Waste, Fraud, and Abuse, Oh My!

Wednesday, the House Ways and Means Committee Subcommittee on Oversight held a hearing to root out waste, fraud, and abuse in refundable credits ostensibly in the spirit of closing the tax gap and reducing the deficit. In announcing the hearing, Chairman Boustany said,

“Refundable tax credits not only reduce an individual’s tax liability, they can also result in payments from the government when the credits exceed one’s tax liability; meaning that millions of Americans have been able to eliminate any income tax liability and even get a check back from the government via refundable credits…At a time of record level federal deficits, the last thing the government can afford is to be hemorrhaging tens of billions of dollars in improper payments. The Subcommittee needs to understand the current levels of waste, fraud, and abuse and what can be done to prevent billions of dollars of improper payments each year.”

To the first part of the statement, that’s a feature, not a bug, of refundable tax credits. The EITC is a work support program and a very successful one. It helps keep millions of families out of poverty and engaged in the labor market. That’s something that should be celebrated, not denigrated. As to the second part of the statement, opponents of the EITC have long criticized the program for having a high rate of overpayments. Since the EITC, as well as all other tax benefits, is self-administered through the tax return, it is subject to human error and overpayments often reflect the EITC’s complexity more than attempts to defraud the program. The tax code in general and the EITC in particular is confusing and makes benefits difficult to calculate. The current workbook for presenting information about what types of income are used to determine eligibility, what your benefit is based on marital status and number of kids, what types of relationships allow someone to claim a qualifying child, etc takes about 63 pages. Predictably, the complexity of this process leads many EITC recipients to enlist the services of paid preparers. In tax year 2006, low-income families lost $3.1 billion of their EITC benefits to high-interest, short-term loans, tax preparation fees and other financial products issued by commercial tax preparers. My colleague David Rothstein argues that this constitutes the real waste of the in the EITC since it functions as an access fee that siphons publicresources from families that have earned them. To be filed under the heading of "Adding Insult to Injury," paid prepares are responsible for the majority of errors in processing returns claiming EITC, not the individuals themselves. 

In recent years, the IRS has initiated multiple actions to increase compliance and reduce errors in administering EITC, which are not captured in the outdated data commonly cited. And, while efforts should be made to increase the efficiency of program delivery, particularly through simplification, it's important to note that overpayments are not a phenomena uniquely associated with the EITC; in fact, the error rate for EITC is much smaller than the error rate in other parts of the tax code. A 2006 IRS study found that 51 percent of rent and royalty income, 57 percent of small business income, and 72 percent of farm income went unreported. The total cost to the federal government from misreported business income (about $109 billion) is at least 10 to 12 times the size of all EITC overpayments. The good folks at the Center for American Progress have put together this graph to illustrate exactly where EITC stacks up among sources of lost revenue.

Clearly, EITC ranks at the bottom of the list. So it would be surprising that EITC recipients get audited at twice the rate of other groups. Not surprisingly, the revenue recovered as a result of these audits yields about a third of audits of other groups. It seems like there might be a better return on investment if those auditing dollars were targeted toward the actual drivers of lost revenue. 

As long as we're on the subject program efficiency, I would be remiss not to highlight the number of incentives that encourage saving and building assets, most of which are highly concentrated among higher income households. Paying higher income households money to do what they would have done anyway is also poor return. Broadening the base of savers is an important policy goal, and directing resources to those households who are in need of that assistance and for whom that incentive will result in the behavior being incentivized is a better way of pursuing that goal.

Narrowly focusing on inefficiencies within EITC misses the more substantial areas within tax policy that, with reform, could render better policy outcomes and increase revenue. Singling out programs that target low-income families for scrutiny without applying a similar lens to a broader spectrum of policies perpetuates a mythology that cutting waste, fraud, and abuse in programs like EITC present a credible solution for addressing our fiscal woes. In reality, the only budgets likely to be impacted by cutting back resources to these programs are those of the families who rely on them. So not only is this approach impractical, it’s also a distraction from real solutions.