# Presentation: 732445

## Issues, Challenges and Opportunities:Low-Income Taxpayers and the Tax CodePresentation to the President’s Advisory Panel on Federal Tax Reform

- David Marzahl, Executive Director
- Center for Economic Progress

## Center for Economic Progress

- Provides tax and financial services to the working poor
- VITA (Volunteer Income Tax Assistance) – Tax Counseling Project:
- Volunteers have prepared more than 100,000 federal income tax returns since 1994
- VITA programs assist almost 2 million taxpayers each year in U.S.
- LITC (Low-Income Taxpayer Clinic) program: volunteers assist more than 500 taxpayers annually – mainly immigrants and many first-time filers
- Financial education programs: opened more than 2,400 bank accounts since 2001, primarily using direct deposit of tax refund
- Programs serve households with annual incomes < $35,000
- National Community Tax Coalition:  brings together 500 organizations around tax practice, tax policy and financial services issues

## Equity in the Tax Code

- A progressive tax code, desirable for equity, may beget complexity; not necessarily a bad thing
- Widening inequality in income and wealth and reduced social mobility; tax code has unique role in facilitating families’ access to “American Dream” – e.g. homeownership & education
- Horizontal equity challenged by disparate tax treatment of wage vs. investment income
- Wage earners assume higher tax burden; other sources of income are taxed at lower rates, undermining principles of fairness

## Tax Credits:  Tools of Social Policy?

**Refundable Tax Credits** – Earned Income Tax Credit (EITC) and Child Tax Credit (CTC)
- For example, EITC has been demonstrated to increase participation and retention in the workforce
**Non-Refundable Credits** – Child & Dependent Care Credit, Education Credits and Saver’s Credit
- All credits have phase-in and phase-out and are targeted; all require additional forms and paperwork
- Non-refundable credits of limited utility to low-income earners, <$25,000
- Non-refundable credits of increasing relevance for earners >$25,000

## Tax Counseling Project: 2004 Tax Filing Season Statistics

- 21,300 tax year 2003 returns completed; 2,700 prior year returns
- 90% obtained a refund; 10% owed tax
- Average refund $1,500; median refund $791
- Average refund for families - $2,508; median refund $2,489
- 60% claimed EITC (refundable)
- 23% claimed Child Tax Credit (refundable)
- 5% claimed the Saver’s Credit
- 4% claimed one of the Education Tax Credits
- 3% claimed Dependent and Child Care Tax Credit
*Refundable tax credits have a substantial impact on low-income taxpayers; non-refundable tax credits much less so*
*Taxpayers with dependents receive large tax benefits from child-related tax credits*

## Tax Counseling Project:  Tax Credits Claimed by Taxpayers with Refunds

## Low-Income Taxpayer Return Preparation 

- Fact:  72% of EITC filers use a paid preparer, 60% of all taxpayers do
- Ritual of filing a tax return is a function of democracy
- High degree of civic pride associated with filing tax return
- Immigrants particularly so
- Filers with multi-year returns eager to “get squared away with IRS” even with penalties
- Use of intermediaries to access tax benefits/credits is increasing
- Paid preparers; on-line filing – “Free File” and for-profit; and VITA

## Taxpayer Awareness and Understanding of Tax Code

- Eligibility for particular tax credits will vary from year-to-year
- EITC recipient population varies by more than 30% annually
- Limited understanding of how withholding impacts tax refunds
- Tax Counseling Project:  Case study
- Taxpayers lack understanding of the connection between size of refund, annual income and household composition
- Taxpayers have limited grasp of the different tax credits – with exception of EITC, which they all want
- Taxpayers have no understanding of interplay of different credits
- Disparate treatment of children within tax code creates unnecessary confusion and errors – new rules for *uniform definition of qualifying child* may help

## Leveraging the Tax Code for Asset-Building

- Vast majority of tax benefits for savings and asset-building flow to moderate and upper income households
- Lump-sum nature of tax refund (and EITC) promotes savings and asset-building
- Syracuse University – Center for Economic Progress study found that 49% of EITC recipients wanted to use some/all of EITC refund for social mobility purpose (Smeeding, 1999)
- Many low-income taxpayers unbanked – solution: open bank accounts at tax sites
- Direct deposit of refunds at tax sites up from 30% to <50%  since 2002; 2,400 new bank accounts
- A refundable Saver’s Credit would incent savings

## Profile of a Low-income Taxpayer

- Renita Jackson Keys, single mother of 4 children
- Lives in Lawndale, an economically disadvantaged neighborhood in Chicago
- Has been Center for Economic Progress tax client since 2001
- Used $1,200 of her refund in 2001 to match $2,400 from matched savings (IDA) program to purchase her first home
- In 2002, used her refund to purchase a car
- 	  - reduced commuting time from 60 to 25 minutes
- In 2003, she received a tax refund of $4,688 from her $14,144 income as a lunch room assistant in a Chicago Public School

## Conclusions

- Streamlining and simplifying tax code is desirable; ditto for tax credits such as EITC
- Some complexity of the tax code is not inherently bad if principles of equity are maintained
- Taxpayers generally desire to comply with tax laws and meet their tax obligations, despite the fact that they often don’t understand the tax code and how it applies to them
- The tax code can facilitate savings and asset-building objectives across *all cohorts of  taxpayers* and is uniquely positioned to link unbanked consumers* *to mainstream financial services