Refundable Tax Credits: Comprehensive Compliance Strategy and Expanded Use of Data Could Strengthen IRS's Efforts to Address Noncompliance
Published: 2016-05-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Refundable tax credits are policy tools available to encourage certain behavior, such as entering the workforce or attending college. GAO was asked to review the design and administration of three large RTCs (the EITC, AOTC, and ACTC). The ACTC is sometimes combined with its nonrefundable counterpart, the Child Tax Credit. For this report GAO described RTC claimants and how IRS administers the RTCs. GAO also assessed the extent to which IRS addresses RTC noncompliance and reviewed proposed changes to the RTCs.
GAO reviewed and analyzed IRS data, forms and instructions for claiming the credits, and planning and performance documents. GAO also interviewed IRS officials, tax preparers, and other subject-matter experts.
section_title: What GAO Found
paragraphs: The Earned Income Tax Credit (EITC), the Additional Child Tax Credit (ACTC), and the American Opportunity Tax Credit (AOTC) provide tax benefits to millions of taxpayers—many of whom are low-income—who are working, raising children, or pursuing higher education. These credits are refundable in that, in addition to offsetting tax liability, any excess credit over the tax liability is refunded to the taxpayer. In 2013, the most recent year available, taxpayers claimed $68.1 billion of the EITC, $55.1 billion of the CTC/ACTC, and $17.8 billion of the AOTC.
Eligibility rules for refundable tax credits (RTCs) contribute to compliance burden for taxpayers and administrative costs for the Internal Revenue Service (IRS). These rules are often complex because they must address complicated family relationships and residency arrangements to determine who is a qualifying child. Compliance with the rules is also difficult for IRS to verify due to the lack of available third party data. The relatively high overclaim error rates for these credits (as shown below) are a result, in part, of this complexity. The average dollar amounts overclaimed per year for 2009 to 2011, the most recent years available, are $18.1 billion for the EITC, $6.4 billion for the CTC/ACTC, and $5.0 billion for the AOTC.
IRS uses audits and automated filters to detect errors before a refund is sent, and it uses education campaigns and other methods to address RTC noncompliance. IRS is working on a strategy to address EITC noncompliance but this strategy does not include the other RTCs. Without a comprehensive compliance strategy that includes all RTCs, IRS may be limited in its ability to assess and improve resource allocations. A lack of reliable collections data also hampers IRS's ability to assess allocation decisions. IRS is also missing opportunities to use available data to identify potential noncompliance. For example, tracking the number of returns erroneously claiming the ACTC and AOTC and evaluating the usefulness of certain third party data on educational institutions could help IRS identify common errors and detect noncompliance.
Proposals to change the design of RTCs--such as changing eligibility rules--will involve trade-offs in effectiveness, efficiency, equity, and simplicity.
section_title: What GAO Recommends
paragraphs: GAO recommends 1) IRS develop a comprehensive compliance strategy that includes all RTCs, 2) use available data to identify potential sources of noncompliance, 3) ensure reliability of collections data and use them to inform allocation decisions, and 4) assess usefulness of third-party data to detect AOTC noncompliance. IRS agreed with three of GAO's recommendations, but raised concerns about cost of studying collections data for post-refund enforcement activities. GAO recognizes that gathering collections data has costs. However, a significant amount of enforcement activity is occurring in the post-refund environment and use of these data could better inform resource allocation decisions and improve the overall efficiency of enforcement efforts.

section_title: Letter
paragraphs: Congress provides assistance in the form of tax credits targeted to  individuals and businesses generally to promote certain social and  economic objectives. These tax credits can be nonrefundable, where the  amount claimed is limited to the taxpayer’s tax liability, or refundable,  where the amount claimed is payable to the taxpayer as a refund to the  extent that the tax credit exceeds the taxpayer’s tax liability. The total cost  of the three largest refundable tax credits (RTC) in 2013, including both  reduction in revenues and increase in outlays, was just under $141  billion. The Internal Revenue Service (IRS) administers these tax credit  programs and disburses the credits to taxpayers.
The Earned Income Tax Credit (EITC), the largest RTC, was enacted in  1975 to encourage work by offsetting payroll taxes for low-income  taxpayers. Research shows the EITC has helped millions of low-income  families move out of poverty and these benefits carry over from one  generation to the next. However, IRS estimates show that the EITC has  also consistently had a high improper payment rate. For the past 5 years,  the estimated improper payment rate averaged 24.7 percent annually,  and for fiscal year 2015, IRS reported that total EITC payments were  $65.6 billion, of which $15.6 billion were estimated to be improper. The  EITC shares similar design features with other, less studied RTCs, raising  questions about how they are designed and administered.
You asked us to review a number of issues related to the design and  administration of three large RTCs available to taxpayers: the EITC, the  Additional Child Tax Credit (ACTC), and the American Opportunity Tax  Credit (AOTC). The objectives of this report are to (1) describe the  claimant population including the number of taxpayers and the amount  they claim along with other selected characteristics for the EITC, ACTC,  and the AOTC; (2) describe how IRS administers these credits and what  is known about the administrative costs and compliance burden  associated with each credit; (3) assess the extent to which IRS identifies  and addresses noncompliance with these credits and collects improperly  refunded credits; and (4) assess the impact of selected proposed  changes to elements of the EITC, ACTC, and AOTC with respect to  criteria for a good tax system such as efficiency, equity, and simplicity.
To address the first objective, we reviewed taxpayer data on EITC,  ACTC, and AOTC claimants and amounts claimed from the IRS Statistics  of Income (SOI) Individual Tax Return File for tax years 1999 to 2013.  For each objective, we used the most recent available data extended as  far back as needed for the purpose of the objective. For the first objective,  where the purpose is descriptive, we extended the data as far back as  necessary to capture important changes in the structure of the credits.
For the second objective, we collected and reviewed IRS forms,  instructions, and worksheets for claiming the three credits; government  and private sector reports on the IRS filing season and taxpayer  experience; IRS policies and procedures describing how IRS verifies  refundable credit claims prior to refund; and the most recent available IRS  data on costs and enforcement. We also interviewed IRS officials and  organizations representing paid and volunteer preparers and taxpayers.
For the third objective, we analyzed National Research Program (NRP)  data on audits of a representative sample of all taxpayers for the most  recent available tax years 2009 to 2011 to calculate noncompliance for  the credits overall and for subcategories of taxpayers and preparers. We  also reviewed and analyzed IRS, GAO, and other reports that explore the  root causes of refundable tax credit noncompliance; IRS policies and  procedures on their compliance strategy; and performance information  the U.S. Department of Treasury (Treasury) and IRS collect to monitor  the effectiveness of various compliance efforts. We interviewed Treasury  and IRS officials, subject-matter experts, and tax preparers on challenges  IRS faces reducing noncompliance with these three refundable credits.  For criteria, we compared IRS information on performance measures and  decision making to Standards for Internal Control in the Federal  Government and federal guidance on performance management. We  also applied criteria concerning the administration, compliance burden,  and transparency that characterize a good tax system, as developed in  our guide for evaluating tax reform proposals.
For the fourth objective, we conducted a literature review and held  interviews with subject-matter experts from government, academia, think  tanks, and professional organizations knowledgeable about refundable  tax credits and specifically the EITC, ACTC, and AOTC. We spoke to  those with expertise on how IRS administers RTCs, how low-income  taxpayers claim the credits, and how tax preparers interact with the  credits. We also spoke to experts across the ideological spectrum. We  conducted interviews to obtain views on criteria commonly used to  evaluate refundable tax credits and possible modifications to the credit.  Based on these interviews and our review of studies, we discuss the likely  impact of modifying elements of the RTC with respect to three criteria for  a good tax system that we identified in prior work—efficiency, equity and  simplicity—and the tradeoffs among these criteria that must be weighed  and evaluated when proposing a change in the credit. More detailed  information on our scope and methodology appears in appendix I.
To assess the reliability of the data we analyzed, we reviewed related  documentation, interviewed knowledgeable agency officials, and  conducted electronic data testing for obvious errors. We also shared our  methodology and preliminary results with knowledgeable agency officials  and asked them to comment on whether the data were sufficiently reliable  for our specific purposes. Based on this review, we determined that the  data we used were sufficiently reliable for the purposes of this report.
We conducted this performance audit from July 2015 to May 2016 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Refundable tax credits (RTC) differ from other credits because a taxpayer  is able to receive a refund check from IRS for the amount their credit  exceeds their tax liability. For example, a person who owed $2,000 in  taxes, but qualified for $3,000 in EITC would receive a $1,000 refund from  IRS. A nonrefundable credit can be used to offset tax liability, but any  excess of the credit over the tax liability is not refunded to the taxpayer. If,  instead of claiming the EITC, that same person claimed $3,000 in a  nonrefundable credit, the person would use $2,000 to reduce the tax  liability to zero, but would not receive the remaining credit amount as a  refund.
According to the Congressional Budget Office (CBO), the number and  costs associated with refundable tax credits have varied over the past 40  years. The first refundable credit, the EITC, was enacted in 1975. In  1998, additional RTCs became effective and by 2010 there were 11  different refundable tax credits. The cost of refundable tax credits peaked  in 2008 at $238 billion, but declined over the next 4 years because of the  expiration of several credits designed to provide temporary economic  stimulus. Starting in 2014, the refundable Premium Tax Credit (PTC)  was made available to some low-income households for the purchase of  health insurance through newly created exchanges, as part of the Patient  Protection and Affordable Care Act (PPACA). According to estimates  from the Joint Committee on Taxation (JCT) and CBO, the cost of the  PTC in its first year was $35 billion and will be about $110 billion by 2021.
In 2015, there were five refundable credits in effect. Four of those were  available to individuals—the EITC, ACTC, AOTC, and PTC. We issued  a report last year assessing IRS’s implementation of PPACA  requirements, including efforts to verify taxpayers’ PTC claims. This  report focuses on the design and administration of the other three  refundable tax credits available to individuals.
subsections: section_title: Earned Income Tax Credit
paragraphs: Congress enacted the EITC in 1975 to offset the impact of Social Security  taxes on low-income families and encourage low-income families to seek  employment rather than public assistance. The credit was also meant to  encourage economic growth in the face of a recession and rising food  and energy prices. Since the credit’s enactment, it has been modified to  provide larger refunds and differentiate between family size and structure.  In fiscal year 2013, taxpayers received $68.1 billion in EITC; an average  amount of $2,362 was distributed to about 29 million taxpayers.
Beginning in 1979, the credit was also available as an advance credit.  This meant that filers had the option to receive their predicted credit in  smaller payments throughout the preceding year and reconcile the  amount received with the amount they were actually eligible for upon filing  their taxes. However, as we reported, the advanced payment option had  a low take-up rate of 3 percent and high levels of noncompliance (as  many as 80 percent of recipients did not comply with at least one of the  program requirements), which led to its repeal in 2010.
The EITC divides the eligible population into eight different groups based  on the number of eligible children claimed by the filer and filing status.  The basic structure of the credit remains the same for each group: the  credit phases in as a percentage of earned income; upon reaching the  maximum benefit, the credit plateaus; and when income reaches a  designated point, the benefit begins to phase out as a percentage of  income. The phase-in and phase-out rates, maximum benefit, and phase- out point all differ depending on filing status (such as single or married  filing jointly) and the number of eligible children claimed.
