President Obama’s stimulus program includes tax cuts for low-income workers. The purpose, of course, is to put money back into taxpayers’ hands so they will spend it and boost the economy. But thanks to the EITC, much of the “tax relief” will go to people who have never paid a cent of tax—and may have already defrauded the government of huge sums each year.
How is this possible? The EITC is a “refundable credit,”—meaning that beneficiaries can receive more from the government than they pay in taxes. As a result, many low-income workers who pay no income taxes will file a tax return for one reason: to get an EITC check.
The incentive to cheat is huge: a worker with two children and earned income less than $38,646 could receive an EITC payment of up to $4,824 in 2008. A related tax credit—the Additional Child Tax Credit (ACTC)—pays this person another $1,126 if his or her income was less than $16,000. 1 For most families in this income bracket, the EITC check is the largest single sum of money they will receive in the course of the year.
Technically, EITC is available only to people with valid Social Security numbers (SSNs). In practice, identity theft, counterfeit Social Security cards, and other scams easily nullify such restrictions. EITC outreach groups—most prominently, the Center on Budget and Policy Priorities—offer tips as to how immigrants can receive EITC payments for years in which they did not have a valid SSN. As a result, illegal aliens are estimated to receive the EITC at even greater rates than their legal counterparts. (See the More Evidence of EITC Fraud section on page 14.)
The ACTC is available to illegals even if they do not have a valid SSN. All they need is an Income Taxpayer Identification Number (ITIN)—which the IRS is only too happy to provide. (See the Illegal Aliens and the EITC section on page 13.)
The General Accounting Office (GAO) verified the vast scale of the fraud, reporting that “…the IRS estimated [it is] between 27 and 32 percent of EITC dollars claimed.” 2
EITC scams are common, well-organized, and massive. In 1993, Dateline, a network television news program, filmed perpetrators paying housing project residents $400 for their names and SSNs. The con men used this information to file federal income tax returns electronically and receive bank loans using the estimated EITC refund as collateral .3
Most illegal immigrants have fraudulent Social Security cards, according to federal security officials. Their favorite target: young children. Social Security Numbers assigned to infants are stolen from medical paperwork and used to file returns. The fraud can go undetected for years—until the child looks for a job as a teenager.4
Media exposure shamed the IRS into conducting its own study. After randomly selecting 1,000 EITC tax returns, the tax collection agency sent criminal investigators to interview the taxpayers. Based on the interrogations, the IRS estimated that $4 billion of the $15 billion in EITC refunds paid in 1993 were made in error—a 27-percent error rate. This revelation led to new control system investments and policy changes, including a slowdown in EITC refunds and a decision to make banks liable for loans made to EITC filers.
More than a decade later, depressingly little changed, as evidenced by this written exchange between Senator Tom Coburn and McCoy Williams, GAO’s Director of Financial Management and Assurance:
As you know, the improper payments made in the Earned Income Tax Credit make up the second largest portion of government-wide improper payments for fiscal year 2005, estimating $9.6 to $11.4 billion dollars paid improperly.
In fiscal year 2004, EITC had an improper payment rate of 25 percent. For fiscal year 2005, it was 28 percent and this is on the low side, because it’s just an estimate. This program does not just need help, it needs a complete overhaul, with an improper payment rate that high.
I am familiar with the legislative proposals in the President’s fiscal year 2007 Budget. OMB believes that if enacted, this proposal would save $232 million in the first year and $5 billion over 10 years. That seems a bit under-ambitious when EITC is making at least $10 billion in improper payments every year…. Mr. Williams, has GAO done any analysis of the President’s proposals? If so, what is the GAO’s assessment? Has GAO made any recommendations regarding the administration and financial controls in the EITC program?
To date, we have not performed an analysis or an assessment of the President’s legislative proposals as they relate to the Earned Income Tax Credit (EITC) program. Regarding any recommendations made, since fiscal year 2001, we have issued three reports that included seven recommendations related to the administration and financial controls in the EITC program5….
