRS and TAS, about how to communicate complex information.  The benefits field, in particular, has lots of studies about how to plan effective communication.  IRS needs to apply that research to its correspondence exam notices and make them salient to the taxpayer’s specific situation.  Presumably, the IRS knows the exact reason the taxpayer’s return was selected for audit.  The audit initiation letter should include that specific reason, not a list of “and/or” possibilities.  The enclosures should relate to that specific reason.  (If there is more than one reason, then the audit should be conducted as an office or field exam, per the IRS’s own justification for “single issue” correspondence exams.)  The IRS should apply its IT resources to get this done, ASAP.

Fourth, the IRS should assign one audit employee to each case.  The audit initiation letter should include the name, badge number, and phone number of the employee to whom the case is assigned, as is required by IRC §7602(a).  Providing this information “personalizes” the process.  It reassures the taxpayer there is a live human being who will work with you on the case, rather than the impersonal, faceless IRS.  The letter should also encourage taxpayers to contact the office immediately if they need to reschedule or would prefer to conduct the audit by phone or correspondence.  By inviting the taxpayer to call to state their preference, the IRS not only signals its willingness to meet the needs of the taxpayer but also gains an opportunity to talk to the taxpayer about the issues.  This approach also increases IRS accountability.  As it stands today, no one employee is accountable for the conduct of a correspondence exam.  If the taxpayer does not respond, the assigned audit employee should be required to make at least two outbound call attempts (or emails/texts if that is available) at different days of the week and times of day. 

(I note that the IRS frequently justifies its “next available assistor” approach to correspondence exam by saying it is good for the taxpayer.  But all IRS functions where employees maintain case inventories – field exam and collection, Appeals, Counsel, and the Taxpayer Advocate Service – have established some type of buddy system to cover for vacations, sick leave, or training.  And the IRS could treat these taxpayers as adults and give them the choice of speaking to their assigned auditor or the next available assistor.)

Fifth, the audit initiation letter should also include a separate sheet providing information for signing on to the virtual appointment, including the requirement for a phone or other device that has a camera, and providing a contact for the taxpayer to discuss any technological challenges the taxpayer may face.  This is where QR code technology could be helpful, providing links to appropriate sites and information.  If the taxpayer is unable to sign on via a device with a camera, a telephone appointment should be arranged.  When the taxpayer requires specific reasonable accommodations, the audit should be converted to an in-person office exam or conducted via telephone, whichever is best for the taxpayer.

Sixth, when the taxpayer attends the virtual office audit appointment, the auditor should iteratively explain the specific issue that is being reviewed and what the IRS needs to see to establish eligibility.  If the taxpayer has documentation, the IRS auditor should look at it via the taxpayer’s device camera and instruct the taxpayer on how to upload, email or fax it.  As with an in-person office audit, at the close of the appointment the taxpayer should know what additional documentation, if any, is needed to prove eligibility.  The employee should memorialize the requested additional documentation in a letter to the taxpayer (or email if allowed).

Seventh, in order for this approach to work, the IRS must test its Documentation Upload Tool (DUT) or similar technology (such as the virtual office platform) with low income taxpayers to determine whether they are able to access and utilize it.  It should work with both the National Institute of Standards and Technology (NIST) and other government agencies and external groups to identify secure but accessible methods for low income taxpayers to sign on and submit information and documentation digitally.

Eighth, the IRS should adopt in correspondence exams the same procedures it uses in office and field exams for identifying alternative mailing addresses.  This approach will minimize the number of default assessments due to taxpayers moving around, especially low income taxpayers who comprise more than half of the correspondence exam population.

Ninth, with respect to all CTC/EITC audits, the IRS should allow taxpayers to establish proof of residency by using Form 8836 and its accompanying Schedule A.  These forms walk taxpayers through how to prove their child or relative lived with them for more than 6 months by having certain officials or professionals attesting under penalties of perjury and completing the periods of time they either have personal or official-records knowledge of the child’s residence.  In an exhaustive 2005 IRS study, this form was shown to be more reliable and probative than the usual documents and notarized statements the IRS currently accepts.  Since that time, I have recommended the IRS use this form in all EITC audits, which the IRS has steadfastly refused to do.  Given its obvious benefits, including reducing taxpayer burden, the IRS’s refusal is just plain baffling and counterproductive.