In order to claim the EITC, the tax filer must work and have earnings that  do not exceed the phase-out income of the credit. Additional eligibility  rules apply to any children that a tax filer claims for the purpose of  calculating the credit. A qualifying child must meet certain age,  relationship, and residency requirements. For example, the child must  be younger than 19 (or 24 if a full-time student) and be a biological,  adopted, or foster child, grandchild, niece/nephew, or sibling of the filer  and live with the filer in the United States for at least 6 months of the  year. Additionally, the child must have a valid Social Security number  (SSN).
The Improper Payments Information Act (IPIA) of 2002, as amended,  requires federal agencies to review programs and activities that may be  susceptible to significant improper payments and report on actions taken  to reduce improper payments. In addition, the Office of Management  and Budget (OMB) identifies high-priority (or high-risk) programs, one of  which is EITC, for greater levels of oversight and review. For fiscal year  2015, IRS estimated that, $15.6 billion—or 23.8 percent—of EITC  program payments were improper. The estimated improper payment rate  for EITC has remained relatively unchanged since fiscal year 2003 (the  first year IRS had to report estimates of these payments to Congress), but  the amount of improper EITC payments increased from an estimated  $10.5 billion in fiscal year 2003 to nearly $16 billion in fiscal year 2015  because of growth in the EITC program overall.
section_title: Additional Child Tax Credit
paragraphs: The Additional Child Tax Credit (ACTC) is the refundable portion of the  Child Tax Credit (CTC) and provides tax relief to low-income families with  children. It also adds to the positive reward the EITC provides to those  who work. The credit was initially created in 1997 by the Taxpayer Relief  Act of 1997 as a nonrefundable child tax credit for most families, but in  2001 was expanded to include the current refundable ACTC for which  more low-income families were eligible. Like the EITC, taxpayers can  use the child tax credits to both offset tax liabilities (CTC) and receive a  refund (ACTC); however, unlike the EITC, the nonrefundable CTC and  the refundable ACTC amounts are entered separately on the Form 1040.  In fiscal year 2013, taxpayers claimed $27.9 billion in ACTC and $27.2  billion in the nonrefundable CTC. Thus, the total revenue cost of the CTC  and ACTC was $55.1 billion.
This report will sometimes combine these credits (referring to them as  CTC/ACTC) when their combined effect is at issue or to facilitate  comparison with other RTCs that do not break out refundable and  nonrefundable components. In general, the ACTC is claimed by those  with lower tax liabilities and lower income than those that claim only the  CTC. As reported by the SOI Division of the Internal Revenue Service, in  2012, 88 percent of the ACTC went to taxpayers with adjusted gross  income below $40,000, while 17 percent of the CTC went to taxpayers  below that income.
Under current law, taxpayers can use the CTC to offset their tax liabilities  by up to $1,000 per qualifying child. If the available CTC exceeds the  filer’s tax liability, they may be able to receive a portion of the unused  amount through the refundable ACTC. The ACTC phases in at 15 percent  of every dollar in earnings above $3,000 up to the unused portion of the  CTC amount. To claim the CTC or ACTC, taxpayers must have at least  one qualifying child. The criteria for qualifying children are slightly  different from that used to determine eligibility with the EITC. For the CTC  and ACTC, the child must be under the age of 17 and a U.S. citizen,  national, or resident, but taxpayers file using either a SSN or individual  taxpayer identification number (ITIN). However, the relationship and  residency requirements are similar for the ACTC and EITC. See figure 1  for a description of the credits and their requirements.
section_title: American Opportunity Tax Credit
paragraphs: The American Opportunity Tax Credit (AOTC) offsets certain higher  education related expenses in an effort to lessen the financial burden of a  college or professional degree for taxpayers and their dependents. The  credit was created by the American Recovery and Reinvestment Act of  2009 as a modification of the nonrefundable Hope Credit and was made  permanent in 2015 with the Protecting Americans from Tax Hikes (PATH)  Act. In 2013, taxpayers claimed $17.8 billion in AOTC.
The AOTC is designed as a partially refundable credit. The entire credit is  worth up to $2,500 and a taxpayer can receive a refundable credit equal  to 40 percent of their credit (for a maximum of $1,000). The size of the  entire credit is determined by taking 100 percent of the first $2,000 in  qualified education expenses and 25 percent of the next $2,000 in  qualified expenses, which include tuition, required enrollment fees, and  course materials. The value of the limit on expenses qualifying for the  credit is not indexed for inflation. In order to claim the AOTC a tax filer or  their dependent must meet certain requirements including adjusted gross  income requirements. Furthermore, they must be in their first 4 years of  enrollment and be at least a half-time student at an eligible post- secondary school. Taxpayers may only claim the AOTC for 4 years.
section_title: More Taxpayers Claim the EITC than Other Refundable Tax Credits and the Largest Share of Benefits Go to Those Making Less than $20,000
paragraphs: More taxpayers claim the EITC than the other two refundable credits we  examine in this report. The EITC is also the most expensive in terms of  tax revenue forgone and refunds paid. In 2013, taxpayers claimed a total  of $68.1 billion in EITC with $59 billion (87 percent) of this amount  refunded; the total was $55.1 billion for the CTC and ACTC with $26.7  billion (48 percent) refunded as ACTC and a total of $17.8 billion in AOTC  with $5 billion refunded (28 percent). There are several reasons why the  ratio between the amount received as tax refunds and the amount used to  offset tax liabilities varies from credit to credit including whether the  credits are partially or fully refundable as well as income levels of the  recipients.
The number of taxpayers claiming the earned income credit increased 50  percent from1999 to 2013, and the total amount claimed after adjusting  for inflation increased 60 percent, due in part to legislative changes which  increased the number of people eligible for the credit and the amount they  could claim. Over that same period, the ACTC also increased, with 20  times more taxpayers receiving the credit in 2013 than 1999. The AOTC  did not see similar constant growth. See figures 2 and 3 for the number of  taxpayers claiming credits and the amounts of credits received over time.
As figure 4 shows, a greater share of EITC benefits goes to lower-income  taxpayers. More than half (62 percent) of EITC benefits go to taxpayers  making less than $20,000, with the largest share (48 percent) going to  those making from $10,000 to less than $20,000. For the other credits,  the benefits are spread more evenly among income groups. The CTC and  AOTC do not have the same income restrictions as the EITC, so higher  income taxpayers also benefit from those credits. For example, taxpayers  making $100,000 or more receive 22 percent of the AOTC. Figure 4 also  shows the percent of each credit claimed per adjusted gross income  (AGI). Examined separately from the nonrefundable CTC, the ACTC also  benefits lower income groups, but is less concentrated on the lowest  income groups than the EITC, with 42 percent going to taxpayers making  less than $20,000. (See figure 11 in appendix III for a comparison of CTC  and ACTC benefits by AGI.)
In addition to being lower income, EITC and ACTC claimants are more  likely to be sole proprietors—persons who own unincorporated  businesses by themselves—and to be heads of households than the  general taxpayer population. As table 1 shows, 16 percent of taxpayers  are sole proprietors, but they represent 25 percent of EITC and ACTC  claimants. (Additionally, but not shown in the table, 29 percent of all EITC  dollars go to sole proprietors.) EITC and ACTC are claimed mostly by  heads of households. While people filing as head of household make up  only 15 percent of the taxpayer population, they represent 56 percent of  ACTC claimants and 47 percent of EITC claimants. AOTC claimants, on  the other hand, are most likely to be married filing jointly (43 percent) or  single (34 percent). Workers without qualifying children, or childless  workers, make up 25 percent of EITC claimants, but receive 3 percent of  benefits. Table 1 shows additional detail on how these characteristics  differ across the three credits.
section_title: Lack of Third Party Data Complicates IRS’s Ability to Administer Credits and Complexity of Credit Requirements Contributes to Taxpayer Burden
subsections: section_title: IRS Relies on Pre-Refund Screening Systems, Correspondence Audits, and Document Matching to Detect, Prevent, and Correct Errors
paragraphs: IRS relies on pre-refund controls and filters to detect, prevent, and correct  errors, a selection of which is shown in figure 5.
Before accepting a return, IRS checks it for completeness and attempts to  verify the taxpayer’s identity and credit eligibility. A series of systems use  IRS and other government data to check whether returns meet certain  eligibility requirements (like whether earned income falls within EITC  income limits) and include the required forms (such as a Schedule EIC).
IRS can use its math error authority (MEA) to correct or request  information on electronic returns with these errors.
During return processing, IRS runs returns through additional systems to  screen for fraud and errors. One system, IRS’s Electronic Fraud  Detection System (EFDS), screens returns for fraud including possible  identity theft. If flagged, IRS stops processing the return and sends a  letter asking the taxpayer to confirm his or her identity. Another system— the Dependent Database (DDb)—incorporates IRS and other government  data, such as the National Prisoner File or child custody information from  the Department of Health and Human Services, along with rules and  scoring models to identify questionable tax returns and further detect  identity theft. Once the suspicious tax returns are identified, the DDb  assigns a score to each tax return. Based in large part on these scores,  as well as available resources, IRS selects a portion of suspicious returns  for correspondence audits, which are audits conducted through the mail.  IRS conducts most of its EITC audits (about 80 percent) and ACTC audits  (about 64 percent) prior to issuing refunds. In these pre-refund audits,  IRS freezes the refund and sends a letter to the taxpayer requesting  documentation such as birth certificates or school or medical records to  verify eligibility. During the audit process, IRS will also freeze and  examine other refundable credits claimed on the return. See table 2 for a  description of how many audits IRS selects specifically for each credit  and the total amount audited including returns selected for other reasons.
IRS’s compliance activities continue after it issues refunds. In addition to  post-refund audits, IRS also conducts the automated underreporter  program (AUR) which matches income data reported on a tax return with  third-party information about income and expenses provided to IRS by  employers or financial institutions. In 2014, this document matching  review process included just over 1 million EITC returns and IRS  recommended $1.5 billion in additional tax.
section_title: Lack of Third Party Data and Filing and Refund Deadlines Complicate IRS’s Enforcement Efforts
paragraphs: Lack of third party data complicates IRS’s ability to administer these  credits, but such data are not easy to identify. According to IRS, the data  it uses should be complete and accurate enough to allow IRS to select  returns with the highest potential for change without placing an undue  burden on taxpayers. IRS reported that it evaluated several different  databases to determine if they were reliable enough to be used under  MEA to make changes to tax returns without going through the audit  process. For example, IRS tested the Federal Case Registry (FCR), a  national database that aids the administration and enforcement of child  support laws. IRS determined that it could not identify errors related to  qualifying children from this database with enough accuracy under its  standards. In addition, IRS participated in a project led by Treasury and  conducted by the Urban Institute that assessed the overall usefulness of  state-level benefit data to help validate EITC eligibility. The study  concluded, based on a number of issues, including different data  collection practices across states that this data would not improve the  administration of the EITC.
Without data reliable enough to be used under MEA, IRS generally  conducts a correspondence audit to verify that a taxpayer meets the  requirements for income and that their children meet both residency and  relationship requirements. Audits are more costly than issuing MEA  notices and they can be lengthy. For example, in 2014 it cost IRS on  average $.21 to process an electronic return (including issuing math error  notices), while an EITC audit cost $410.74. However, as mentioned  above, cost savings should be weighed against other goals such as  fairness and burden on taxpayers.
More EITC claimants make income errors than qualifying children errors,  but the dollar value of the errors due to noncompliance with qualifying  children requirements is larger than the dollar value of the income errors.  Verifying eligibility with residency and relationship requirements can be  complicated and subject to interpretation. IRS offers training to tax  examiners on various types of documentation that could be used to verify  EITC requirements and tax examiners are allowed to use their judgment  to evaluate whether residency or relationships requirements are satisfied.  This lack of available, accurate, and complete third party data  complicates IRS’s efforts to verify qualifying children eligibility  requirements, increasing IRS’s administrative costs and taxpayer burden.
Filing and refund timelines also complicate IRS’s ability to administer  these credits. IRS states on its website that more than 90 percent of  refunds are issued within 21 days. It is important that IRS issues refunds  on time because when it is late, taxpayers’ refunds are delayed, and IRS  is required to pay interest on delayed refunds.  However, it is also  important to allow enough time to ensure refunds are accurate and issued  to the correct individuals. The IRS strategy with respect to improper  payments is to intervene early to ensure compliance through outreach  and education efforts as well as various compliance programs. Even so,  in order to meet timeliness goals, IRS issues most refunds months before  receiving and matching information returns, such as the W-2 to tax  returns, rather than holding refunds until all compliance checks can be  completed. As a result, IRS ends up trying to recover fraudulent refunds  and unpaid taxes after matching information and pursuing discrepancies.  We previously reported that, in 2010, it took IRS over a year on average  to notify taxpayers of matching discrepancies, increasing taxpayer  burden. In August 2014, we recommended that IRS estimate the costs  and benefits of accelerating W-2 deadlines and identify options to  implement pre-refund matching using W-2 data as a method to combat  the billions of dollars lost to identity theft refund fraud, allowing the agency  more opportunity to match employers’ and taxpayers’ information. In  response to our recommendation, IRS conducted such a study and  presented the results to Congress in 2015.
In December 2015, Congress moved the W-2 filing deadlines to January  31 and required IRS to take additional time to review refund claims based  on the EITC and the ACTC. As such, most individual taxpayers who  claim either credit would not receive a refund prior to February 15. JCT  estimated that the entire provision will result in $779 million in revenue  from fiscal years 2016 to 2025. According to IRS officials, they are  evaluating how to implement these changes and the impact on the  administration of the credits.
section_title: Complexity of Eligibility Rules and Complying with IRS Enforcement Activities Contribute to Taxpayer Burden
paragraphs: The complexity of eligibility requirements, besides being a major driver of  noncompliance and complicating IRS’s ability to administer these credits,  are also a major source of taxpayer burden.  For example, for the EITC  and ACTC, each child must meet certain age, residency and relationship  tests.  However, given complicated family relationships, determining  whether children meet these eligibility requirements is not always clear- cut, nor easily understood by taxpayers. This is especially true when filers  share responsibility for the child with parents, former spouses, and other  relatives or caretakers, as the following figure illustrates.
Examples of Complications that Can Arise when Applying the EITC Eligibility Rules     Scenario 1:  A woman separated from and stopped living with her husband in January of last year, but they are still married. She  has custody of their children. She is likely eligible for the Earned Income Tax Credit (EITC) because she can file using  the head of household status.
However…..If the couple separated in November, she is likely not eligible for the EITC because she was not living  apart from her husband for the last 6 months of the year and therefore cannot claim the head of household filing  status.
Scenario 2:  An 18-year old woman and her daughter moved home to her parents’ house in November of last year. She is likely  eligible for the EITC because she was supporting herself and her child.
However…..If she always lived at her parents’ house, she is likely NOT eligible for the EITC because she was a  dependent of her parents for the full tax year and therefore cannot claim the EITC on her own behalf.
Scenario 3:  A young man lives with and supports his girlfriend and her two kids.  He and the mom used to be married, got  divorced, and are now back together. He is likely eligible for the EITC because the children are his stepchildren and  therefore meet the relationship requirement.
However…If he and the mom were never married, he is likely NOT eligible for the EITC because the children are not  related to him.
The complexity of eligibility requirements, besides being a major driver of  noncompliance and complicating IRS’s ability to administer these credits,  is also a major source of taxpayer burden. For example, for the EITC and  ACTC, each child must meet certain age, residency, and relationship  tests. However, given complicated family relationships, determining  whether children meet these eligibility requirements is not always clear- cut, nor easily understood by taxpayers. This is especially true when filers  share responsibility for the child with parents, former spouses, and other  relatives or caretakers, as the following textbox illustrates.
Differences in eligibility requirements among the RTCs also contribute to  complexity. In 2013, according to our analysis of IRS data, 11.4 million  taxpayers claimed both the EITC and ACTC while another 5.3 million  claimed the EITC, ACTC, and CTC, navigating multiple sets of  requirements for income levels and child qualifications. We have also  previously reported that the complexity of education credits like the AOTC  means that some taxpayers do not make optimal choices about which  education credits to claim. Faced with these complexities, many  potential credit recipients seek help filing their tax returns, typically from  paid preparers. Fifty-four percent of taxpayers claiming the EITC use paid  preparers to help them navigate these requirements and complete the tax  forms. These preparers provide a service that relieves taxpayers of costs  in terms of their own time, resources, and anxiety about the accuracy of  their returns. However, the preparer costs may be an additional burden if  their fees are excessive or their advice inaccurate. As we previously  reported, the fees charged for tax preparation services vary widely and  may not always be explicitly stated upfront. As noted later in this report,  unenrolled paid preparers—those generally not subject to IRS  regulation—have higher error rates for the RTCs than taxpayers who  choose to prepare their own returns.
Taxpayers who choose to prepare their own returns file a tax return  (some version of Form1040) along with additional forms, such as the  Earned Income Credit schedule, Schedule 8812 for the CTC, or Form  8863 to claim education credits. To determine both eligibility and the  amount of the credit, taxpayers can consult separate worksheets included  with the forms. These can be long and detailed; Publication 596, which  includes instructions and worksheets for claiming the EITC, is 37 pages  long. IRS reported that most taxpayers who self-prepare use tax software  when they file their returns and that, on average, the burden for RTC  returns was about 11 hours per return in 2013.
In addition to the costs of filing a claim for a credit, complying with IRS  enforcement activities also contributes to taxpayer burden. In tax year  2013, IRS rejected over 2 million electronically filed EITC claims. IRS  rejects these claims for a variety of reasons, such as missing forms,  incorrect SSNs, or if another taxpayer has claimed the same child.  Taxpayers can handle some of these issues, such as a mistyped SSN, by  correcting their electronic returns. IRS reported that a majority (74.4  percent) of rejected returns are corrected and resubmitted electronically.  IRS also reported that this process takes taxpayers on average half an  hour—shorter than if they had to make this correction after filing. Other  issues impose a larger burden. To claim a child that someone else has  already claimed for the EITC, taxpayers can fill out and resubmit their  return on paper and then face a possible audit with its associated costs.
When processing the tax return, if IRS identifies potential noncompliance  with eligibility requirements it can initiate a correspondence audit and  send a letter to the taxpayer requesting documentation showing that the  taxpayer meets those eligibility requirements. For taxpayers overall, IRS  estimated that participating in a correspondence exam takes taxpayers 30  hours, which, combined with any out of pocket costs, is valued on  average at $500. In 2015, IRS conducted just under 446,000 EITC  exams, which means that approximately 1.6 percent of people filing a  EITC claim were audited compared to about .9 percent for individual  taxpayers overall in 2014.
However, this compliance burden may be larger for some populations.  For example, according to attorneys who represent low-income tax filers,  these filers may have difficulty proving they meet residency and  relationship requirements due in part to language barriers, limited  computer literacy, and complicated family structures. To prove a  residency requirement—that a child lived with the taxpayer in the United  States for more than half the year—taxpayers may submit a document  with their address, name, and the child’s name that could include school  or medical records or statements on letterhead from a child-care provider,  employer, or doctor. Again, according to low-income tax clinic  representatives, these can be hard to cobble together for families with  limited English proficiency or who move multiple times throughout the  year. To prove a relationship requirement, unless they are claiming their  son or daughter, taxpayers must submit birth certificates proving the  relationship. For example, to claim a great-grandchild, the taxpayer must  submit the child’s, grandchild’s, and great-grandchild’s birth certificates.  The names must be on the birth certificates, or they will also need to  submit another type of document such as a court decree or paternity test.  For multigenerational families or situations in which another relative is  taking care of the child, locating and assembling the necessary chain of  birth certificates can be a challenge.
If IRS determines that a taxpayer improperly claimed the EITC due to  reckless or intentional disregard of rules or regulations, it may ban the  taxpayer from claiming the credit for 2 years—even if the taxpayer  qualifies for it. However, the National Taxpayer Advocate reported that  IRS’s procedures automatically imposed the ban on taxpayers who did  not respond to IRS’s notices and put the burden of proof onto taxpayers  to show they should not have received the ban. According to IRS  officials, in response to these concerns, IRS implemented new training  programs, strengthened managerial oversight, and added protections for  taxpayers to ensure they only systematically issue bans to taxpayers with  a history of noncompliance. In 2015, IRS issued fewer 2-year bans than  in previous years.
Despite the compliance burden and costs associated with these RTCs,  the burden may be lower than benefits from spending programs. For  example, tax credit recipients can self-certify, they do not need to meet  with caseworkers, nor submit up-front documentation as is required with  some direct service antipoverty programs such as Supplemental Security  Income (SSI) or Temporary Assistance for Needy Families (TANF). The  simplified up-front process may contribute to higher participation rates.  The EITC participation rate — over 85 percent as reported by Treasury—  is in the high end of the range for antipoverty programs. GAO previously  reported that the SSI participation rate in 2011 was about 67 percent of  adults who were estimated to be eligible, while the TANF participation  rate was about 34 percent. IRS does not estimate participation rates for  AOTC or ACTC.
section_title: Developing a Comprehensive Strategy for RTC Compliance Efforts and Greater Use of Available Data Could Help IRS Better Target Limited Enforcement Resources
subsections: section_title: IRS’s Lack of a Comprehensive Compliance Strategy for RTCs Hampers Its Ability to Make Informed Resource Allocation Decisions
paragraphs: Sustained annual budget reductions at IRS have heightened the  importance of determining how best to allocate declining resources to  ensure it can still meet agency-wide strategic goals of increasing taxpayer  compliance, using resources more efficiently, and minimizing taxpayer  burden. In an effort to improve efficiency, IRS consolidated administration  of the EITC, ACTC, and AOTC across several different offices within the  Wage & Investment Division. Return Integrity and Compliance Services  (RICS) oversees the division’s audit functions. Within RICS, Refundable  Credits Policy and Program Management (RCPPM) is responsible for  refundable credit policy, enforcement, and establishing filters for  computerized selection of returns for audit. Refundable Credits  Examination Operations is responsible for conducting the audits,  oversight and training of personnel, maintaining the phone and mail  operations, and addressing personnel and union issues. Although these  offices work collaboratively to formulate and implement policies and  process workload, they lack a comprehensive strategy for RTC  compliance efforts. IRS is working on an operational strategy to document  all current EITC compliance efforts and identify and evaluate potential  new solutions to address improper payments. However, this review only  focuses on efforts to improve EITC compliance and does not include the  other refundable credits. The lack of a comprehensive strategy that takes  into account all ongoing compliance efforts for the three RTCs (the EITC,  ACTC, and AOTC) presents several potential challenges, as discussed  below.
subsections: section_title: IRS Does Not Report Error Rates for All RTCs and It Is Unclear How It Uses Compliance Data to Make Resource Allocation Decisions
paragraphs: IRS measures compliance by estimating an aggregate error rate for the  EITC and error rates for certain subcategories of EITC claimants (e.g.,  claimants grouped by type of tax preparer). IRS uses National Research  Program (NRP) data for these estimates because it employs a  representative sample that can be used to estimate error rates for the  universe of taxpayers. In addition to measuring compliance with the tax  code, the error rates help IRS understand taxpayer behavior; information  IRS could use to develop compliance strategies and allocate resources.  According to IRS, it estimates net overclaim percentages (net misreported  amount divided by the amount reported) for the RTCs. IRS reported it  uses these overclaim percentages to identify areas for potential future  research. However, IRS does not report the frequency of these errors or  amounts claimed in error across credits, which makes it difficult to  compare noncompliance across the credits. Analyses which incorporate  relative frequencies and the magnitudes of these errors could be used by  IRS to inform resource allocation decisions.