The GAO’s recommendations were hardly earth-shattering. Among other things, the agency urged the IRS to take steps to better quantify EITC payment error rates; to determine why IRS service centers had been unable to stop questionable EITC refunds; and to collect reliable cost/benefit data so as to better estimate the reduction in fraudulent tax refunds per dollar spent in EITC fraud prevention.
None of the GAO’s recommendations have been fully implemented.
Getting a (Fraudulent) EITC Advance
Most EITC recipients receive the benefit after filing their tax returns. A small number—about 3 percent—takes advantage of the Advance Earned Income Tax Credit (AEITC). They receive a portion of the credit throughout the year in their paychecks.
While AEITC usage is low, the rate of fraud is high. A recent analysis of the AEITC program provides details:
As many as 80 percent of AEITC recipients did not comply with at least one of the program requirements GAO reviewed, and some were noncompliant with more than one during the 3 years we reviewed.
Almost 40 percent (about 200,000 recipients) did not file the required tax return; these individuals received $42 million to $50 million each year.
Of the about 60 percent (more than 300,000) AEITC recipients who did file a return, about two-thirds misreported the amount received.6
The GAO’s notes that its findings are based on its analysis of the tax returns of those recipients who were “potentially” eligible for the advance. The agency cautions that “…about 20 percent, or more than 100,000 AEITC recipients, may not have been eligible for the AEITC because they had an invalid Social Security number….”
This implies that, by analyzing only returns with valid SSNs, the GAO may have underestimated the extent of AEITC fraud.
The problem is large but not insurmountable:
The IRS obviously has not seen fit to devote enough
resources to AEITC non-compliance. The GAO charitably chalks this up to
“resource constraints.” In fact, it smacks of politics as usual.
Everybody’s Doing It?
Fraudulent payments are a long-standing problem that affects every federal program. Advocates for poor people insist that EITC fraud is unfairly singled out by those who would reduce all payments to deserving poor people. But the size and intensity of EITC fraud is demonstrably larger than that in other federal programs. We know this because of new reporting requirements Congress recently imposed on federal agencies.
The Improper Payments Act of 2002 (IPIA) requires agencies to identify programs and activities susceptible to fraudulent payments, estimate the amount of such payments, and report on actions they have undertaken to reduce them. In fiscal 2005, the GAO reviewed 18 such reports, covering 57 programs, with $38.8 billion of improper payments reported.8 The EITC ranked second among the 57 programs in fraudulent payments. Only Medicare, at $12.1 billion, reported a larger dollar amount. As a percent of total program spending, however, EITC fraud far exceeds that of any other program:
More than 30 percent of EITC outlays are “improper,” according to the Treasury Department’s accountability report. This is by far the largest error rate of the major programs reviewed by the GAO. The runner up—the Department of Housing and Urban Developments’s (HUD) notoriously corrupt Section 8 housing subsidy—estimated its improper payments at 11.6 percent of outlays, while Medicare’s payment fraud is estimated at 3.6 percent.
For the record, the following major programs did not submit Improper Payment reports in FY2005: School lunch programs; State Children’s Health Insurance Program (SCHIP); Woman, Infants, and Children (WIC); Medicaid; Child Care and Development Fund; Temporary Assistance for Needy Families (TANF); and Community Development Block Housing Grant.
EITC Fraud in Context
The IRS estimates that a single type of illegal scheme—offshore sheltering of income—practiced by 505,000 taxpayers in 2000 resulted in tax losses of $20 billion to $40 billion. This one scheme, used by only a half million high-income evaders, cost the Treasury two to four times as much as the six million EITC noncompliers10…
Mr. Liebman has a point: The amount of federal tax dollars lost to EITC fraud is trivial alongside the amount lost due to the fraudulent tax manipulations of middle- and upper-income Americans, who do not receive the credit. The latter amount, called the “tax gap,” is the difference between what these taxpayers should pay and what they actually pay on a timely basis.
In tax year 2001, the total tax gap ranged from $312 billion to $353 billion, according to the IRS.11 That is about 30 times the amount lost to EITC fraud that year—an estimated $10 billion.
