On February 9, the Treasury Inspector General for Tax Administration (TIGTA) released a report on EITC compliance problems. Per TIGTA:
"The Internal Revenue Service (IRS) has made little improvement in reducing improper Earned Income Tax Credit (EITC) payments since 2002, when it was first required to report estimates of these payments to Congress, ... The IRS estimates that 23 to 28 percent of EITC payments are issued improperly each year, which equated to $11 billion to $13 billion in EITC improper payments in Fiscal Year (FY) 2009."
TIGTA's recommendations mostly sound to me like "try harder." I think part of the problem is due to complexity (the EITC eligibility and calculation are some of the more difficult provisions in the law). Some of it may also be due to the EITC built-in incentive to try to claim a high credit, including increasing your taxable income to generate the largest credit amount. For an example of some of the EITC complexity, take a look at this IRS website on the EITC - it seems a bit daunting to me.
Why no better solution? Is the EITC just fundamentally flawed as a way to deliver benefits to low-income workers? Well, it does work for the majority of filers, but a 25% error rate is too high.
Back in 2001, I had an EITC proposal included in the Joint Committee on Taxation's simplification study for Congress (here - summary of page 7 and full text on page 205). It called for a mechanism to get the benefit to workers through reduced or zero Social Security withholding. Part of the concept would have been similar to the Advanced EITC which was repealed recently. I also noted that if we ever went to a return-free system for a majority of individuals, EITC reform would be helpful.
What do you think would reduce the tax gap resulting from EITC errors?
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Eliminating the EITC altogether would eliminate the tax gap, of course, although that will never happen.
The biggest thing that needs to be done is to reduce or eliminate the built-in incentive to earn *no more* than the income that allows you to maximize your credit. It becomes too easy for people to game the system to take advantage of that incentive - and you'd be surprised at the number of people who know almost to the dollar how much they can earn to get that maximum, and come in with W-2s with only that amount of income.
If you tied the EITC to withholding, and paid it out over the course of employment during the year rather than in one lump sum at tax time (almost no one that I saw used Advance EITC, probably because it made it harder to game the system), that would probably help - it would shift the compliance burden toward employers, who are a little bit easier for the IRS to police than are individual taxpayers.
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