In order to show how IRS can use these error rates to inform its  compliance strategy and resource allocations, we estimated aggregate  error rates for the EITC, the AOTC, and the CTC/ACTC, which combines  the refundable ACTC with its nonrefundable counterpart the CTC.  Estimating the CTC/ACTC makes it possible to compare error rates for  this credit with those for the EITC and AOTC because these credits  include the refunded amounts as well as the amounts used to offset tax  liabilities. The CTC/ACTC error rate estimate will exclude any  adjustments due to dollars shifted between refundable ACTC and  nonrefundable CTC. For example, a taxpayer who understates her  income may claim a higher ACTC, but if IRS adjusts the income, the  effect could be that the refundable ACTC decreases and the  nonrefundable CTC increases. This adjustment does not necessarily  result in saved dollars or revenue protected, but rather a shifting of dollars  from a refund to a lower tax liability, depending where the taxpayer is in  relation to the income phase-out rate. Without making these adjustments  for the CTC/ACTC estimates, the error rates for the credits would not be  comparable.
The relative frequency of error rates by different types of credit could be  useful information for determining the allocation of enforcement  resources. As figure 6 shows, the estimated average error rates for  overclaims and underclaims from 2009 to 2011 can vary considerably by  credit type. The EITC and AOTC have similar average error rates for  overclaims of 29 percent and 25 percent, respectively, but the CTC/ACTC  error rate for overclaims is 12 percent—less than half of the other two  credits. Although they are much smaller, the underclaim rates vary in a  similar way, with the 4 percent AOTC error rate being twice as large as  the CTC/ACTC rate. The relative frequency of errors by type of credit may  help IRS better focus its limited resources.
In addition to the error rates, information about the amount estimated to  be claimed in error would also be useful for resource allocation. From  2009 to 2011, the average amount overclaimed for the RTCs also had  considerable variation by credit type. The average yearly amount  overclaimed for the EITC was $18.1 billion, for the CTC/ACTC was $6.4  billion, and for the AOTC was $5.0 billion. (See appendix II for more  details about credit amounts erroneously claimed.) Combining these  dollar amounts with the error rate information can further inform resource  allocation. For example, although the AOTC had an overclaim rate of 25  percent—nearly as large as the EITC’s 29 percent rate—the amount  overclaimed was only about one-third of the EITC’s amount. Both the rate  and the amount—among other considerations like effects on equity and  compliance burden—would factor into a plan for allocating enforcement  resources.
The lack of a comprehensive compliance strategy that includes  information on error rates by type of credit and categories of taxpayers  could limit IRS’s ability to recognize gaps in its enforcement coverage and  compliance efforts. For example, IRS previously reported in its EITC  compliance studies that unenrolled paid preparers have higher error rates  than other preparer types. Our analysis of NRP data, discussed later in  this report, showed that this pattern of noncompliance by type of preparer  is also true for the ACTC and AOTC. With this information, a compliance  strategy can be devised that takes into account these other credits.
Additional information could also help IRS better plan resource allocations  among the RTCs. IRS devotes a large percentage of its RTC  enforcement resources to the EITC, but has not made clear the basis for  this allocation. As previously noted, in 2014, IRS selected 87 percent (or  435,000) of its RTC audits based on issues related to the EITC and 6  percent (or 31,000) of its audits based on issues related to the ACTC.  The returns that IRS selects for EITC audit may also be audited for other  RTC issues. For example, in addition to the 31,000 returns selected for  ACTC audits in 2014, another 382,000 returns were audited for the ACTC  even though they were selected for another RTC issue—almost always  an EITC issue. This approach allows IRS to pick up a lot of potentially  erroneous ACTC claims, which IRS can then also freeze as part of the  EITC audit. However, this approach raises several concerns about  whether IRS is achieving an optimal resource allocation: (1) the very low  audit coverage of the approximately 5 million claimants who claim the  ACTC but not the EITC could risk a reduction in voluntary compliance, (2)  using EITC tax returns as a selection mechanism for ACTC audits may  not be the best way to identify ACTC noncompliance, and (3) questions  about equity in audit selection for ACTC arise because EITC claimants  are generally lower-income than claimants for other credits. Weighing  these concerns and other factors like administrative costs could help IRS  create a comprehensive strategy for the RTCs that could provide a  framework for IRS to make decisions about how to allocate resources and  to communicate what criteria it uses to make these allocations.
Although IRS lacks a comprehensive RTC strategy, it has been able to  identify some compliance trends for other credits besides the EITC. IRS  officials observed an increase in the ACTC overclaim percentage from  2009 to 2011. According to IRS, confirming and understanding the nature  of that potential increase will require more research. To that end, IRS  plans to begin work in 2016 on an ACTC compliance study similar in  nature to the recent EITC 2006-2008 Compliance Study. Officials could  not provide a start date or timeline for completion and said the rate at  which this work progresses will depend on competing priorities given  limited budget and staff. However, they stated that the CTC/ACTC  compliance study remains a high priority project. Previously, we reported  that IRS could identify ways to reduce taxpayer noncompliance through  better use of NRP data and that ACTC was one area where further  research could provide information on how to address noncompliance.
section_title: RTC Performance Indicators Are Difficult to Interpret and Do Not Include Indicators for Equity and Compliance Burden
paragraphs: Another challenge related to the lack of a comprehensive plan is that  certain IRS performance indicators may be difficult to interpret. IRS relies  on the no-change rate and default rates to make resource allocation  decisions. IRS closes audits as defaults when the taxpayer (1) does not  respond to any IRS notice or (2) responds to some notices but not the last  one asking for agreement with a recommended additional tax  assessment. IRS officials stated that they believe that taxpayers who  default are generally noncompliant because taxpayers selected for audit  receive multiple notices and the refunds can equal several thousand  dollars, giving them the information and incentive to engage with IRS.  Therefore, when there is a high default and a low no-change rate, IRS  officials said that they interpret that as an indicator that the taxpayers  selected for audit were not entitled to the credit claimed.
Even so, it can be difficult to interpret a low no-change rate when it  includes defaults. As we previously reported, in fiscal years 2009 through  2013, the no-change rate ranged from 11 percent to 21 percent for all  closed correspondence audits but rose to 28 percent to 45 percent when  IRS had contact with the taxpayers throughout the audit and did not close  the audit through a default. Without knowing the reasons why taxpayers  default, it is difficult to know how to interpret the no-change rate. To the  extent that some of the taxpayers who default are compliant, the reported  no-change rate underestimates what would be the actual no-change rate.  The Taxpayer Advocate has raised concerns that taxpayers may not  understand the notices, which could be contributing to the low response  rate.
The difficulty interpreting the no-change rates and default rates can make  the results of IRS’s assessments of its programs less certain. According  to IRS, two of the most effective and reliable enforcement programs for  addressing RTC compliance and reducing improper payments are post- refund document matching and audits. IRS stated that it protects over $3  billion dollars in revenue based on these enforcement activities, but the  default rate is over 50 percent. The no-change rate indicates that the  overwhelming majority of the cases IRS selects have mistakes that  require an adjustment. However, because the defaults are included  among the no-change audits and the default rate is high, it calls into  question the extent to which the cases being selected are actually  noncompliant. Table 3 shows the number of returns IRS identifies through  these various enforcement activities, the no-change rate, and the default  rate.
The no-change rates for these enforcement activities are very low but the  associated default rates are high. This disproportion can make the no- change rate misleading as an indicator of noncompliance. For example, if  10 percent of the defaulting taxpayers in the case of document matching  were actually compliant, the no-change rate would double to about 14  percent, and if 50 percent were compliant, the no-change rate would  increase to about 40 percent. These figures could call into question  whether IRS is getting useful information out of no-change rates when the  default rate is so high and little is known about the compliance  characteristics of defaulting taxpayers.
Another challenge that IRS faces is that the set of indicators that it uses  to make resource allocation decisions does not include indicators for  equity and compliance burden. When evaluating enforcement strategies,  such as developing new screening filters for exam selection, IRS officials  look at filters that produce a low response rate and a low no-change rate.  For example, at the 2015 annual strategy meeting, IRS managers  recommended increasing the number of Disabled Qualifying Child (DQC)  cases that they plan to work each year based on a high default rate (70  percent compared to a 54 percent default rate for other programs) and a  low no-change rate of between 3 and 6 percent. Based on these high  default and low no-change rates, program managers recommended  increasing the number of cases that they plan to work or replacing cases  waiting to be worked with DQC cases as a way to reduce their backlog of  unclosed cases. The managers did not evaluate the recommendation on  the basis of equity or compliance burden. In addition, IRS did not provide  any reliable indicator of compliance burden associated with any of the  refundable tax credits that we reviewed. According to IRS officials,  reviewing taxpayers’ responses is resource intensive, and by reducing  that process, IRS could perform more audits elsewhere. However, as  discussed above, the no-change rate on which they based their decision  may be an unreliable estimate of actual taxpayer noncompliance when,  as the officials said, they do not know why taxpayers did not respond to  notices.
A more comprehensive strategy that documents RTC compliance efforts  could help IRS officials determine whether their current performance  indicators are giving them reliable information and their current allocation  of resources is optimal, and if not, what adjustments are needed. IRS  officials could also use this review as an opportunity to ensure program  managers have a balanced suite of performance measures which  adequately address all priority goals. For example, the desire to reduce  inventory or concentrate resources on efforts with the lowest no-change  rate could take precedence over undue taxpayer burden.
section_title: Agency-wide Administrative and Compliance Challenges Complicate RTC Oversight
paragraphs: IRS faces administrative and compliance challenges which also  complicate the administration of RTCs. Due in part to long-standing  concerns about the EITC improper payment rate, EITC examinations  account for nearly 39 percent of all individual income tax return audits  each year. However, the EITC only accounts for about 5 percent of the  tax gap in tax year 2006 (the most recent estimate available). In a 2013  report, we demonstrated that a hypothetical shift of about $124 million in  enforcement resources among different types of audits could have  increased direct revenue by $1 billion over the $5.5 billion per year IRS  actually collected in 2013. An agency-wide approach that incorporates  ROI calculations could help IRS allocate enforcement resources more  efficiently not just among the credits, but also across EITC and non-EITC  returns. We previously recommended that IRS develop a long-term  strategy and use actual ROI calculations as part of resource allocation  decisions to help it operate more effectively and efficiently in an  environment of budget uncertainty. In response to our recommendation,  IRS has begun a project to develop ROI measures that could be used for  resource allocation decisions.
We have previously reported that while IRS publishes information  regarding the coverage rates and additional taxes assessed through  various programs, relatively little information is available on how much  revenue is actually collected as a result of these enforcement activities.