But wait a minute. There were 130 million federal tax returns filed in 2002, and only 19.6 million of them received the EITC. So on a per-capita basis, the difference between EITC and middle- and upper-income tax fraud is only about one-sixth as large as the aggregate amounts suggest.
Even more telling is the percent of total tax liability each group fraudulently avoids.
In tax year 2001, middle- and upper-income taxpayers paid the federal government $1.767 trillion on time, a figure equal to 83.4 percent to 85.0 percent of their total tax liability. This implies that the noncompliance rate for all federal taxes is from 15 percent to 16.6 percent of the true tax liability. This is about half of the estimated EITC fraud rate of 30 percent.12
So if fraud is measured relative to total tax liability, the EITC crowd is about twice as fraudulent as middle- and upper-income taxpayers.
Moreover, late payments and enforcement efforts such as IRS audits and collection activities (payment arrangements, liens, levies, and other legal actions) recover some of the tax gap. For 2001, the IRS expects to eventually collect $55 billion of the tax gap, reducing the noncompliance rate.
By comparison, fraudulent EITC payments are rarely recovered.
It is not that middle- or upper-income taxpayers are more honest than EITC recipients—although that may indeed be the case. Most of us simply cannot avoid paying taxes because of withholding. And most of us cannot “hide” income because employers report our wages and salaries and tips directly to the IRS through the form W-2. Less than 1.5 percent of income subject to withholding is misreported on income tax returns.13
Skeptics still believe the tax code is tilted toward the rich and that the EITC should be expanded to ease the burden on low-income workers. The data simply do not support this view.
In 1980, the richest 1 percent of taxpayers paid 19.1 percent of all federal income taxes; by 2006, their tax share had more than doubled to 39.9 percent. Over the same period, the share paid by the bottom half of taxpayers fell sharply—to 3.0 percent in 2006 from 7.1 percent in 1980.14
Tax rates have declined for all taxpayers since the 1980s—thanks to the Reagan revolution. But those in the poorest half have been the biggest beneficiaries of the trend. Their average tax rate (taxes as a percent of Adjusted Gross Income) fell from 6.1 percent in 1980 to 3.0 percent in 2006. For the top 1 percent, the decline was more muted: from 15.5 percent to 12.6 percent.
Bottom line: the tax system is far more progressive today than it was in 1980.
Most of the increased progressively reflects changes in tax rates and other policies designed to ease the burden on lower-income taxpayers. Some of it, however, is unintended—the result of high rates of tax fraud among low-income taxpayers. The EITC is responsible for much of this troubling trend.
Illegal Aliens and the EITC
The Internal Revenue Code
does not prohibit illegal aliens from receiving the EITC if they meet the
prescribed eligibility requirements. Foremost among them is filing a legitimate
Low-wage employers opted against paying illegals “off the books.” To them, the EITC was a valuable wage subsidy paid for by taxpayers. Illegals receiving the EITC were willing to work for less than their counterparts who did not file for the credit.
The decision by the IRS to make ITINs available to illegals was made solely to increase the likelihood that they would pay taxes—not to enforce the immigration laws. In its publications, website, and forms, the IRS makes clear that the ITIN is “for tax purposes only.”15
Illegal aliens soon realized they had nothing to fear, and lots to gain, from filing for the EITC. The stampede for ITINs was on:
Since 1996, the IRS has issued more than 14 million ITINs. Annual issuance has exceeded 1 million in seven of the last eight years—a sure sign that the influx of illegal alien workers is larger than commonly believed.
ITIN issuance spiked sharply in 1997, and fell dramatically in the next few years. The volatility stems from changes to EITC eligibility rules. Prior to 1998 taxpayers with ITINs were eligible for the credit. The Clinton welfare reform law, in an effort to curb use by illegal aliens, required valid Social Security numbers. As a result, since 1998 immigrants without SSNs, or whose EITC-qualifying children do not have SSNs, are not eligible for the credit—even if they have ITINs.
