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.

2. 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.

3. 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.

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.

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.

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.

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.

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.