Additional analysis of available RTC collections data could also inform  resource-allocation decisions. Currently, IRS reviews the amount of  revenue collected annually based on EITC post-refund enforcement  activities, but it could not verify the reliability of that data during the  timeframe of the GAO audit. Such data could be used to calculate a  collections rate—the percentage of tax amounts assessed that is actually  collected.  A reliable collections rate could be used as an additional data  point for informing and assessing allocation decisions.
According to federal internal control standards, managers need accurate  and complete information to help ensure efficient and effective use of  resources in making decisions. Recognizing that not all recommended  taxes would be collected or collected soon after the audit, IRS could still  use available data to compute a collections rate for post-refund  enforcement activities and conduct further analyses of assessments from  post-refund audits and document-matching reviews. IRS officials said  they have conducted such studies in the past, and they were resource- intensive. Nonetheless, given that collections data are needed for both  the detailed analyses described above, as well as for an agency-wide  analysis of the relative costs and results of various enforcement activities  to inform resource-allocation decisions, there may be opportunities to  coordinate the data collection efforts to reduce overall costs.
In addition to collections, an agency-wide approach could help IRS  develop a strategy for addressing Schedule C income misreporting—a  long-time challenge for IRS—and a key driver of EITC noncompliance.  According to IRS, income misreporting is the most commonly made error  on returns claiming the EITC, occurring on about 67 percent of returns  with overclaims. Self-employment income misreporting represents the  largest share of overclaims (15 to 23 percent) while wage income  misreporting represents the smallest (3 to 6 percent). In the claimant  population as a whole, 76 percent of taxpayers earn only wage income,  while the remaining 24 percent earn at least some self-employment  income. As shown in figure 7, error rates in terms of overclaimed  amounts of credit were largest for Schedule C filers for the EITC and  AOTC. The error rate for Schedule C filers claiming the CTC/ACTC was  not statistically different from the error rate for filers without a Schedule C.
Although Schedule C income misreporting is larger for EITC claimants,  IRS’s enforcement strategies are more likely to be effective with wage  income misreporting than Schedule C income misreporting. According to  IRS, it addresses income misreporting through (1) DDb filters designed to  identify taxpayers making up a fake business; (2) the questionable refund  program designed to identify and follow-up with taxpayers lying about  where and how long they worked; and (3) the post-refund document  matching program that matches returns with other information such as W- 2s. While these methods may catch some income misreporting by the  self-employed, they rely to a great extent on the types of third party  income and employment documentation that are likely to be available for  wage earners but are largely absent for the self-employed. According to  IRS officials, starting in tax year 2011, IRS started matching other  information such as Form 1099K Merchant Card payments to tax returns  to verify self-employment income. IRS also addresses EITC  noncompliance through correspondence audits but Schedule C income  issues are more conducive to field audits than correspondence audits.  However, EITC Schedule C returns are less likely to be selected for field  audits because the dollar amounts do not meet IRS thresholds.
Addressing Schedule C income misreporting has been a long-standing  challenge for IRS. In 2009, we reported that according to IRS, sole  proprietor income was responsible for about 20 percent of the tax gap.  A key reason for this misreporting is well known. Unlike wage and some  investment income, sole proprietors’ income is not subject to withholding  and only a portion is subject to information reporting to IRS by third  parties. We have made several recommendations over the years to  address this issue. In 2007, we recommended that Treasury’s tax gap  strategy should cover sole proprietor compliance in detail while  coordinating it with broader tax gap reduction efforts. As of March 2015,  no executive action has been taken to address this recommendation, nor  has Treasury provided us with plans to do so. We maintain that without  taking these steps, Treasury has less assurance that IRS is using  resources efficiently to promote sole proprietor compliance.
In 2009, we recommended IRS develop a better understanding of sole  proprietor noncompliance, including sole proprietors improperly claiming  business losses. As of November 2015, IRS partially addressed this  recommendation by researching sole proprietor noncompliance and  focusing on those who improperly claim business losses. The results of  this research will take several years to compile but IRS plans to provide at  least rough estimates of disallowed losses in 2016. This research, when  completed, could help IRS to identify noncompliant sole proprietor issues  and address one of the drivers of EITC noncompliance.
section_title: IRS Is Missing Opportunities to Use Available Data to Identify Drivers of ACTC and AOTC Noncompliance
paragraphs: IRS does not track the number of returns erroneously claiming the ACTC  and AOTC identified through screening activities. (IRS currently tracks  this information for the EITC). As we noted earlier, according to federal  internal control standards, managers need accurate and complete  information to help ensure efficient and effective use of resources in  making decisions. IRS conducts various activities to identify and prevent  the payment of an erroneous refund, such as screening returns for  obvious mistakes and omissions. IRS officials said this information would  help them deepen their understanding of common errors made by  taxpayers claiming these credits and the insights could then be used to  develop strategies to educate taxpayers. IRS officials reported that they  are working to figure out how to extract these data for the ACTC and  AOTC so they can begin to track the data and use them to refine their  overall compliance strategy. Although IRS said that it understands the  potential usefulness of these data, it has not yet developed a plan that  includes such desirable features as timing goals and resource  requirements and a way to develop indicators from the data that would be  most effective for understanding and increasing compliance.
IRS may also be missing an opportunity to use information from the  Department of Education (Education) to detect and correct AOTC errors.  Education collects in its Postsecondary Education Participants System  (PEPS) a list of institutions and their employer identification numbers  (EIN), which would indicate whether the institution the student attends is  eligible under the AOTC. The PATH Act of 2015 requires taxpayers  claiming the AOTC to report the EIN for the education institutions to which  they made payments.
There is some evidence that PEPS may be a useful tool for detecting  noncompliance. In a review of the AOTC, the Treasury Inspector General  for Tax Administration (TIGTA) used PEPS data and identified 1.6 million  taxpayers claiming the AOTC for an ineligible institution in 2012. TIGTA  recommended that IRS coordinate with Education to determine whether  IRS could use Education data to verify the eligibility of educational  institutions claimed on tax returns. While IRS agreed that these PEPS  data could identify potentially erroneous claims, it did not agree to further  explore using the data.
IRS has not determined whether PEPS can be used for enhancing AOTC  compliance for two reasons. First, IRS does not have math error authority  (MEA) to correct errors in cases where taxpayer-provided information  does not match corresponding information in government databases.  IRS would still need to conduct an exam to reject a claim with an ineligible  institution. For example, if the EIN on a submitted return is not contained  in the PEPS database of eligible institutions, IRS does not have the  authority to automatically correct the return and notify the taxpayer of the  change. Instead, IRS would have to contact the taxpayer for additional  documentation or open an examination to resolve discrepancies between  PEPS data and the tax return information. Secondly, IRS believes its  current selection process is sufficient because IRS already identifies more  potentially fraudulent returns with its filters than it can examine given its  current resources. In 2012, IRS identified 1.8 million returns with  potentially erroneous education claims and selected 9,574 for exam, for  an exam rate of 0.5 percent. To identify these returns for exam, IRS used  its pre-refund filters of students claiming the credit for more than 4 years,  returns without the 1098-T form, or students in an unexpected age range.
The administration submitted legislative proposals for fiscal years 2015  and 2016 that, among other things, would establish a category of  correctable errors. Under the proposals, Treasury would be granted MEA  to permit IRS to correct errors in cases where information provided by a  taxpayer does not match corresponding information provided in  government databases. We have previously reported that expanding  MEA with appropriate safeguards could help IRS meet its goals for the  timely processing of tax returns, reduce the burden on taxpayers of  responding to IRS correspondence, and reduce the need for IRS to  resolve discrepancies in post-refund compliance, which, as we previously  concluded, is less effective and more costly than at-filing compliance.  However, Congress has not granted this broad authority.
Although correctable error authority may reduce compliance and  administrative burden, it raises a number of concerns. Experts have  raised concerns that such broad authority could put undue burden on  taxpayers. For example, the National Taxpayer Advocate has raised  concerns that IRS’s current math error notices are confusing and place a  burden on taxpayers as they try to get answers from IRS. The JCT also  raised concerns about whether all government databases are considered  sufficiently reliable under this proposal.
However, an assessment of the completeness and accuracy of PEPS  data may be useful for IRS enforcement efforts even in the absence of  correctable error authority. First, while IRS believes its current selection  process is sufficient, without assessing the PEPS data, it cannot know  whether its case selection could be improved by this additional  information about ineligible institutions. Second, if an IRS assessment of  PEPS data determined that pre-refund corrections based on those data  would be effective, the case for correctable error authority would be  easier to make to Congress. As our work on strategies for building a  results-oriented and collaborative culture in the federal government has  shown, stakeholders, including Congress, need timely, action-oriented  information in a format that helps them make decisions that improve  program performance.
subsections: section_title: IRS Could Use Previous Years’ Tax Returns to Identify AOTC Noncompliance, but Congressional Action Is Needed
paragraphs: Taxpayers can only claim the AOTC for 4 years, but IRS does not have  MEA to freeze a refund on a claim that exceeds the lifetime-limit rule. In  2015, TIGTA found that more than 400,000 taxpayers in 2012 received  over $650 million for students claiming the AOTC for more than 4 years.  According to IRS officials, they have processes to identify students who  exceed the 4-year lifetime limit based on information from prior returns.  Those returns are candidates for audits. However, as noted earlier, IRS  identifies far more candidates for audits than it can perform given current  staffing levels. In 2011, we recommended that Congress consider  providing IRS with MEA to use tax return information from previous years  to ensure that taxpayers do not improperly claim credits or deductions in  excess of lifetime limits where applicable. Granting this authority would  help IRS disallow clearly erroneous claims, reduce the need for an audit,  and promote fairness by limiting claims to taxpayers who are entitled to  them. It would also assist taxpayers in self-correcting unintentional  mistakes where they may have chosen an incorrect educational tax  benefit since they exceeded the lifetime limit. As we recommended in  2011, we continue to believe that Congress should consider providing  MEA to be used with credits and deductions with lifetime limits. Any RTCs  that contain these limits such as the AOTC should fall under this authority  as well if it is granted by Congress.
section_title: IRS Has Made Efforts to Promote RTC Awareness and Compliance by Taxpayers and Paid Preparers
paragraphs: IRS has several efforts intended to educate taxpayers about eligibility  requirements and improve compliance including social media messaging,  webinars, and tax forum presentations. According to IRS, these efforts  are intended to promote participation among taxpayers eligible for these  credits, ensure that taxpayers are aware of the eligibility requirements  before filing a tax return, and prevent unintentional errors before they  occur. Additionally, IRS designated an EITC Awareness Day to increase  awareness among potentially eligible taxpayers at a time when most are  filing their federal income tax returns. The 10th Annual EITC Awareness  Day was January 29, 2016.
According to IRS, it currently has limited ability to measure the  effectiveness of its outreach efforts. As recently as 2011, IRS officials  said they were able to measure the effectiveness of the efforts through a  semi-annual survey where they tested, for example, the effect of  concentrating messaging in certain areas on taxpayer awareness of the  EITC. Although IRS reported it no longer has the funds for that survey,  officials said IRS still commissions an annual survey intended to improve  services to volunteers and external stakeholders. IRS officials also said  that they collect user feedback to assess use and effectiveness of their  EITC website and make changes accordingly. For example, after users  cited problems with easily locating information on maximum income limits  for the EITC, IRS reported that it revised its website to make income  information more prominent.