Despite this “crackdown,” the total number of tax returns claiming the EITC continued to rise. This could not have happened had illegals been shut out of the EITC program. Instead, they filed tax returns using bogus Social Security numbers (SSN).
The IRS makes it easy. The tax collection agency does little to verity the validity of SSNs, the existence of dependent children, or to ascertain that they have lived with the taxpayer for more than six months of the year as required by law. With relative impunity illegal aliens claim as dependents children still in Mexico. Illegal alien husbands and wives often file separate returns on which both claim the same kids.”
More Evidence of EITC Fraud
Illegal immigrants defrauded the tax credit program long before the IRS effectively encouraged them to do so. This is from a GAO report issued in October 1994:
Limited data from manual reviews under the 1994 EITC Compliance Initiative show that a minimum of 160,000 taxpayers, out of about 8.7 million who filed paper returns claiming the EITC, entered 205(c) instead of an SSN for a qualifying child. According to IRS officials, the taxpayers who filed these returns likely are illegal aliens. IRS expects most of these refunds to be denied because taxpayers will not be able to support their claims. For example, IRS expects many claims to be denied because dependents will not meet residency requirements. In addition to the 160,000, an unknown number of illegal aliens would have received the EIC because the amount they claimed was below the Compliance Initiative’s dollar threshold.16**
This finding is the result of a special “Compliance Initiative” undertaken to measure the extent of the fraud. Such initiatives are few and far between. The vast majority of fraudulent EITC claims go unreported and unpunished.
IRS forms do not require illegal aliens to identify themselves as such; therefore, the agency does not know how many illegal aliens receive EITC. Estimates of EITC usage among illegal aliens have been published by private think tanks, however.
Steven A. Camarota, of the Center for Immigration Studies, examines EITC recipiency rates among Mexican immigrants in a report issued in July 2001. Camarota finds that immigrants in general, and Mexican immigrants in particular, use every major means-tested program at higher rates than natives.
The EITC stands out as the program most likely to be received by illegal alien households (see table on page 12).
Households headed by illegal Mexican immigrants are more than three times as likely to receive the EITC than households headed by native-born Americans. In no other means-tested program do illegals receive such de facto preferential treatment.
Moreover, immigrants receive larger average benefit payments than natives. For the EITC, average payment amounts in 1999 were as follows:
● natives $1,456
● all immigrants, $1,693
● Mexican immigrants, $1,887
This is because EITC payments, like payments for public assistance and food stamps, typically reflect the number of people in the households. Because immigrant households are larger on average (primarily because of higher fertility), the size of their average payment is also larger.
Mr. Camarota issues a cautionary note to those who yearn for amnesty or would confer guestworker status on all illegal aliens:
Use of means-tested programs by illegal immigrants from Mexico points to a fundamental problem that would almost certainly exist with any guestworker program. Even if guestworkers are made technically ineligible for means-tested programs, it seems almost certain that they would make use of them anyway by receiving benefits on behalf of their native-born children. After all, the findings …indicate that despite an outright ban on their use, illegals from Mexico actually use such programs at higher rates than natives in many cases.19
EITC Recipiency by State
State data provide
evidence of a link between the EITC and illegal aliens. States with large
illegal alien populations have above-average fractions of federal tax returns
claiming the credit.
The positive correlation is evident in the table on page 13. The table on page 13 ranks the 15 states with the largest illegal alien populations on their illegal alien population shares. At the top is Arizona, where an estimated 9 percent of residents are illegals. California ranks second, with a rate of 8 percent illegal, although it has the largest illegal population–—2.84 million. Tied for last place are Massachusetts, New York, and Virginia, each with 3 percent.
EITC was claimed on 17.28 percent of tax returns filed by residents living in these 15 states, versus 16.64 percent of returns from residents living in other states. The average EITC benefit was also significantly larger—$1,733 in the top 15 illegal alien venues versus $1,689 in the rest of the country.
Zeroing in on states with the five highest illegal alien population shares (Arizona, California, Texas, Florida, and Nevada), the recipiency rate differences are even more pronounced. Residents of those states claimed the EITC on 19.10 percent of their tax returns, versus 16.22 percent in the rest of the country.
