Search This Blog

Sunday, January 28, 2024

EITC Awareness Day and Week Hopefully Also Can Focus on Needed Improvements

EITC reminder

The Earned Income Tax Credit (EITC) was added to the law in 1975 (Tax Reduction Act of 1975 (P.L. 94-12, SEC. 204; 3/29/75). So, the first note I'd like to make is that March 29, 2025 will be the 50th anniversary of the EITC. The Congressional Research Service has a nice report on the history of the EITC (4/28/22 version).

There is a federal annual EITC Awareness Day, which was January 26, 2024 (IR-2024-22).

Employers have federal (and perhaps state) obligations to tell employees about the EITC. Law changes in California in 2023 require employers to notify employees of the EITC (and a few other items such as CalFile and VITA) twice per year rather than only once per year (SB 131, Chapter 55 (7/10/23)). AB 1355 (Chapter 277 (9/30/23)) allows the notification to be emailed to employees, within specified parameters. The California EDD provides information on the notification and sample language.

On January 27, 2024, California Governor Newsom issued a proclamation that January 26 to February 2, 2024 is CalEITC Awareness Week. 

For many reasons, it seems that a week is certainly needed for EITC awareness and better yet, some way to more frequently help taxpayers be aware of the EITC and the benefits to eligible taxpayers and their communities of making sure it is claimed. Data from the IRS indicates that about 24% of eligible workers do not claim the EITC. The IRS tracks this data by state and you can find it here. CA R&T §19851 states that "hundreds of millions of federal dollars go unclaimed by the working poor in California."

How does this happen? The Tax Policy Center notes that about 5 million eligible individuals do not claim the credit leaving about $7 billion of benefits unclaimed!  These funds certainly could help low-income workers. The Center suggests that reasons for not claiming the EITC include its complexity causing some to not be sure if they qualify, and having income below the filing threshold so they do not file. For the non-filers, perhaps they did not have federal or state income tax withholding, so they are not filing to get those taxes refunded. 

A good portion of the EITC represents a refund of employments taxes withheld or paid by the employer for the employees wages. This illustrates a fundamental problem with the credit in that it is making taxpayers pay taxes they don't owe and then having to file to get the refund and perhaps, depending on earned income and family size, getting an additional amount via the EITC. Why not design the system to not have the EITC-eligible worker not pay the tax in the first place (and that would also provide the benefit per paycheck rather than when the return is filed).

I had the opportunity to suggest such a change back in 2001 in a paper included in the JCT's Study of the Overall State of the Federal Tax System and Recommendations for Simplification, as required by the Tax Reform Act of 1986 (summary at page 7 and full text at page 205). I think others have made similar suggestions over the years. 

Basically, federal income tax withholding could be changed to only start once an employee has earned a certain amount of income. All employees could have, say the first $15,000 of wages not subject to Social Security taxes with an increase in the wage base to address this. Or the change could only be made for workers paid at minimum wage or perhaps 1.10% of minimum wage. 

There used to be an advanced EITC system where the worker applied and the employer would not withhold certain taxes. It was repealed several years ago because there was almost no one using it. Perhaps there is a way to bring that back with better use of technology to help low-income workers get the funds for sure and get them more evenly throughout the year. For example, use of the IRS website to help with the calculations and any form to be completed for the employer (as part of the W-4 for example).

Here is an excerpt of what I wrote over 20 years ago (and I had a lot of background info and data on the EITC in the report too, and I had forgotten that something I've been suggesting in more recent years, I suggested back in this 2001 report - moving to a return-free tax system!).  

    "The EITC could be restructured to be an immediate offset of payroll taxes in more than one way. For example, all employees could have an exemption from Social Security (FICA) and Medicare taxes (referred to in this paper as “payroll taxes”) on a specified amount of wages. Of course, to offset the reduction in tax collections, the tax rates and maximum amount of earned income subject to payroll taxes would need to be adjusted. Another alternative would be to have payroll taxes computed on a graduated rate basis tied to the worker’s wage base (similar to how federal income tax withholding is computed). Because the current EITC structure can result in refunds greater than the worker’s payroll tax amount, additional changes would be needed to maintain the current level of benefit provided by the EITC to taxpayers with one or more qualifying children. These changes might be achieved through increased dependency exemptions or child credits for individuals with specified amounts of earned income. 

     Beyond simplification, an additional potential benefit of an alternative structure and simplification of qualifying status requirements would be that it might make it easier to move to a return-free tax system. Structural changes as described above would also serve to provide the EITC benefit to low-income taxpayers in each paycheck without a need for individuals to apply to receive an advance EITC.  In addition, these structural changes could be implemented in a manner so as to reduce the current high marginal tax rates that result from the phase-out provision of the EITC."

This proposal reminds me of a similar suggestion that I and two SJSU econ professors wrote about a few years ago. To better target sales tax exemptions such as on food and infant diapers and to more easily have the sales tax apply to more types of personal consumption, convert the sales tax to a formula calculation (personal consumption = income less savings), because one benefit is that instead of providing a food exemption that primarily benefits higher income individuals because they spend more on food, you could exempt low-income individuals from all sales tax by exempting them from the calculation if their income is below a specified level. And the benefit could continue for income levels by use of a graduated rate structure based on income. I just note this because it is another example where it might be easier to just not collect a tax in the first place rather than structure a tax credit or use inequitable exemptions to help lower-income taxpayers. This sales tax paper can be found here and there are additional benefits of it in that businesses would no longer pay or have to collect sales tax (there would need to be a transition phase-in as revenues adjusted).

But back to the EITC ... perhaps the upcoming 50th anniversary calls for efforts to examine how it can be simplified and all eligible individuals can readily obtain its benefits.

What do you think?

No comments: