Tax Notes logo

OMB and EITC Overclaims: Loving and Other Issues

Posted on Feb. 5, 2014

TaxProf  yesterday reported  on OMB’s report detailing the problems with the EITC overclaim rate. As readers of our blog know, this is an issue I care deeply about. It stems from in part my ten plus years directing a low income taxpayer clinic when I saw first-hand how the EITC can make such a positive difference in peoples’ lives, and how at times IRS compliance actions hurt the very people the program is meant to benefit. Proving eligibility is no easy task.  At the same time, I also care deeply about our tax system, and I acknowledge that despite well-documented problems that bring into question the accuracy of the overclaim rate (such as that summarized in a CBPP write up from a couple of years ago here), improper EITC claims are a problem, and a problem that carries a hefty price tag.

A few quick thoughts. I find it troubling that of all the areas where there are compliance issues in the tax system, the one that tends to get the most attention is the EITC. In a prior post called EITC: Do Attitudes on Redistribution Fuel a Particular Focus on Errors, I have previously pointed to interesting articles by Larry Zelenak and others who suggest that OMB focus on EITC to the exclusion of other issues—such as underreporting of income by small businesses—may not be defensible legally and is likely reflective of a bias against transfer programs and perhaps poor people generally.

As to the EITC itself, understanding the problem as reported by OMB requires an analysis of the how the IRS determines the EITC data it publishes.  As I understand the improper EITC payment rate, it is calculated as follows:

Improper EITC Payment Rate =  (Total Overclaims – Total Claims Protected/Recovered)/Total EITC Claims

An incorrect EITC will either reduce a positive tax liability or result in a refund. The effect of an incorrect dollar of claimed and not prevented or recovered EITC should have a revenue effect on the fisc, just as unreported income on a Schedule C taxpayer reduces the amount of tax that should be reported and paid.

As I have previously noted, there is significant and well-grounded criticism of how IRS calculates the Total Overclaims part of that equation. There are many claimants who file returns appropriately claiming the EITC but who throw their hands up and fail to respond or to follow through when subjected to IRS correspondence audits. The IRS recently changed its methodology for calculating overclaims. I understand that as of 2010 or so IRS now gives a range that reflects differing (and more realistic) assumptions about the number of nonresponders who are eligible for some or all of the credit. Even assuming that there are a significant number of EITC claimants whose EITC is improperly disallowed, and factoring on others who may be eligible for the EITC but due to the provision’s complexity or other reasons fail to claim the credit, the incorrect claims account is a pretty sizeable amount of dollars (though way less than the tax that is attributable to underreported business income). Treasury in its FY 2012 Agency Financial Report pegged the range of improper payments at between $11.6 and $13.6 billion taking into account the EITC Improper Payment Rate and total EITC claimed. Absent a major commitment of resources, IRS’s ability to change the part of the equation dealing with erroneous EITC recovered or prevented will likely not increase. The name of the game for those who truly care about tax compliance (and not bashing low income taxpayers) is reducing the Total Overclaims part of the equation. IRS and Congress have taken a number of steps in recent years to do just that.

Preparers are a key part of the story—EITC claimants use commercial preparers at a clip close to 70%. I briefly discuss the expanded EITC due diligence in an earlier post called IRS Leaves Hundreds of Millions of Dollars in Preparer Penalties on the Table(Title A).  Targeted due diligence reflects an effort to leverage the role that preparers play in the tax system.  Importantly, so is the now-stalled preparer regulation regime, a proposal that I have also discussed here in a post called Cheating and Visibility on Taxes: IRS Efforts to Regulate Tax Return Preparers Should Continue.

Despite what some may allege, the IRS’s efforts to more directly regulate unlicensed preparers is not as best as I can see part of agency capture meant to line the pockets of big commercial preparers or a hidden way to raise revenues, as WSJ suggested back in 2010 in a piece called H&R Blockheads.  While I do not offer a comprehensive history of the decision to adopt the testing and education plan at stake in the Loving case, I think it far-fetched to believe that two of the main players involved in getting IRS to adopt the proposal, Nina Olson or Doug Shulman, were in the pockets of H&R Block or others in the industry, or that their motivation was to generate revenues as part of a general love of big government. The decision to more directly regulate unlicensed preparers reflected the agency’s best efforts to decrease overclaims by leveraging third parties who play such a major role in delivering the EITC and other expenditures administered in the tax system. While some may disagree on the efficacy or legality of that program, or question its value in light of the likely increased cost associated with return preparation stemming from more regulation, we should give the agency the benefit of the doubt and allow IRS to try to drive down the overclaim rate in the way that it believes is most likely to succeed.

Subject Areas / Tax Topics
Copy RID