Residents of the top five illegal alien states also received significantly larger benefits—an average $1,785—or 5.2 percent more than the $1,696 average in the rest of the country. The differential reflects, in part, the relatively large number of children in illegal immigrant households.
EITC benefits rise dramatically when children enter the picture. There is thus a strong incentive for low-income households—including illegals—to have children (anchor babies) or to misrepresent their status as custodial parents in order to qualify for larger EITC payments.
Is the EITC Under-Utilized?
Given the income of the people we are talking about, I would prefer “fraud” of people taking it when they are NOT eligible for it, than people NOT taking it when there [sic] eligible for EITC.22
This blogger is not alone. Many liberals believe the EITC application process is overly complex and difficult for low-income workers to understand—a deliberate ploy to discourage legitimate beneficiaries from applying. A little fraud on the part of individuals who are not eligible for the credit is, well, poetic justice.
The perception that millions of eligible individuals do not file for the credit and end up forgoing millions of dollars for which they are qualified has fueled a well-funded EITC outreach campaign. (See the section on Liberal Activism.)
Is the EITC underutilized? Is it a well-kept secret relative to, say, Food Stamps or Medicaid?
Au contraire! When the GAO studied the issue a few years ago, it found that EITC was the most accessible of the major entitlement programs. The proportion of eligible people who were enrolled varied as follows:
The EITC is utilized by 75 percent of households eligible for the benefit. For eligible households with two children, EITC participation rises to an amazing 96 percent.
GAO calls these estimates “conservative” because they exclude households that are estimated to have received EITC benefits in error. Despite the adjustment, the EITC’s overall participation rate is about 50 percent higher than that of Food Stamps, and significantly above that of Medicaid.
Why are EITC participation rates so high? Factors include the ease with which potential participants can access the program. For example, local Medicaid, TANF, and Food Stamp Offices typically require face-to-face interviews before individuals can receive benefits. Traditional office hours of 8:00 a.m. to 5:00 p.m. pose a barrier to potential applicants who work and would have to take time off to apply.
By comparison, getting an EITC check is breeze. All persons who file a return are eligible should receive the EITC automatically, because the IRS processes it automatically. Only persons whose employment is not reported to the IRS (i.e., they work off the books) or who do not file an income tax return will not receive the credit.
Perhaps the greatest incentive to participate in the EITC is the size of the benefit: A two-person family could receive up to $4,824 in 2008. For most recipients, it is the largest single check they receive during the year. And unlike Food Stamps or Medicaid, it is cash and therefore available for the most pressing needs. ■
1. Center on Budget and Policy Priorities, 2008 EITC Outreach Kit.
2. Ernest Istook, “Congress Will Send Billions to Tax Cheaters,” Heritage Foundation, February 5, 2008. http://www.heritage.org/Press/Commentary/ed020508a.cfm.
5. GAO, Letter to Senator Coburn, September 6, 2006. http://www.gao.gov/new.items/d061067r.pdf.
6. GAO, “Advance Income Tax Credit: Low Use and Small Dollars Impede IRS’s Efforts to Reduce High Noncompliance,” August 2007. http://gao.gov/new.items/d071110.pdf.
8. GAO, “Challenges Remain in Meeting Requirements of the Improper Payments Information Act,” Testimony, March 9, 2006. http://www.gao.gov/new.items/d06482t.pdf.
10. Jeffrey Liebman, “Earned Income Tax Credit: The Compliance Challenge,” The Century Foundation. http://www.tcf.org/Publications/EconomicsInequality/EITC.pdf.
11. IRS, “Understanding the Tax Gap,” March 2005. http://www.irs.gov/newsroom/article/0,,id=137246,00.htm.
14. Tax Foundation: http://www.taxfoundation.org/taxdata/show/23408.html.
17. David Jordan, IRS analyst, February 3, 2009. (202) 874-0945.
22. democraticunderground.com blog http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=114x7297#7369.