Last week there was a fair bit of coverage of TIGTA’s annual IRS beatdown for the high error rates associated with the EITC. The headline story is one that those who follow the EITC have read before—of the many billions of dollars that taxpayers claimed, a good chunk of it went to those who were not entitled to receive it. Specifically, IRS estimates that between 21 and 25 percent of the EITC payments were issued improperly during fiscal year 2012, or approximately $11.6 billion to $13.6 billion. Over the past ten years, IRS estimates that between $110 and $132.6 billion in EITC was improperly paid. Now, while the annual underreporting tax gap overall is in the order of magnitude of hundreds of billions of dollars, improper refunds under the EITC are far from chump change, and Congress and IRS are right to target compliance efforts at areas of the tax code (such as the EITC) that are susceptible to errors.
In this post, I’ll briefly discuss why I think EITC error rates get a particular type of attention; in a later post, I will return to the connection that the EITC has with unprecedented and largely ineffective IRS and Congressional efforts to meaningfully reduce the EITC error rate. Those efforts now permeate some of the major tax procedure issues of our day, including the Loving case, which arose in part because IRS views regulating unlicensed commercial preparers (who prepare close to 70% of EITC returns) as a key part of its strategy to reduce the EITC error rate.read more...
The EITC Error Rate: Something Special
TIGTA’s report on EITC noncompliance is ostensibly generated by requirements under the Improper Payments Act (“IPA”) of 2002, Improper Payments Elimination and Recovery Act of 2010, and the Improper Payments Elimination and Recovery Improvement Act of 2012, (collectively, IPERA) and corresponding executive orders the Obama Administration has issued. The focus of the legislation and executive guidance is to require federal agencies to identify programs with high error rates (over 10%) and regularly report on and implement strategies to reduce errors. The Congressional and executive attention on improper payments has been thought to reduce improper payments. According to a recent alert by the Chief Financial Officer Council (a group of CFOs from federal agencies) the legislation and executive attention has led to government-wide error rates decreasing from 5.42 percent in FY 2009 to 4.35 percent in FY 2012 “and the Government has avoided making $47 billion in improper payments over the last three years.”
Despite the general success, IPERA has not led to meaningful reductions in the EITC error rates. (To be fair, other agencies have also had issues complying; a recent report by the Council of the Inspectors General found 11 of 64 agencies –including IRS and Treasury, counted for these purposes as two agencies–not in compliance). TIGTA’s report criticized IRS for not complying with Executive Order 13520 Under Executive Order 13520, IRS is required to provide information regarding improper payments to TIGTA on an annual basis. The Order requires TIGTA to review the IRS report and comment on steps IRS is taking to reduce the error rate to below 10% for improper payments (which TIGTA notes in its report includes overpayments as well as underpayments). Last week’s report thus flows from the federal legislation and associated executive orders that apply not only to IRS and Treasury, but other agencies as well.
What else does IRS and TIGTA identify as triggering additional reporting and associated efforts for targeting reductions in error under IPERA? The EITC is the only such item in the tax code that IRS has considered to be required to be reported on under the federal law. I am no expert on the requirements triggering reporting under this federal law. I note however that there has been criticism for only singling out the EITC under this legislation, given that other provisions (including other credits) in the Code may have higher error rates and contribute more to the tax gap than does the EITC.
For more on that I commend readers to look at Duke Law Professor Lawrence Zelenak’s 2005 UCLA law review article Tax or Welfare? The Administration of the Earned Income Tax Credit at pages 1896-1899. In the article, Professor Zelenak criticizes the IRS for reporting on the EITC and not reporting other tax items with high error rates. In a more recent article Unequal Burdens in EITC Compliance Professor Karie Davis-Nozemack picks up this point, also noting the somewhat peculiar place the EITC has as the sole item IRS reports on under the improper payment legislation:
This is strange, particularly considering that EITC overpayments are estimated to be only five percent of the tax gap. In contrast, twenty percent of the tax gap (four times the EITC overpayment amount) is attributable to underreported self-employment income. Between ten and fifteen times the EITC overpayment amount is attributable to misreported business income. Commentators have also identified other tax credits that likely meet IPERA designation, including alternative fuel credits, and research credits. Others have argued that “improper refunds of withholding and estimated tax payments” are subject to IPIA as well. TIGTA estimates that the improper First Time Home Buyer Credits paid in 2009 and 2010 were hundreds of millions of dollars. Improper payments at these levels should be subject to IPERA, at the very least.(citations omitted)
Why So Special?
Why this particular concern with EITC noncompliance relative to other likely high error issues like research credits and withholding and estimated tax payments? I think Professor Zelenak gets it right, and it has to do with the EITC becoming more of a federal transfer program, with upwards of 90% of the claimed amount refunded rather than applied against income tax:
[Nonreporting of other issues is] probably attributable to the notion (perhaps more subconscious than conscious) that amounts paid as withholding or estimated tax continue to be, in some sense, the taxpayer’s own money, even when the amounts paid do not exceed the taxpayer’s correct tax liability. Under this view even an improper refund of withholding is seen as returning to the taxpayer his own money, thus blinding the OMB and the GAO to the fact that such refunds clearly fit within the category of improper payments by federal agencies. Anyone locked in the mindset demonstrated by the OMB and the GAO will consider an improper refund of the taxpayer’s own money to be a much less serious problem than an improper EITC payment (which transfers to the recipient not the taxpayer’s own money, but the money of some other taxpayer). (citations omitted)
In Zelenak’s 2005 article, he connects the dots even further, noting that ones’ views on compliance issues such as the EITC relative to other areas of noncompliance in the tax system is suggestive of “everyday libertarianism”, a term coined by Professors Liam Murphy and Thomas Nagel in The Myth of Ownership: Taxes and Justice. In that book, Murphy and Nagel “suggest that almost everyone – politicians, the public, and policy wonks alike – uses a framework of “everyday libertarianism” when thinking about questions of tax and transfer policy.” Everyday libertarianism is the belief – “unexamined and generally nonexplicit,” which only adds to its power – that people earn their income without any assistance from the government. As a result, the government bears a heavy burden of justification when it decides to tax away any portion of a person’s pretax income.” (citations omitted).
Bringing it Back to Tax Procedure
How does this relate to tax administration and tax procedure? Here is where I think Professor Zelenak is at his most perceptive, essentially arguing that the libertarian streak on transfer policy manifests itself a second time when applied to how one thinks about program error rates:
Although unremarked by Murphy and Nagel, everyday libertarianism seems to come into play a second time, at the compliance and enforcement stage. Under this second-level influence of everyday libertarianism, the money one is legally required to pay as tax is still seen as being one’s own money (in a somewhat attenuated sense, to be sure). When a person fails to pay a tax he is keeping his own money, and a person’s keeping his own money is not a terribly objectionable result. The ghost of the claim to one’s pretax income survives the enactment of the tax statute requiring one to pay part of that income to the government. This contrasts sharply with the everyday libertarian view of overpayments of welfare. Neither the substantive legal rules nor everyday libertarianism gives a person any semblance of a right to a welfare overpayment. Far from being viewed as a mere keeping of one’s own money, receipt of a welfare overpayment is viewed as the wrongful taking of the pretax income of others, and as such it is an unmitigated wrong.
The resulting concern with EITC error goes a long way in explaining why Congress and the IRS have cooked up some novel approaches to reducing EITC errors, including the now in limbo return preparer regulation regime we have previously discussed, the draconian disallowance penalty in Section 32(k) that can restrict individuals from claiming an EITC for 10 years if there is a claim that is found to be fraudulent, and expanded and particularized due diligence rules that apply only to EITC returns.
I will return to these novel approaches in future posts.