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Profitwise News and Views
January 2004 Issue
An Informed Discussion of the Earned Income Tax Credit-Milwaukee The Earned Income Tax Credit (EITC) continues to be a controversial public benefit tool. The EITC was last highlighted in the Profitwise Winter 2003 edition (PDF, 648KB). On May 5, 2003, the Consumer and Community Affairs division of the Federal Reserve Bank of Chicago went to Milwaukee to host another conference entitled, "An Informed Discussion of the Earned Income Tax Credit." The event included a keynote address by Professor John Karl Scholz, and was followed by panel discussions of key issues and opportunities associated with the credit. This article summarizes the new insights provided by the forum's discussion. Keynote Address Professor Scholz discussed a current flashpoint issue on EITC policy: the new IRS proposal to increase the burden of proof on those claiming the credit. He cited a study by the Internal Revenue Service (IRS) concluding during the 2000 filing season, which found that $8.5 billion to $9.9 billion of the $31.3 billion (27.0 to 31.7 percent) of EITC claims were erroneous (made by ineligible taxpayers). Most of the inaccuracies were "qualifying child" errors. Typically the child who was claimed for the purposes of the EITC either did not live in the household or did not have a qualifying relationship to the person who was claiming the child. In response to the high error rates found by the study, the IRS has introduced a new proposal to obtain greater proof of eligibility for people claiming the credit. Scholz agreed with critics of the unprecedented demand of the more than four million working poor who now claim the credit. "The proposal targets single fathers, and adults other than single mothers and married couples," explained Scholz; "it will target aunts, uncles, grandparents, foster parents, and the like who claim the EITC." If this happens, it will require taxpayers to show evidence of the claimant's relationship to the child, and evidence that the child lived with the claimant for at least six months. "Now, among a lot of people, there is concern that this documentation will be very difficult," stated Scholz. "For instance, how many of us could find our marriage certificates?" Scholz asked. He cited a current New York Times article on the new IRS proposal stating that the backlog in California to obtain a copy of a marriage license could be as long as two or three years.1 He also stated that the requirement to produce school records may also create hardships; the tax filing calendar year spans two school years. Scholz summed up his remarks by stating that there are two sides to every story. "On the one hand, there could be as much as $10 billion in EITC noncompliance, and this could suggest that the IRS proposal is quite important. On the other side is a sense of fairness, why on earth would you subject low-skilled, low-income taxpayers to greater scrutiny than any other taxpayers in the tax system?" 
Steve Holt noted that the huge administration costs involved with the EITC; however, they do not appear in the form we traditionally recognize. They are not the cost of welfare offices or caseworkers. Holt observed that the average computer-literate person who wanted to file their tax return online, would naturally just go to www.irs.gov Arlene Kay followed up on the study of the 2000 filing season cited by Scholz. According to Kay, since the study, "the IRS has put into place some internal safeguards that have reduced the number of potential fraudulent or inadequate returns by about a third. This should help us to whittle away some of the problems that have been noted." Jon Peacock focused on the Wisconsin EITC and stated that outreach for the credit was particularly important. "The private sector, for better or worse, is the main vehicle by which people get the credit, and that's not necessarily bad. It's great that the private sector is there to let people know," stated Peacock. He added, "I think we need to do a better job of having alternatives, though. What are the negatives [to private sector distribution]?" Peacock then referenced a recent Brookings Institution study that indicated half of EITC recipients in Milwaukee are using both private sector preparers and obtaining refund anticipation loans (RALs). He stated that obtaining the credit via RALs was better than not getting the credit at all; however given the fees and interest associated with RALs, it is a very costly way of implementing the EITC. Peacock urged interested parties to work creatively to discover hard-to-find attractive alternatives. Robert Weinberger discussed the role of the paid preparers. He suggested that there is a spectrum of possible alternatives to having the EITC tax return completed. The spectrum ranges from, on one extreme, a completely self-administered program, where recipients complete their own return, and to the other extreme, of having a government employee complete the return. Somewhere in the middle are several alternatives. The first is called "preparer due diligence," where the preparer informs the taxpayer of the taxpayer's record keeping and substantiation requirements, but does not audit the return. "This is where we have been [and are] right now," stated Weinberger. The next step up the line would be "certified preparers," where the paid preparer would utilize enhanced diligence and conduct a sort of quasi-audit verification. "They would determine whether school records or documentation need to be improved," explained Weinberger; "it would be the equivalent of what the department of motor vehicles does in many states where they outsource to service stations emissions testing, instead of doing it themselves." The next step is "pre-qualification." "This is what the IRS is now proposing," stated Weinberger. Here, the IRS itself takes in the returns rather than having the preparers do the screening, and the IRS determines who are the high-risk applicants. The IRS will then ask high-risk applicants to send in documents that verify their claims. Weinberger concluded by advocating for the "certified preparer" enhanced due diligence model where professional preparers are utilized in some form of quasi-government function. Weinberger believes this model will be both the most efficient and cost-effective. 
Deborah Blanks discussed her work with the Milwaukee Asset Building Coalition (MABC). MABC is a coordinated effort of Milwaukee area service providers to integrate wealth-building and other initiatives among Milwaukee County's low-income residents. This coordinated effort has included increasing the number of individuals who file for the EITC, obtain a bank account, complete financial literacy courses, or start an individual development account (IDA). Blanks discussed the EITC as a major tool that increases the number of people who can accumulate assets and explained the importance of this feature. She related her personal experience of when her grandfather was able to provide her with a car when she was in college. "It wasn't the kind of car a young girl in college wanted to drive to make her look cool," explained Blanks, "but it was an asset." As a college student, the car made a big difference for Blanks. She explained how the ability to accumulate assets enables people to begin to interact and operate more productively in society. It also enables one generation to help the next, allowing parents and grandparents to pass assets to their children, and thus enables them to become more independent and engaged in society quicker than if they had to accumulate enough assets on their own. Blanks also cautioned against equating poverty with personal failure. She believes some of the welfare reforms enacted in 1996 reflect the English Poor Laws of old, which essentially reasoned that the poverty of the poor was a result of their own mistakes and incompetence, and that poor parents were bad parents. She closed by saying that the EITC helps people to move out of poverty and to make the dream of America a dream for all its citizens. Margaret Henningsen stated that too much emphasis is placed on EITC recipients as being poor, and not enough focus is placed on the fact that EITC recipients work for a living and earn money. She discussed the idea that the business community sees EITC recipients as a marketing opportunity to sell their products. These businesses recognize the profit potential in communities where people receive the Earned Income Tax Credit. Her financial institution, Legacy Bank, prides itself on helping traditionally underserved communities and has developed an outreach campaign to EITC recipients. Legacy has chosen to fulfill its mission by getting involved with key community groups such as the MABC. By getting involved with the EITC, Legacy has been able to grow its business by developing products that serve the needs of EITC recipients, such as specialized accounts. Legacy also became a Volunteer Income Tax Assistance (VITA) site to assist people with filing their returns and receiving the credit. To Henningsen, the goal is to help people obtain the credit as a jump start to accumulating and growing wealth. Stephen Percy discussed findings of recent research studies conducted on the EITC in Milwaukee. The research found a need to increase awareness of the EITC, as 56 percent of individuals surveyed from an EITC eligible neighborhood were not aware of the credit. Further, 75 percent were not aware of the free income tax assistance available through the VITA program sites. When asked who completed their taxes, 82 percent responded that a commercial preparer had assisted them. When asked what they did with the refund, the most frequent responses included purchasing food, clothes, paying debts, and buying furniture. Only 30 percent said that they opened or added money to a deposit account. A remarkable 85 percent of those who used a VITA site had not been there the year before. Respondents indicated that a referral from a friend or neighbors led them to the VITA site. Percy commented on the implications of the research findings. He stated that VITA sites will most likely serve more people next year, as this year's EITC recipients will inform their friends and neighbors. Also, publicity and marketing efforts for the VITA sites would help, including efforts to inform people of the documentation they need to bring and beginning the marketing effort by January 1, 2004. Finally, Percy emphasized the importance of leveraging the EITC to magnify its impact, such as through Individual Development Accounts, where the funds could be used for education or starting a new business. Robert Weinberger identified several opportunities attached to the EITC: Second, to augment the number of returns filed through "free help" alternatives such as IRS walk-in services, VITA, and Tax Counseling for the Elderly sites, Weinberger suggests utilizing the network of commercial tax preparers by providing vouchers for approved paid preparers. In addition, the IRS could change its current policy of not competing against the private sector, and instead, provide software or online filing. Third, promotion of the EITC and outreach efforts could be expanded. Currently, about 4.3 million families or about 25 percent of those eligible, don't file. This represents $2.7 billion in missed benefits, where 38 percent would be going to households with three or more children. Those most likely not to file are workers with very low incomes, women moving from welfare to work, and immigrant families. The problem of non-filing will grow, because 2.5 million current welfare recipients are projected to move off welfare into the workforce by 2007. Based on experiences in Chicago, New York, Indiana and Washington, data indicates that EITC promotional campaigns are effective. Finally, tax season is the one time of the year that people collect together all their financial information and are open to advice. This is an opportunity to connect taxpayers to deposit accounts and other bank products, plus other government benefits. Conclusion Consensus emerged that the cost of administering the EITC has been placed on those claiming the credit. Commercial tax preparers were recognized as the main vehicle by which the majority of recipients obtain the credit, and this has inherent costs and benefits. Various recommendations were made as to ways to optimize access to the EITC at reasonable cost, direct or indirect, to recipients. As an extension of the Federal Reserve's overall goal to promote a stable economy and sustainable growth, the Consumer and Community Affairs division of the Federal Reserve Bank of Chicago is concerned with critical topics such as the EITC, and its ramifications for local economies and disadvantaged individuals and communities. We will continue to explore topics relevant to our mission in future forums and publications. Steven Kuehl is the consumer regulations director for the Consumer and Community Affairs division, Federal Reserve Bank of Chicago. Mr. Kuehl conducts seminars and workshops, and frequently writes on matters dealing with consumer banking regulations. Mr. Kuehl served as senior examiner for consumer regulations compliance and CRA (Community Reinvestment Act) with the Federal Reserve Bank of Chicago, and later managed a technical advisory service program targeted to banks in the Seventh Federal District. Prior to joining the Fed, he was an examiner for the Office of Thrift Supervision. Mr. Kuehl holds a B.S. in finance and economics from Carroll College and a Juris Doctor from the Chicago Kent College of Law. Notes: 1 See Mary Williams Walsh, "IRS to Ask Working Poor for Proof on Tax Credits," New York Times, April 25, 2003. |
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and log in. "Well you can't, at least not directly," explained Holt, "because the software developers who were involved in preparing tax preparation software didn't want the IRS developing their own software business. So, to file your taxes [electronically], you have to use a private software product." Holt argues that the IRS has essentially privatized the costs of administering the EITC and put those costs onto the individual taxpayer who must figure out how to finance it. "This is an issue of how to get benefits to recipients in a cost-effective manner," stated Holt.
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