Tenth, the IRS should conduct a research study to test the effectiveness of certain messages in eliciting a response from low income taxpayers.  Several studies have already been conducted, including one by Day Manoli and Nicholas Turner on Nudges and Learning: Evidence from Informational Interventions for Low-Income Taxpayers.  This study found that timely reminder notices about the availability of the EITC increased take up of the childless worker EITC by 80% among the test population in the year of the notice.  A similar study designed around increasing responsiveness to correspondence exams, including focus groups exploring how letter recipients perceived the messages, could greatly enhance taxpayer communication and participation. 

The IRS should also build upon the important research conducted by TAS in 2016 and 2017 in which it sent out educational letters, under the signature of the NTA, to taxpayers whose returns claiming children had broken certain rules in the Dependent Database.  The letter referenced the specific issue and explained the eligibility rule in plain language.  One part of the study offered a toll-free Extra Help line to get questions about eligibility for the EITC and the CTC.  The letters had significant future compliance effects in several areas, without the cost of an audit.  The IRS should conduct a follow up study including focus groups to determine whether taxpayers understood the eligibility rules as a result of the letter.

The IRS recently announced the permanent establishment of the Customer Experience Office.  From the announcement, it appears the office will primarily focus on taxpayer service.  I hope the office defines “taxpayer service” more broadly, to include how taxpayers are served by the audit and collection process of the IRS (answer = poorly).  If it does so, the correspondence exam process is a good place to start.  While it is at it, the office can look at how to create a ”feedback loop” so correspondence auditors can learn what happens to the cases after they leave correspondence exam, as this post suggests.  Taxpayers who are under audit, and their representatives, will be enormously grateful for any improvements, and the rest of us taxpayers will be very happy that the IRS no longer wastes resources and violates taxpayer rights in this audit process.

How Did We Get Here? Correspondence Exams and the Erosion of Fundamental Taxpayer Rights – Part 1

Over the past several decades, correspondence examinations have become the IRS’s primary method for auditing individual taxpayers.  The Transactional Records Access Clearinghouse (TRAC) at Syracuse University just reported that of the 659,003 individual audits conducted by the IRS in Fiscal Year (FY) 2021, all but 100,000 were conducted by correspondence.  TRAC reports that correspondence exams now account for 85% of all audits, up from about 80% in the previous two years.

Originally designed for “less complex” matters, correspondence exams are now used for complex factual issues including the child tax credit, earned income tax credit, self-employment income (gross receipts and expenditures), and charitable deductions.  Correspondence is also the only method applied in “unreal” audits – examinations that the IRS doesn’t count as “audits” under IRC § 7602 because it says they don’t arise to an examination of the taxpayer’s books and records.  Through the Automated Correspondence Examination (ACE) system, unless the taxpayer responds in writing, a correspondence exam automatically moves from one stage to the next, up to the issuance of a Notice of Deficiency, without any human intervention.

IRS maintains that correspondence exams are an efficient and cost-effective method of conducting audits.  For example, in a summer 2021 release, the IRS justifies the low cost of these audits ($150 for the IRS!) by highlighting the minimal burden on taxpayers.  This blog will show just how wrong the IRS is about the burdens correspondence audits impose on taxpayers and their consequences.

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Over the decades, advocates for taxpayers, myself included, have consistently criticized this method and maintained it does not adequately protect taxpayer rights, including the right to be informed, to pay no more than the correct amount of tax, to challenge the IRS and be heard, and to a fair and just tax system.  Recently, The Tax Law Center at New York University and the Center for Taxpayer Rights published a paper about this topic, Exclusionary Effects of the IRS Correspondence Audit Process Warrant Further Study, in which we question the effectiveness of correspondence exams and propose additional research and pilots.