To address underutilization of the AOTC, IRS has been working to  improve the quality and usefulness of information about the credit. We  reported in 2012 that about 14 percent of filers in 2009 (1.5 million of  almost 11 million eligible returns) failed to claim an education credit or  deduction for which they appeared to be eligible, possibly because filers  were unaware of their eligibility or were confused. In response to the  recommendation in our 2012 report, IRS conducted a limited review in  2013 that determined that over 15 million eligible students and families  may not have been or were not claiming an education benefit. Identifying  these potentially eligible taxpayers will help IRS develop a comprehensive  strategy to improve use of these tax provisions.
We also recommended in 2012 that IRS and Education work together to  develop a strategy to improve information provided to tax filers who  appear eligible to claim a tax provision but do not. IRS has been  implementing this recommendation by coordinating with Education to (1)  create an education credit web page on the department’s Federal Student  Aid website and (2) improve IRS’s AOTC and Lifetime Learning Credit  Communication Plan. To improve understanding of requirements for  education credits, IRS has enhanced information and resources on  IRS.gov and revised the tax form for claiming education credits (Form  8863, Education Credits American Opportunity and Lifetime Learning  Credits) to include a series of questions for the taxpayer to ascertain  credit eligibility.
IRS has also made efforts to address compliance issues associated with  certain tax preparers. As shown in figure 8, unenrolled preparers have the  highest error rates for RTCs among preparers. For the EITC, unenrolled  preparers have the highest overclaimed rate at 34 percent of total credit  claimed, and, as IRS reported, they are the type of preparer most often  used by EITC claimants, preparing 26 percent of all EITC returns. In  contrast, although comprising only 3 percent of all returns with the EITC,  returns prepared by volunteers in the IRS-sponsored Volunteer Income  Tax Assistance and Tax Counseling for the Elderly programs have the  lowest error rate at 16 percent.
IRS’s chief compliance effort for paid preparers is the EITC Return  Preparer Strategy designed to identify preparers submitting the highest  number of EITC overclaims and tailor education and enforcement  treatments to change their behavior. The strategy uses a variety of  methods to address preparer noncompliance including (1) educational  “knock-and-talk” visits with preparers before filing season; (2) due  diligence visits where IRS officials determine whether preparers complied  with due diligence regulations, such as documenting efforts to evaluate  the accuracy of information received from clients; and (3) warning and  compliance letters to preparers explaining that IRS has found errors in  their prior returns. The EITC preparers that appear to be associated with  the most noncompliance receive the most severe treatments, which  include visits from revenue agents, and if necessary, an assessment of  penalties: $500 per noncompliant return, or if the preparer used a bad  preparer tax identification number, penalties of $50 per return, up to a  maximum of $25,000. (The PATH Act of 2015 expanded preparer due  diligence requirements and penalties to the CTC and AOTC.) These  preparers can also be referred to the Department of Justice for civil  injunction proceedings. If fraud is identified, these preparers can be  referred to criminal investigation.
The project recently found that less severe, lower cost treatments, such  as warning letters, affect preparer behavior but more severe, higher cost  due diligence visits improve preparer behavior the most. IRS expanded  the number of preparers it selected to contact from 2,000 in fiscal year  2012 to around 31,000 in fiscal year 2015.
According to IRS data, the EITC Return Preparer Strategy has protected  around $1.7 billion in revenue of EITC and CTC/ACTC claims since fiscal  year 2012. In fiscal year 2015, the project protected over $465 million in  revenue ($386 million in EITC savings and $79 million in CTC/ACTC).  Also, the proposed preparer penalties for the 2015 effort totaled $30  million with an overall due diligence visit penalty rate of around 85  percent.
Any attempts to improve preparer compliance through increased  regulation by Treasury and IRS are likely to require congressional action.  IRS issued regulations in 2010 and 2011 to require registration,  competency testing, and continuing education for paid tax return  preparers and to subject these new registrants to standards of conduct in  their practice. However, the courts ruled that IRS did not have the  statutory authority to regulate these preparers. In 2014, we suggested  Congress consider granting IRS the authority to regulate paid tax  preparers. Establishing requirements for paid tax return preparers could  improve the accuracy of the tax returns they prepare, not just returns  claiming EITC.
section_title: Evaluating Proposed Changes to the RTCs Involves Assessing Trade-offs in Their Impact on Equity, Efficiency, and Simplicity
paragraphs: A variety of proposals have been made to change the design of the EITC,  ACTC, and AOTC. The proposals generally focus modifications on one or  more elements of the credits such as how much of the credit is  refundable, the maximum amount of credit, the level of the phase-in and  phase-out income ranges, and rates. Changing these elements will have  certain effects on their equity, efficiency, and simplicity that are common  across the credits. For example, increasing or decreasing refundability  affects the distribution of the credits’ benefits by income level which has  implications for whether the change is viewed as increasing or decreasing  equity. The following review of proposals has been organized according  to the basic design elements of the credits where the effects of certain  proposals to change these elements are evaluated according to the  standard criteria of a good tax system.
subsections: section_title: Efficiency, Equity, and Simplicity Are Standard Criteria for Evaluating Tax Credits
paragraphs: Evaluating tax credits requires identifying their purpose (or purposes) and  determining their effectiveness. The tax credits reviewed in this report are  intended to encourage taxpayers to engage in particular activities, to  offset the effect of other taxes, and to provide assistance for certain  categories of taxpayers. The EITC, for example, has the purposes of  offsetting the payroll tax, encouraging employment among low-income  taxpayers and reducing poverty rates. Determining effectiveness can be  challenging due to the need to separate the effect of a tax credit from  other factors that can influence behavior. Even if the credit claimants  increase their subsidized activities, the credits are ineffective if they  merely provide windfall benefits to taxpayers who would have engaged in  the activities in the absence of the credit. Even when the credits are  determined to be effective, broader questions can still be asked about  whether they are good tax policy. As explained in our 2012 report, these  questions are addressed by applying criteria such as economic efficiency,  equity, and simplicity which have long been used to evaluate proposed  changes to the tax system. The criteria may sometimes conflict with one  another and some are subjective. As a result, there are often trade-offs  between the criteria when evaluating a particular tax credit.
Economic efficiency deals with how resources are allocated in the  economy to produce outcomes that are consistent with the greatest well- being (or standard of living) of society. Tax credits may affect the  allocation of resources by favoring certain activities. A credit’s effect on  efficiency depends on its effectiveness—whether people change their  behavior in response to the credit to do more or less of the activity as  intended—and its effect on resource allocation— whether the effect of the  credit increases the overall well-being of society. The tax credit can  increase efficiency when, for example, it is directed at addressing an  externality like spillovers from research where the researchers do not gain  the full benefit of their activities and might, without the credit, invest too  little in research from the point of view of society as a whole. Finally, a  tax credit may be justified as promoting a social good like improving  access to higher education for disadvantaged groups.
Equity deals with how fair the tax system is perceived to be by  participants in the system. There are a wide range of opinions regarding  what constitutes an equitable, or fair, tax system. However, there are  some principles—for example, a taxpayer’s ability to pay taxes—that  have gained acceptance as useful for thinking about the equity of the tax  system. The ability-to-pay principle requires that those who are more  capable of bearing the burden of taxes should pay more taxes than those  that are less capable.
Equity judgments based on the ability-to-pay principle can be separated  into two types. The first is horizontal equity where taxpayers who have  similar ability to pay taxes receive similar tax treatment. Tax credits affect  horizontal equity when, for example, they favor certain types of economic  behavior over others by taxpayers in similar financial conditions. Views of  a credit’s effect on horizontal equity usually depend on whether eligibility  requirements that exclude some filers and include others are viewed as  appropriate. The second type is vertical equity where taxpayers with  different abilities to pay are required to pay different amounts of tax. Tax  credits affect vertical equity through how their benefits are distributed  among people at different income levels (or other indicators of ability to  pay such as their level of consumption spending). Distribution tables,  where the tax benefits of the credits are grouped by the income level of  the recipients, are often used by policy analysts to help them make  informed judgments about the equity of tax policies like the RTCs. People  may have different notions about what is a fair distribution but they cannot  make a judgment about the fairness of a particular policy without  consulting the actual distribution of tax benefits.
Simplicity is a criterion used to evaluate tax systems because simple tax  systems tend to impose less compliance burden on the taxpayer and less  cost on tax administrators than more complex tax systems. Taxpayer  compliance burden is the value of the taxpayer’s own time and resources,  along with any out-of-pocket costs paid to tax preparers and other tax  advisors, invested to ensure their compliance with tax laws. Compliance  costs include the value of time and resources devoted to activities like  record keeping (for the purpose of tax compliance and not records that  would be kept in any case), learning about requirements and planning,  preparing and filing tax returns, and responding to IRS notices and audits.  The administrative costs include the resources used to process tax  returns, inform taxpayers about their obligations, detect noncompliance,  and enforce compliance with the provisions of the tax code. However,  while simplicity is linked to administrability, they are not always the same.  For example, a national sales tax may be relatively simple for taxpayer  compliance but difficult to administer as it requires distinguishing between  tax-exempt and taxable commodities and between taxable retail sales  and nontaxable sales among companies.
section_title: A Review of Changes Proposed for One or More of the Key Features of the Refundable Tax Credits
paragraphs: Changes to the RTCs can be analyzed using the above criteria where the  changes are grouped according to the key design elements of the credits  that are most affected by the changes. The key design elements are (1)  the degree to which the credit is refundable; (2) the eligibility rules for  filers and qualifying children or dependent students; (3) the structure of  the credit consisting of parameters that determine credit rates and phase- in and phase-out ranges; and (4) the credit’s interaction with other code  provisions. As mentioned above, changing these elements will have  effects that are common for all the credits. In the following review of  proposals, a description of the effect on revenue will be a provided where  possible but a dollar estimate of revenue costs cannot be provided  because it depends too much on variable details of proposals. For  example, increasing refundability would increase revenue costs but the  amount would depend, as explained below, on factors like the  refundability rate and income or spending threshold of refundability.
subsections: section_title: Changing Refundability Affects Access to the RTCs by Taxpayers with Lower Incomes and Judgments about Equity of the Credits
paragraphs: Refundability can affect judgments about vertical equity by providing a  larger share of the tax benefits to lower income filers than a  nonrefundable credit does. These filers are more likely to have little or no  tax liability and thus are not able to fully benefit from the nonrefundable  credit. Refundability, as such, may have little effect on judgments on  horizontal equity because these judgments depend chiefly on the  eligibility rules which need not be different from those under a  nonrefundable credit.
The effect of refundability on compliance and administrative costs  depends on how the change in refundability is implemented. If the  eligibility rules, a major source of complexity as described above, are not  changed when refundability is introduced, it may have less impact on  compliance burden and administrative costs. However, other structural  changes may be needed when refundability is introduced that can add  complexity and compliance burden for the taxpayer. For example,  additional calculations were made necessary for the CTC when the ACTC  was introduced as its partially refundable counterpart with a phase-in  range and rate. In addition, administrative burden could increase if the  population of claimants changes when refundability is introduced. IRS  costs could increase if IRS reviews more returns when the number of  claimants increases in response to refundability and taxpayer compliance  burden may increase if the claimants include more taxpayers for whom  understanding or documenting compliance is more difficult.
