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