Prior blogs in our series giving an advance look at the Center for Taxpayer Rights’ Reimagining Tax Administration workshop briefs have covered the characteristics of the Earned Income Tax Credit/Advance Child Tax Credit population and the impact of administrative burden on that population’s ability to claim and receive those credits. You can read those blogs here and here.
Today’s blog analyzes whether the eligibility rules for tax benefits targeted to low income households actually fit the characteristics of the target population, and whether these eligibility rules leave benefits on the cutting room floor for some otherwise eligible children. In Part 2 of this workshop brief (to be published tomorrow), we explore the risks that might arise in using the tax system to deliver these benefits to that population, how other countries have tried to come up with approaches that minimize that risk, and why, even given the risks, we might still want to run such programs through the tax code.
All of the workshop sessions are recorded, and the videos are available here on the Center’s website, along with slide decks and other materials. — Nina
Eligibility Rules: Background
Eligibility for the various family benefit and anti-poverty credits is dependent on several factors, including income (e.g., adjusted gross income or earned income), marital and tax filing status, citizenship and residency status, and the number and presence of eligible children. The four-part qualifying child test used for various tax benefit provisions considers the relationship of the child to the taxpayer, where the child resides throughout the year, the age of the child, and (in some cases) the amount of financial support given to the child by the taxpayer. The primary issue regarding tax credit eligibility is whether the adults receiving that benefit have a connection with the child; relationship and residency serve as proxies for determining who cares for and has responsibility for the child.”read
Claiming Benefits for a Child
Presented by Elaine Maag, Principal Research Associate, Urban-Brookings Tax Policy Center
Forty percent of all child subsidies come from tax benefits, outstripping traditional benefit programs including Medicaid, Children’s Health Insurance Program (CHIP), and income security programs such as SSI, TANF, Social Security and SNAP.
Due to the difficulty that comes with delivering benefits directly to children, there are several ways in which agencies try to deliver benefits to adults most closely connected to the child:
- Medicaid and the Children’s Health Insurance Program (CHIP) follows the tax filing relationship;
- Social Security survivor benefits are provided to the legal representative or designated payee, which may be different from the Medicaid adult;
- Temporary Assistance for Needy Families (TANF) gives benefits to families regardless of marital status, so the adult can be an unmarried partner living in the household with the child;
- Supplemental Nutrition Assistance Program (SNAP) grants benefits to those who share meals with the child, which may be the TANF unit or the tax unit; and
- the Child Tax Credit (CTC) adopts the qualifying child test applied to the dependency exemption (IRC § 151-152). Unlike the EITC, the CTC/dependency exemption includes a support test.
These different eligibility tests raise the question, in awarding benefits, what criteria should policymakers care about so long as we know the child actually exists? For example, one goal would be to minimize overlapping claims. Going beyond the taxable unit so that the benefit can follow the child as the child moves throughout the year could increase duplicate claims, but if the definition is intuitive – e.g., by focusing on providing the benefit to the taxpayer who provides care for the child regardless of the taxpayer’s relationship to the child – overlapping may not be a significant issue.
The existing piecemeal system creates problems for both the applicants and agencies administering the benefits. Confusion arises when the benefit units don’t match. For example, if an individual is denied benefits under one program’s eligibility rules, that person may be less likely to apply for benefits under another program despite being eligible. Conversely, an individual eligible for benefits under one program might incorrectly claim benefits another program. These mismatches create compliance costs for the agencies. Further, requiring multiple agencies to determine eligibility for the same households increases administrative costs and applicant burden.
Although there are problems associated with having different eligibility rules for each program, there are also costs associated with creating a uniform eligibility test across all family benefit and anti-poverty programs. First, a uniform definition would create winners and losers – if an individual is ineligible for one program, that individual is ineligible for all programs. Second, while each of these programs is designed to reduce poverty and provide benefits to children, their methods and goals are different. A uniform definition might not coincide with each program’s individual goals.
As discussed in Workshop 2, the tax system’s current test for whether individuals can receive benefits on behalf of children does not adapt to the changing structure of the American family, and thus excludes children and families from receiving much-needed cash benefits. One potential area of focus for policy makers should be to try to determine with whom the child lives and deliver benefits to that household, which could bring a degree of uniformity between the various programs and reduce compliance and learning costs for the taxpayer and administrative costs for the agencies. (See Workshop 3 for a discussion of administrative burden.)
