U.S. Refundable Credits: The Taxing Realities of Being Poor

Abstract

This paper looks at the American experience in using tax law to deliver benefits to low and moderate-wage workers. First examining two recent cases in which individuals improperly claimed the earned income tax credit, this paper explores some of the challenges to both taxpayers and tax administrators associated with using the tax system to deliver benefits that are dependent on levels of attachment to children and the presence of earned income. The paper then explores two approaches to improve compliance. One approach is a proposal in a recent Heritage Foundation policy briefing recommending that only parents with legal custody of their children should be entitled to receive the earned income tax credit. The state of California initially excluded self-employment income from its definition of earned income in its state earned income tax credit. Both measures fail to reflect characteristics of the lives of the working poor, including a growing reliance on multi-generational living arrangements and shared care of children, a surge in nontraditional employment associated with the gig economy, and a reliance on third parties such as return preparers and tax software providers. Despite the problems with the proposals, they reflect genuine compliance concerns. This paper concludes with recommendations to address those compliance concerns that will likely serve the goal of improving integrity, while also ensuring the law and administration of the law reflects the lives of lower-income Americans who increasingly rely on the tax system to meet basic needs and support their families. As the American tax system is increasingly a key component of the safety net, this paper is especially timely and can assist policymakers who wish to balance improvements in program integrity with a respect for taxpayer rights and achievement of other program goals.