To get a sense of the disproportionate impact the IRS overall audit strategy has on Earned Income Tax Credit taxpayers, and why it is so important not only to revise that strategy but also to reform the audit process, please take a look at some rather stunning statistics from the IRS Statistics of Income compliance webpage.  Table 17 sets forth Exam Coverage and Recommended Additional Tax After Exam, by Type and Size of Return, for Tax Years 2010-2018.  (I am using Tax Year (TY) 2018 because it best aligns with the NTA Annual Report numbers, which use Fiscal Year (FY) 2019, discussed later in this post). 

Total TY 2018 individual tax returns filed:                                                      153,927,628

Total TY 2018 individual tax returns with EITC:                                              26,492,486

EITC returns are 17.2% of all TY 2018 individual returns.

Total audit closures of TY 2018 individual tax returns:                                  234,543

Total TY 2018 individual tax return audit closures selected for EITC:            165,611

EITC returns are 70.6% of all TY 2018 individual audit closures.

Total TY 2018 individual audit closures with no change:                                41,276

Total TY 2018 individual audit closures, selected for EITC,with no change: 28,277

EITC returns are 68.5% of all TY 2018 individual no-change audits.

What this data tell us is that over 70% of all IRS individual audit closures for TY 2018 returns involved EITC despite the fact that only 17.2% of individual income tax returns claim the EITC.  This is up from what I reported in the 2005 Annual Report to Congress, when 48% of IRS individual examinations involved the EITC despite only 17% of individual income tax returns claim the EITC.  And remember – these “audit” numbers don’t include “unreal audits” involving EITC, such as math errors under IRC § 6213.  Further, EITC audits constitute more than 2/3 of the no-change individual audit closures.  Now, this figure does not take into account downstream adjustments to proposed assessments in appeals or Tax Court, or abatements in audit reconsiderations.  Given the low response rate for correspondence exams, that there are any no-change audits is stunning to me.  At any rate, the IRS spent resources forcing 28,000 people – 12% of all TY 2018 EITC audit closures! — to produce documentation of eligibility, when they were eligible all along.

These numbers are all the more outrageous when you consider the fact that the dollar amount of EITC improper payments are only $16 billion or 3.6% of the IRS’s current $441 billion gross tax gap estimate.  (It is only 1.6 % if you buy the Commissioner’s $1 trillion tax gap estimate, which I don’t).  Why would the IRS focus so much on low income taxpayers?  Certainly, the fact that EITC is subject to improper payment reporting requires the IRS to audit some EITC returns.  But the requirement to audit some returns is not a justification for adopting an assembly-line approach to the most low-income taxpayers.  Could it possibly be the IRS uses that approach because it beefs up the overall audit coverage rate and the number of audits, at really low cost?

Now comes the National Taxpayer Advocate’s 2021 Annual Report to Congress, with its 9th Most Serious Problem focusing on Correspondence Exams.  Let’s take a look at some of the data (relating to FY 2019) presented in the report: 

  • 53% of individual (IMF) audits were on taxpayers with Total Positive Income (TPI) under $50,000. Of this 53%, 82% of the taxpayers claimed refundable credits including the EITC.  (TPI includes “only total positive income values from wages, interest, dividends, other income, distributions, Schedule C net profits, and Schedule F net profits.  Losses are treated as zero.”  MSP #9, endnote 7.)
  • 92% of IMF audits on taxpayers with TPI under $50,000 were conducted by correspondence exam. 
  • The average direct time spent by an IRS auditor on a correspondence exam for taxpayers with TPI under $50k was 2 hours, compared to 11 hours for office exam and 41 hours for field exam.
  • 4% of Wage & Investment Division correspondence exam resources was spent answering phone calls; 96% was spent on handling correspondence.  The Level of Service on the correspondence exam line was 40.7% (Note that this is for 2019, so it is pre-pandemic ….)
  • 35% of 361,000 IMF audits closed in FY 19 for taxpayers with TPI under $50,000 were the result of no taxpayer participation, of which 14% involved undeliverable mail.
  • Unlike field auditors, who can use both internal and external sources, including USPS trace, to locate better addresses, correspondence examiners can only use internal sources.
  • Only 3% of taxpayers with TPI under $50,000 were represented in correspondence audits.
  • Of the 24,700 petitions to Tax Court in FY 19, 17,700 originated in correspondence exam.
  • 94% of audit reconsiderations originated in correspondence exam; 44% of these original audits closed because there was either no record of a taxpayer response or IRS correspondence was undeliverable.
  • 88,000 of taxpayers audited in FY 19 with TPI under $50,000 were placed in collection; 45% of these were in Currently Not Collectible-Hardship status as of 10/28/21.