Social Welfare Considerations of EITC Qualifying Child Noncompliance
Presented by Emily Lin, Financial Economist, Office of Tax Analysis, Department of the Treasury
In Fiscal Year (FY) 2020, according to the IRS, nearly one quarter (24%) of EITC payments, or $16 billion, were made to taxpayers completely or partially ineligible for the credit, with 30% (and half of the dollar amount) of these errors attributable to nonqualifying children. This aggregate data, however, doesn’t provide insight into how to improve administration of the credit or the social welfare loss of noncompliance. For example, what is the value of an improperly paid EITC dollar, and what is the cost of reducing those errors? EITC noncompliance is also subject to duplicative reporting, because EITC overclaims are considered elements of the IRS tax gap as well as “improper payments” under Office of Management and Budget (OMB) guidance for the Improper Payments Information Act of 2002 (IPIA).
A summary of EITC errors on Tax Year (TY) 2006 to 2008 returns is shown in the table below.
As shown above, failure to meet the qualifying child test constitutes 30% of returns with EITC errors and over half of dollars incorrectly claimed. What this data does not provide is answers to the following research questions:
- Who are the taxpayers incorrectly claiming the EITC?
- Do they live with the child at all during the year?
- Do they have a relationship with the child?
- Why did the correct person not claim the child?
- What is the social welfare loss and the net revenue loss of the wrong person claiming the credit?
To understand the nature, extent, and impact of EITC errors, the Treasury Department’s Office of Tax Analysis (Treasury) analyzed the IRS National Research Program (NRP) results of a random sample of over 12,000 returns claiming the EITC between 2006 and 2011. (You can find the study here.) Together with the returns, Treasury analyzed Social Security records and information returns. From the study, Treasury was able to determine the number of improper payments and the amount of money associated with those payments in connection with qualifying child errors.
The charts below summarize the type of qualifying child error in returns incorrectly claiming children for EITC purposes as well as who is making the ineligible claims.
Of the 31.4 million children claimed each year, on average, 4.8 million were claimed in error (based on annual average data above). Of that 4.8 million children, 3.4 million met the rules relating to children (e.g., the age test). Thus, 71% of the children claimed in error could be claimed by someone else. This constitutes 38% of all EITC overclaims.
The study further found that in the vast majority of cases, these children met the EITC relationship test with the person incorrectly claiming them on the return.
- 47% of the children were a son or daughter of the taxpayer;
- 37% of the children were an other qualifying relative;
- 15% of the children had lived with the taxpayer at some point during the year; and
- Only about 12% of the children failed to meet the residency and relationship test.
The researchers then matched the children claimed in error to their non-claiming parents, as follows:
- Use Social Security records to identify the non-claiming/non-audited parents of children claimed in error.
- Search for the tax and information returns of the non-audited parent. Did this parent file a tax return? Did this parent claim the EITC?
- Determine whether the non-audited parent could have claimed the EITC with respect to this child based on income.
Treasury found that for 21% of the children, they could not find Social Security Numbers (SSNs) for any parent (they were deceased, had an ITIN, or were foster parents). For 20% of the children, the parent on the NRP return was the only parent on record with SSA, and for 19% of the children, they identified one non-audited parent who was not on any return. Of these latter parents, only 27% had earned income and those who did had very low income. Thus, 36% or 1.2 million of the children were not claimed by the other parent on a return. (Only 4% of the children were claimed by both parents – i.e., duplicate claims.) But could the other parent have claimed the child for EITC?
For Tax Years 2006 through 2011, it appears that 47% (or 0.5 million) of non-claiming parents appeared eligible to claim 0.6 million children. Of the non-claiming parents who were ineligible to claim the child, in many cases they had already claimed the maximum number of children for EITC purposes, or their income was above the phase-out range for EITC. Thus, they may have allowed another family member to claim the child.
Treasury then determined the amount of EITC forgone for the sample of 0.6 million children associated with incorrect EITC claims. The study found that 39% of the $1.449 billion in EITC overclaims could have been claimed by another parent, resulting in $561 million in foregone EITC payments.
Based on this study, the researchers were able to make several conclusions about the nature of improper EITC payments. First, the official EITC improper payment rates overstate the revenue loss to the government because they do not take account of forgone claims. Second, most improperly claimed children are claimed by a relative, not by a stranger or a friend. About 11% of these children are claimed by a relative they live with for all or part of the year, meaning this taxpayer would be eligible to claim the child but for their relationship to the child. Third, the research indicated that while some errors appear to be accidental, most improper payments reflect a credit-maximizing motive. Finally, about 2 million of the 3.4 million children claimed in error could not have been claimed by a tax-filing parent under the current eligibility rules. While some of these children may not be the intended beneficiaries of the credit, more research is necessary to determine the social welfare loss associated with the exclusion of these children.