TaxProf yesterday reported on OMB’s report detailing the problems with the EITC overclaim rate. As readers of our blog know, this is an issue I care deeply about. It stems from in part my ten plus years directing a low income taxpayer clinic when I saw first-hand how the EITC can make such a positive difference in peoples’ lives, and how at times IRS compliance actions hurt the very people the program is meant to benefit. Proving eligibility is no easy task. At the same time, I also care deeply about our tax system, and I acknowledge that despite well-documented problems that bring into question the accuracy of the overclaim rate (such as that summarized in a CBPP write up from a couple of years ago here), improper EITC claims are a problem, and a problem that carries a hefty price tag.
read more...A few quick thoughts. I find it troubling that of all the areas where there are compliance issues in the tax system, the one that tends to get the most attention is the EITC. In a prior post called EITC: Do Attitudes on Redistribution Fuel a Particular Focus on Errors, I have previously pointed to interesting articles by Larry Zelenak and others who suggest that OMB focus on EITC to the exclusion of other issues—such as underreporting of income by small businesses—may not be defensible legally and is likely reflective of a bias against transfer programs and perhaps poor people generally.
As to the EITC itself, understanding the problem as reported by OMB requires an analysis of the how the IRS determines the EITC data it publishes. As I understand the improper EITC payment rate, it is calculated as follows:
Improper EITC Payment Rate = (Total Overclaims – Total Claims Protected/Recovered)/Total EITC Claims
An incorrect EITC will either reduce a positive tax liability or result in a refund. The effect of an incorrect dollar of claimed and not prevented or recovered EITC should have a revenue effect on the fisc, just as unreported income on a Schedule C taxpayer reduces the amount of tax that should be reported and paid.
As I have previously noted, there is significant and well-grounded criticism of how IRS calculates the Total Overclaims part of that equation. There are many claimants who file returns appropriately claiming the EITC but who throw their hands up and fail to respond or to follow through when subjected to IRS correspondence audits. The IRS recently changed its methodology for calculating overclaims. I understand that as of 2010 or so IRS now gives a range that reflects differing (and more realistic) assumptions about the number of nonresponders who are eligible for some or all of the credit. Even assuming that there are a significant number of EITC claimants whose EITC is improperly disallowed, and factoring on others who may be eligible for the EITC but due to the provision’s complexity or other reasons fail to claim the credit, the incorrect claims account is a pretty sizeable amount of dollars (though way less than the tax that is attributable to underreported business income). Treasury in its FY 2012 Agency Financial Report pegged the range of improper payments at between $11.6 and $13.6 billion taking into account the EITC Improper Payment Rate and total EITC claimed. Absent a major commitment of resources, IRS’s ability to change the part of the equation dealing with erroneous EITC recovered or prevented will likely not increase. The name of the game for those who truly care about tax compliance (and not bashing low income taxpayers) is reducing the Total Overclaims part of the equation. IRS and Congress have taken a number of steps in recent years to do just that.
Preparers are a key part of the story—EITC claimants use commercial preparers at a clip close to 70%. I briefly discuss the expanded EITC due diligence in an earlier post called IRS Leaves Hundreds of Millions of Dollars in Preparer Penalties on the Table(Title A). Targeted due diligence reflects an effort to leverage the role that preparers play in the tax system. Importantly, so is the now-stalled preparer regulation regime, a proposal that I have also discussed here in a post called Cheating and Visibility on Taxes: IRS Efforts to Regulate Tax Return Preparers Should Continue.
Despite what some may allege, the IRS’s efforts to more directly regulate unlicensed preparers is not as best as I can see part of agency capture meant to line the pockets of big commercial preparers or a hidden way to raise revenues, as WSJ suggested back in 2010 in a piece called H&R Blockheads. While I do not offer a comprehensive history of the decision to adopt the testing and education plan at stake in the Loving case, I think it far-fetched to believe that two of the main players involved in getting IRS to adopt the proposal, Nina Olson or Doug Shulman, were in the pockets of H&R Block or others in the industry, or that their motivation was to generate revenues as part of a general love of big government. The decision to more directly regulate unlicensed preparers reflected the agency’s best efforts to decrease overclaims by leveraging third parties who play such a major role in delivering the EITC and other expenditures administered in the tax system. While some may disagree on the efficacy or legality of that program, or question its value in light of the likely increased cost associated with return preparation stemming from more regulation, we should give the agency the benefit of the doubt and allow IRS to try to drive down the overclaim rate in the way that it believes is most likely to succeed.
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Where is the connection between preparer regulation, and reducing EIC overpayments? Preparers have to pay a fee and take a test. Bank robbers have to pay a fee to get a license to drive the getaway car, and I’m sure if tested they could answer that bank robbery is illegal. But licensing and testing are not going to reduce bank robberies.
IRS already has and uses the tools to identify preparers connected with EIC errors. Registration and testing just makes it more likely that when caught, they will go underground. Most professional preparers don’t file EIC returns. Most who do, are honest. Why burden 99% of the community, rather than focus on stopping the 1%?
The idea behind regulations is that minimum competency standards would likely promote tax compliance. This would not guarantee compliance, because standards do not necessarily ensure that the professional knows adequately the rules. As you and others point out, the connection between competency and education requirements and compliance is less direct when the problem is one of scruples rather than knowledge. Yet, part of the idea is that questionable preparers—including those who prey on EITC claimants by stealing refunds–would have less incentive to engage in that behavior if their ability to prepare returns was put in greater jeopardy. The use of underground or shadow preparers is a huge problem, and could likely get worse with increased oversight. I linked a while back to an excellent post by taxgirl discussing that problem.I think if there were a public awareness campaign and concerted effort to root out those preparers the additional costs and risks are worth it. I also think generally the views of the agency responsible for administering the program should have a great deal of weight in the policy debate, especially when the large majority of those who work most directly with low income taxpayers who are most affected by unscrupulous/incompetent preparers supports the proposal. As to the additional costs of education and testing, I think that on balance the fee and the amount of time are far from excessive, and the claims the plaintiffs make in Loving as to the costs they incur do not seem in any way material. If people are truly concerned about mom and pop preparers, or additional costs that taxpayers would incur, there are ways to minimize the effect of increased regulation (e.g., waiver of fees for preparers who prepare fewer than X returns, increased amount of credit to reflect the privatized nature of delivering the benefit, disclosure on return of amount of prep fee to facilitate greater awareness of true costs of extra regulation).
I should have begun by stating that it doesn’t really matter, because IRS already has its backdoor regulation firmly in place. It enforces compliance by requiring preparers who file electronically, to submit to all sorts of office visits and file inspections — some targeted, some random; some already in effect, some to be added later. As I have noted previously, I have managed so far to avoid this interference with my work, not only as a tax preparer but as a lawyer for my clients, advising them in both tax matters and non-tax legal matters, by “preparing” returns but not “filing” them. However, I expect the “mandatory e-filing” noose to continue tightening. I am fortunate to practice in a state that does not push it.
I have probably missed all sorts of academic commentary on this form of IRS regulation. If the legal profession sees a danger in IRS barriers to electronic filing, it does not seem to be a major topic of discussion. Perhaps the Tax Court should require the same draconian measures for legal clinics that must e-file pleadings. Then someone might notice the implications for interference with client confidentiality.