So.  The primary method of auditing low income individual taxpayers is by correspondence.  If you are more affluent, you are more likely to have a single auditor assigned to your case in office or field exam, but not if you are low income – i.e., in correspondence exam, no one employee is assigned to your case.  If you are more affluent, the IRS is more likely to spend more time looking at your documentation, and communicating with you.  Not so if you are low income.  If you are more affluent, the IRS makes more of an effort to actually locate a more current address if mail is returned undeliverable.  Not so if you are low income.

It’s not just that mail is undeliverable.  IRS audit notices are incomprehensible to taxpayers.  In 2007, the Taxpayer Advocate Service did a survey of a representative sample of taxpayers who had been audited about their EITC claims.  More than 25 % of those taxpayers said they did not understand from the initial letter that they were under audit.  More than 70% said the audit letter was difficult to understand, including they did not understand what documentation the IRS wanted them to provide.  If you don’t understand you are under audit, that will affect your response.  And if you don’t understand what you should send in to prove your eligibility, that will affect your audit outcome.

And in fact, we see this in the no-response and agreed rates of audits of low income taxpayers versus more affluent ones, who are more likely to have a single auditor assigned to the case.  Here’s a chart from the 2021 Annual Report to Congress:

To make matters worse, past TAS studies have compellingly shown that correspondence exam procedures actively harm taxpayers.  In 2012 TAS reviewed a representative sample of taxpayers whose EITC claims were disallowed in correspondence exam and later conceded in full by Chief Counsel when the taxpayer filed a United States Tax Court petition.  In that study we found that these taxpayers, on average, contacted the IRS five times during the audit (one taxpayer contacted the IRS 21 times!).  78 % were ultimately able to submit documentation that was accepted by IRS appeals officers or counsel attorneys after the Tax Court petition was filed.  In 20% of those cases, appeals/counsel accepted documented that IRS auditors had rejected. 

Correspondence exams have been a recurring topic in the Annual Reports to Congress when I was the National Taxpayer Advocate.  At a quick glance, I found Most Serious Problems on various aspects of correspondence exam in Annual Reports from 2001 (my first), 2002, 2003, 2005, 2006, 2007, 2008, 2009, 2011, 2013, 2014, 2015, 2016, 2018, 2019, and 2020.  (My recollection is, in the years we didn’t write about some aspect of correspondence exam, we were just tired of it and decided to give it a rest for one year.)  TAS has conducted numerous research studies on the topic.  And yet the IRS response has been unchanged over the years.

Why does the IRS persist in believing correspondence exam is an efficient, cost-effective method of auditing?  First of all, because it defines efficiency and cost-effectiveness from the IRS perspective – that is, correspondence exam works for the IRS.  It doesn’t have to dedicate (human) resources to the task; it can churn out a lot of audits and get a lot of assessments, all of which feed into its reports of audit coverage and enforcement results.

In fact, correspondence exams are a classic example of IRS assessing efficiency from a superficial cost-benefit analysis, disregarding the administrative burden these exams impose on taxpayers, especially low income taxpayers.  As Les, Keith and I discuss in an upcoming article, the learning, compliance, and psychological burdens of an administrative process can significantly undermine the policy goals of a program, and can even be used to deliberately deter eligible taxpayers from benefitting from a program.

In this blog post, we’ve seen that IRS intransigence over years regarding the correspondence exam process has created a procedural justice nightmare for taxpayers, especially low income ones, as well as generating lots of unnecessary and expensive downstream work for itself.  In part 2 of this “How Did We Get Here?,” I’ll discuss some recommendations for fixing this mess.