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Earned Income Tax Credit Can Help but not Obama's Way

May 1, 2014

The Earned Income Tax Credit (EITC) has been the subject of several reform proposals recently. President Obama and Senator Patty Murray have proposed expansions of the EITC without further reforms. Republicans have proposed reforms that would provide a fairer and more efficient social safety net.

The EITC provides refundable tax credits to people who work but earn less than the program’s phase-out amount (over $43,700 for a single parent with two chilren). Originally enacted in 1975, the EITC has grown to be the federal government’s largest anti-poverty cash transfer program. While the current program has its problems, it is a relatively efficient way to provide assistance to low-income workers.

EITC Benefits for a Single Parent with Two Children

EITC Benefits for a Single Parent with Two Children

Source: IRS

The EITC Encourages Work

The EITC succeeds in part because it encourages people to work. Classic big-government liberal programs just seek to provide a basic income to people, even if they don’t work. Under that kind of program, people making less than the guaranteed basic income would have an incentive to remove themselves from the labor force and live on the government dole.

In contrast, the EITC encourages work. A person who earns more money can get more government assistance, up to a point. For example, the graph shows how the EITC increases with income levels, before it starts to phase out.

Expansion of the EITC program can also help to consolidate some of the current grab bag of assistance programs under one system, to deliver benefits more efficiently and effectively. Done properly, the use of the EITC or a similar program in place of many of our current assistance programs could also help lower the effective marginal tax rates of low-income earners.

Obama Expansion Would Expand Erroneous Payments

Simply increasing the amount of assistance available under the EITC, in the way President Obama and Senator Murray have proposed, would do nothing to solve the program’s biggest problem: erroneous payments. The IRS estimates these account for up to 25 percent of all EITC payments, costing the government more than $10 billion in 2012. Between 2003 and 2012, the Treasury Department estimates that erroneous payments totaled as much as $133 billion. As would be expected, the improper payment rate spiked by over 35 percent after President Obama expanded the program in 2009 without making other reforms. The IRS has said it is required to process tax returns within 45 days of receiving them, which leads to unverified EITC payments.

A portion of EITC returns are identified for audit and the refundable portion of the EITC for those suspected returns are withheld until an audit can be completed. Because the IRS knows that erroneous payments are a problem, they audit EITC returns at a much higher rate than other returns. In 2011 these made up 31 percent of all individual audits. Despite this process, the audits prevented just $2.1 billion in improper payments in 2012, compared with over $10 billion in actual erroneous payments.

Democrats Insist Government Knows Best

Republicans have proposed reforms to the EITC, or replacing the EITC with other assistance programs that encourage work. By consolidating many public assistance programs into a simpler program, both beneficiaries and taxpayers could benefit. Republicans have also proposed numerous jobs bills, but Democrat Majority Leader Harry Reid refuses to allow votes on these ideas. By providing some assistance while getting government out of the way of job creators, the free market would be allowed to work without undue government mandates.

Democrats have proposed that the government simply expand benefits in the same EITC program that already has error rates of up to 25 percent. They also continue to push an increase in the minimum wage that CBO has said will cost up to one million jobs. In a cruel twist, those who would lose their jobs because of the Democrats’ minimum wage hike would then be ineligible for the EITC, since they have no earnings. That is no way to serve taxpayers and the families who most need this assistance.