Changes have been proposed to expand refundability for the currently  partially refundable CTC/ACTC and AOTC. For the CTC/ACTC, the  refundable ACTC is limited to 15 percent of income in excess of the  $3,000 refundability threshold up to a maximum of $1,000 for each child  and for the AOTC the refund is limited to 40 percent of qualified spending  up to a maximum of $1,000. Modifications of these credits that have been  proposed include raising the refundability rate and reducing the  refundability threshold for the CTC/ACTC or in the case of the AOTC,  making the credit fully refundable. The principal effect of these  modifications is to increase the share of benefits going to low-income  filers by increasing their access to the credit. In the AOTC, the expansion  could also increase effectiveness as described in appendix III by  increasing access to the credits by low-income filers who are more  responsive to changes in the price of education. The effect on revenue of  these changes would vary considerably depending chiefly on the extent to  which refundability is increased.
section_title: Changes in Eligibility Rules Can Affect Judgments about the RTCs’ Equity and Effectiveness
paragraphs: Modifications to the RTCs’ eligibility rules affect the criteria of a good tax  system by changing taxpayers’ access to the credits. The change in  access in turn can affect judgments about equity and effectiveness. For  example, expanding the availability of the AOTC to part-time in addition to  half-time and full-time students could affect judgments about vertical  equity by increasing access for lower income filers if they are more  represented among part-time students. This proposal may also increase  the effectiveness of the AOTC by targeting more of the population that is  more responsive to education price changes, but, as described in  appendix III, these effects have not been tested.
Another change to eligibility rules that has been proposed for RTC filers  would require that SSNs be provided by all claimants of the AOTC and  the ACTC and that, in some cases, claimants’ qualifying children or  student dependents have SSNs. SSNs are currently required for all  EITC claimants and qualifying children but claimants of the other RTCs  can use individual taxpayer identification numbers (ITIN). IRS issues  ITINs to individuals who are required to have a taxpayer identification  number for tax purposes, but who are not eligible to obtain an SSN  because they are not authorized to work in the United States. In 2013,  4.38 million tax returns were filed with ITINs (about 3 percent of all  returns) which claimed $1.31 billion in CTC, $4.72 billion in ACTC, and $  204 million in AOTC, or 5 percent, 17 percent, and 1.1 percent of the total  credits claimed, respectively.
The effect of restrictions on access to the credits by ITIN users depends  on whether all filers claiming refundable tax credits and their qualifying  children or permit “mixed-use” households to obtain a partial credit. Most  households using ITINs are mixed-use households in the sense that they  use both ITINs and SSNs on their returns. In 2013, 2.68 million returns  (or 61 percent of all ITIN returns) were mixed-use returns having (1) a  parent with an ITIN and at least one child with an SSN or (2) a parent with  an SSN and at least one child with an ITIN. If the change requires that the  parent have an SSN, about 82 percent of current ITIN users will be  excluded. A change that permits RTCs for a child or parent with an SSN  would exclude 39 percent of current ITIN filers.
Restrictions on access to RTCs by ITIN users may affect judgments  about vertical equity of the credits. ITIN claimants of the CTC, ACTC, and  AOTC tend to have similar or lower levels of income than claimants who  do not use ITINs. As figure 9 shows, 31 percent of CTC claimants with  ITINs have incomes less than $40,000 while 17 percent of all CTC  claimants have incomes as low and 56 percent of AOTC claimants have  incomes less than $40,000 while 41 percent of all AOTC claimants have  incomes this low. On the other hand, the income levels of the ACTC  claimants with ITINs generally track those of all ACTC claimants: 87  percent of all ACTC claimants and 88 percent of ACTC claimants with  ITINs have incomes less than $40,000.
Restrictions on ITIN use may also have implications for compliance. From  2009 through 2011, credit claimants using ITINs had higher overclaim  error rates than other claimants. The overclaim error rate for CTC  claimants using ITINs was 14 percent as opposed to 6 percent for all CTC  claimants. Similarly, the CTC/ACTC error rate was 32 percent for ITIN  users and 10 percent for all claimants. As we discussed above,  complying with the eligibility rules can be challenging for everyone and  the ITIN users may have greater difficulty from factors like language  barriers which could contribute to these higher error rates.
The scope of the SSN requirement—whether it includes the taxpayer, the  spouse if married filing jointly, or the qualifying dependents—would add to  the complexity of administering and complying with the credits. For  example, the value of the credit could be apportioned among taxpayers  who meet the criteria (e.g., if three of the four individuals claimed on a tax  return have SSNs, the taxpayers would be eligible for 75 percent of the  total value of the credit). Determining and enforcing compliance with  these apportionment rules could be difficult. On the other hand, as noted  above, a majority of ITIN households are mixed use and in the absence of  an apportionment procedure, taxpayers with valid SSNs could be denied  access to the credits entirely. Lastly, the AOTC is likely to be less  effective to the extent that ITIN users are excluded because, as they have  lower incomes than other claimants, they are more likely to respond to an  effectively lower cost of education due to the credit by increasing  attendance.
section_title: Changes to the Structure of the RTCs Involve Trade-offs among Equity, Efficiency, and Revenue Cost
paragraphs: A change in the structure of the RTCs can affect all the criteria for  evaluating the credits as part of a good tax system. The credit structure  includes features that determine the rate at which the credit is calculated.  The phase-in range – the range of income levels over which the credit  amount is increasing; the plateau range – the range where the credit  amount is unchanged and reaches the maximum amount  and the phase- out range – where the credit amount is declining. The cut-off amount of  income determines the end of the phase-out range and maximum income  that can qualify for the credit. All the RTCs have phase-in and phase-out  ranges subject to different phase-in and phase-out rates and the EITC  also has different values for these ranges that vary according to the  number of qualifying children being claimed. The phase-in range  generally provides incentives for increasing the activity promoted by the  credit: as they work more, EITC recipients receive a larger credit amount  and, as they spend more on education, AOTC recipients also get a larger  credit. The phase-out ranges generally introduce disincentives by  reducing the credit benefit for any increase in the activity that the credit is  intended to promote.
One of the key trade-offs in this structure is between the size of the  maximum credit amount and the steepness of the phase-out range. If the  maximum credit amount is increased with no change in the qualifying  income cut-off amount, the phase-out range becomes steeper—the  phase-out rate increases—and therefore disincentives increase over the  phase-out range. In this case, the increase in the maximum credit  reduces efficiency in the phase-out range. On the other hand, if  disincentives are to be reduced without reducing the maximum credit, the  qualifying income cut-off amount must be increased in order to flatten the  phase-out range and thereby lower the phase-out rate. However, by  increasing the cut-off income amount, the credit becomes available to  people with higher incomes, affecting judgments about the equity of the  credit and increasing its revenue cost.
Structural modifications proposed for the EITC include expanding the  credit for childless workers. As described in appendix III, the EITC for  childless workers is much lower than the credit for workers with children  and has not been shown to have an effect on workforce participation or  raising these workers out of poverty. Expanding the credit for childless  workers generally means increasing the maximum credit with the follow- on effects described above on other parameters like the phase-out rate.  The effect on efficiency, equity, and simplicity will depend upon which  parameters are changed and will have similar trade-offs.
Although the relative effects of expanding the credit for childless workers  will depend on details of the parameter changes, the overall effect is likely  to increase the effectiveness of the credit. Increasing the credit for  childless workers would increase work incentives for individuals for  whom, as described in appendix III, the current EITC is ineffective  because it provides little or no work incentive. The expansion of the credit  for childless workers could also affect judgments about equity of the EITC  by decreasing the percentage of taxpayers living in poverty and by  changing how benefits are distributed by income level.  The expansion  would also affect judgments about horizontal equity concerns arising from  the current large disparity in the credit available to filers with and without  children. In addition, expanding the EITC for childless workers is unlikely  to add complexity to the filing process for taxpayers, although it would  increase the number of taxpayers claiming the credit. A major source of  complexity for the EITC that increases both compliance and  administration burden is determining whether a dependent meets the  requirements for a qualifying child. These determinations would not be  necessary for the childless worker. However, again depending on  specifics of proposals like the size of the maximum credit, the revenue  cost could be high.
Proposed structural changes for the AOTC can impact its effectiveness  by increasing or decreasing access to the credit. Modifications that  expand access include increasing the maximum credit, raising the upper  limit on income for credit claimants and lowering the phase-out rate.  Changes like these may also reduce effectiveness because the credit is  now more available to taxpayers for whom it is likely to be a windfall while  less of the increase is available to lower income people who are more  responsive to education price changes. These changes may also affect  judgments about equity because the increase in the phase-out range  would increase the share of the credit going to higher income taxpayers.  However, the increase in the maximum credit benefits the lower income  filers as well as those with higher income. Modifications that reduce  access include reducing the maximum credit and phase-out income and  increasing the phase-out rate. Modifications like these may concentrate  the AOTC’s benefit on lower income individuals and could increase  effectiveness by reducing the windfall going to higher income taxpayers.
Changes to the CTC/ACTC illustrate how structural changes interact to  affect the criteria for evaluating the credit. For example, a modification  that increases the credit per child and increases the income limit may  have offsetting effects on judgments about equity by reducing the share  of benefits going to low-income taxpayers but at the same time increasing  the credit amount per child. However, raising the amount of the credit  may not benefit lower income taxpayers to the extent that the refundability  threshold and rate prevent them from accessing the full credit. Further  adjustments such as eliminating the current refundability threshold of  $3,000 and making the credit refundable up to $1,000 at a refundability  rate of 25 percent may provide more benefits to lower income taxpayers.  However, the more adjustments are made the harder it is to determine  the net effect on equity.
section_title: Changes That Address Interactions of the RTCs with Other Programs Attempt to Improve Effectiveness by Increasing Transparency
paragraphs: The RTCs share purposes and target populations with a variety of  government spending programs and other provisions of the tax code. We  previously estimated that, in 2012, 106 million people, or one-third of the  U.S. population, received benefits from at least one or more of eight  selected federal low-income programs: the ACTC, the EITC, SNAP, SSI,  and four others. Almost two-thirds of the eight programs’ recipients were  in households with children, including many married families. Without  these programs’ benefits, we estimated that 25 million of these recipients  would have been below the Census Bureau’s Supplemental Poverty  Measure (SPM) poverty threshold. Of the eight programs, the EITC and  SNAP moved the most people out of poverty. In addition, the AOTC  interacts with other spending provisions like Pell grants and tax provisions  like the Lifetime Learning Credit and the deduction for tuition and fees to  provide subsidies for college attendance.
This shared focus of certain tax benefits has led to consideration of their  combined effect on incentives and complexity.  As figure 10 shows, the  combined effects of the EITC, CTC/ACTC, and the dependent exemption  produce a steeper phase-in of total benefit amounts than that attributable  to any of the tax benefits alone. As incomes increase, total benefits peak  and then decline sharply when the phase-out range of the EITC is  reached. How taxpayers respond to the RTCs will depend on the  taxpayer’s ability to sort out and assess the combined effects of all these  tax benefits. Each RTC was the product of unique social forces and was  designed to address a specific social need. As a result, it is unlikely that  attempts were made to coordinate and focus on the combined tax rates,  combined subsidy rate and combined incentive effects and effects on  compliance and administration. The lack of coordination that leads to  increased administrative and compliance burden is exemplified in the  differing age limits of what constitutes an eligible child for different tax  benefits.
Interactions like these have raised concerns that the RTCs and other  provisions may not be coordinated to be most effective. To increase  coordination and transparency, a number of different ways have been  proposed to consolidate the tax benefits. Proposals include combining tax  benefits for low income taxpayers (such as CTC/ACTC, dependent  exemption and child related EITC ) into a single credit or combining  child  related benefits into a single credit while creating a separate work credit  based on earnings and unrelated to the number of children in the family.  In a similar vein, proposals have been made to combine education tax  benefits by using the AOTC to replace all other education tax credits, the  student loan interest deduction and the deduction for tuition and fees.  These proposals may also expand certain features of the credit like  increasing refundability or making the credit available for more years of  post-secondary education. Consolidation can make incentives more  transparent to taxpayers and increase simplicity and decrease  compliance and administrative burden to the extent it includes  harmonizing and simplifying the eligibility requirements.
section_title: Conclusions
paragraphs: Each year the EITC, ACTC, and AOTC help millions of taxpayers—many  of whom are low-income—who are working, raising children, and paying  tuition. Nonetheless, challenges related to the RTCs’ design and  administration contribute to errors, improper payments, and taxpayer  burden.
Annual budget cuts have forced IRS officials to make difficult decisions  about how best to target declining resources to ensure they can still meet  agency-wide strategic goals of increasing taxpayer compliance, using  resources more efficiently, and minimizing taxpayer burden. In light of  these budget cuts, it is essential that IRS take a strategic approach to  identifying and addressing RTC noncompliance in an uncertain budget  environment. IRS is working on a strategy to document current EITC  compliance efforts and identify and evaluate potential new solutions to  address improper payments, but this review does not include the other  refundable credits. A more comprehensive approach could help IRS  determine whether its current allocation of resources is optimal, and if not,  what adjustments are needed.
IRS is also missing opportunities to use available data to identify potential  sources of noncompliance and develop strategies for addressing them.  For example, IRS does not track the number of returns erroneously  claiming the ACTC and AOTC identified through screening activities. This  information would help IRS deepen its understanding of common errors  made by taxpayers claiming these credits; IRS could then use these  insights to develop strategies to educate taxpayers. IRS has also not yet  evaluated the Department of Education’s PEPS database of eligible  educational institutions; these data could help IRS identify potentially  erroneous AOTC returns.
Finally, although IRS reviews the amount of revenue collected from EITC  post-refund enforcement activities, it could not verify the reliability of that  data during the timeframe of the GAO audit.  By not taking necessary  steps to ensure the reliability of that data and linking them to tax  assessments to calculate a collections rate,   IRS lacks information  required to assess its allocation decisions. Periodic reviews of collections  data and analyses could help IRS officials more efficiently allocate limited  enforcement resources by providing a more complete picture about  compliance results and costs.
Over the years we have recommended various actions IRS and Congress  could take to reduce the tax gap; several of these would also help bolster  IRS’s efforts to address noncompliance with these credits. For example,  developing a better understanding of sole proprietor noncompliance and  linking sole proprietor compliance efforts with broader tax gap reduction  could help IRS to identify noncompliant sole proprietor issues and  address one of the drivers of EITC noncompliance. Providing IRS with the  authority to regulate paid preparers would also help. In addition, as we  recommended in 2011, we continue to believe that Congress should  consider providing IRS with math error authority to use tax return  information from previous years to enforce lifetime limit rules. Any  refundable tax credits that contain these limits such as the AOTC should  fall under this authority as well if it is granted by Congress. Structural  changes to the credits, such as changes to eligibility rules, will involve  trade-offs with respect to standard tax reform criteria, such as  effectiveness, efficiency, equity, simplicity, and revenue adequacy.
section_title: Recommendations for Executive Action
paragraphs: To strengthen efforts to identify and address noncompliance with the  EITC, ACTC, and AOTC, we recommend that the Commissioner of  Internal Revenue direct Refundable Credits Policy and Program  Management (RCPPM) to take the following steps:  1.  Building on current efforts, develop a comprehensive operational  strategy that includes all the RTCs for which RCPPM is responsible.  The strategy could include use of error rates and amounts, evaluation  and guidance on the proper use of indicators like no-change and  default rates, and guidance on how to weigh trade-offs between equity  and return on investment in resource allocations.  2.  As RCPPM begins efforts to track the number of erroneous returns  claiming the ACTC or AOTC identified through pre-refund  enforcement activities, such as screening filters and use of math error  authority, it should develop and implement a plan to collect and  analyze these data that includes such characteristics as identifying  timing goals, resource requirements, and the appropriate  methodologies for analyzing and applying the data to compliance  issues.  3.  Assess whether the data received from the Department of Education’s  PEPS database (a) are sufficiently complete and accurate to reliably  correct tax returns at filing and (b) provide additional information that  could be used to identify returns for examination; if warranted by this  research, IRS should use this information to seek legislative authority  to correct tax returns at filing based on PEPS data.  4.  Take necessary steps to ensure the reliability of collections data and  periodically review that data to (a) compute a collections rate for post- refund enforcement activities and (b) determine what additional  analyses would provide useful information about compliance results  and costs of post-refund audits and document-matching reviews.
section_title: Agency Comments and our Evaluation
paragraphs: We provided a draft of this report to Treasury and IRS. Treasury provided  technical comments which we incorporated where appropriate. In written  comments, reproduced in appendix IV, IRS agreed with three of our four  recommendations and described certain actions that it plans or is  undertaking to implement them.
After sending us written comments, IRS informed us it could not verify the  reliability of the collections data it provided during the timeframe of our  audit. We removed this data from the report and modified our fourth  recommendation to address data reliability.  The revised recommendation  states that IRS should take necessary steps to ensure the reliability of  collections data and then periodically review that data to compute a  collections rate for post-refund enforcement activities and determine what  additional analyses would provide useful information.
In response to this recommendation, IRS stated it is taking steps to verify  the reliability of the collections data, but further analysis would not be  beneficial because the majority of RTC audits are pre-refund.  However,  we found that a significant amount of enforcement activity is occurring in  the post-refund environment. According to IRS data, IRS conducted  87,000 EITC post-refund audits and over 1 million document-matching  reviews in 2014.
We recognize that gathering collections data has costs and the data have  limitations, notably that not all recommended taxes are collected.  However, use of these data— once IRS is able to verify its reliability –  could better inform resource allocation decisions and improve the overall  efficiency of enforcement efforts. In fact, the Internal Revenue Manual  states that examiners are expected to consider collectability as a factor in  determining the scope and depth of an examination. IRS also stated that  previous studies have indicated that post-refund audits of RTCs have a  high collectability rate. However, the studies that IRS provided did not  include collection rates for the EITC, ACTC, or AOTC.  IRS further  cautioned that collections can be influenced by factors like the state of the  economy; however an appropriate statistical methodology would take  such factors into account.  Finally, opportunities may exist to reduce the  costs of data collection efforts, for example, if coordinated as part of an  agency wide analysis of the costs and results of various enforcement  efforts.
IRS disagreed with our conclusion that its compliance strategy and  selection criteria for its prefund compliance program do not consider  equity and compliance burden. In its comments, IRS describes its audit  selection process but did not explain how it measures equity or  compliance burden. Without such measures, it is not possible to assess  whether IRS is achieving its strategic goals of increasing taxpayer  compliance, using resources more efficiently, and minimizing taxpayer  burden. Finally, IRS stated that nonresponse to its taxpayer enquiries is a  strong indicator of noncompliance but did not provide data to support this  assumption.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the Secretary of the  Treasury, Commissioner of Internal Revenue, and other interested  parties. In addition, the report will be available at no charge on the GAO  website at http://www.gao.gov.
If you or your staff has any questions about this report, please contact me  at (202) 512-9110 or mctiguej@gao.gov. Contact points for our offices of  Congressional Relations and Public Affairs are on the last page of this  report. GAO staff members who made major contributions to this report  are listed in appendix V.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: This report (1) describes the claimant population including the number of  taxpayers and the amount they claim along with other selected  characteristics for the Earned Income Tax Credit (EITC), Additional Child  Tax Credit (ACTC), and American Opportunity Tax Credit ( AOTC); (2)  describes how the Internal Revenue Service (IRS) administers these  credits and what is known about the administrative costs and compliance  burden associated with each credit; (3) assesses the extent to which IRS  identifies and addresses noncompliance with these credits and collects  improperly refunded credits; and (4) assesses the impact of selected  proposed changes to elements of the EITC, ACTC, and AOTC with  respect to three criteria for a good tax system: efficiency, equity, and  simplicity.
To describe the taxpayer population claiming the EITC, ACTC, and  AOTC, we used the IRS Statistics of Income (SOI) Individual Study for tax  years 1999 to 2013. The SOI Individual Study is intended to represent all  tax returns filed through annual samples of unaudited individual tax  returns (about 330,000 returns in 2013), which are selected using a  stratified, random sample.
IRS performs a number of quality control steps to verify the internal  consistency of SOI sample data. For example, it performs computerized  tests to verify the relationships between values on the returns selected as  part of the SOI sample and edits data items to correct for problems, such  as missing items. The SOI data are widely used for research purposes  and include information on returns prior to changes due to IRS audits. We  used SOI data to describe the number of returns claiming credits, the  credit amounts, and characteristics about credit claimants, such as filing  status or adjusted gross income (AGI) for each credit.
When necessary, we combined the nonrefundable Child Tax Credit (CTC)  with the ACTC, referring to the combined credit as the CTC/ACTC. We  did this when their combined effect is at issue or to facilitate comparison  with other RTCs that do not break out refundable and nonrefundable  components. Similarly we combined the refundable and nonrefundable  portions for AOTC estimates. However, unlike the other credit amounts,  SOI data do not report the nonrefundable AOTC amounts. Estimating the  level of nonrefundable AOTC requires decomposing the nonrefundable  education credits into AOTC and other nonrefundable education credit  amounts using education expenses amounts and other line items  reported on the tax return that determine the taxpayer’s eligibility for  claiming the credit. These computations are done by tax return prior to  producing the aggregate total AOTC estimates.
We reviewed documentation on SOI data, interviewed IRS officials about  the data, and conducted several reliability tests to ensure that the data  excerpts we used for this report were sufficiently complete and accurate  for our purposes. For example, we electronically tested the data for  obvious errors and used published data as a comparison to ensure that  the data set was complete. The SOI estimates of totals and averages in  the report, excluding ITIN estimates, have a margin of error of less than  3.5 percent of the estimates unless otherwise noted. The SOI  percentages, excluding ITIN percentages, have a margin of error of less  than 1 percentage points unless otherwise noted. Totals based on ITIN  returns have a margin of error less than 18 percentage points unless  otherwise noted. Percentages and ratios based on ITIN filers have a  margin of error of less than 8 percentage points unless otherwise noted.  We concluded that the data were sufficiently reliable for the purposes of  this report.
To describe how IRS administers these credits, we reviewed  documentation on program procedures from the Internal Revenue Manual  (IRM), internal documents describing audit procedures, and  memorandums from IRS officials. We also interviewed IRS officials who  oversee or who work on administering the refundable tax credits. To  describe what is known about the administrative costs, we reviewed  information IRS provided us on processing returns and conducting audits.  To supplement these cost data, we spoke with IRS and Treasury officials  about challenges IRS faces in administering the credits. To describe the  compliance burden associated with each credit, we collected and  reviewed IRS forms, worksheets, and instructions for each credit. We also  reviewed the National Taxpayer Advocate’s annual reports to Congress,  including the most serious issues affecting taxpayers. Finally, we  interviewed experts involved with tax preparation to determine challenges  taxpayers face when claiming the credits.
To assess the extent to which IRS identifies and addresses  noncompliance with these credits and collects improperly refunded  credits, we reviewed reports by GAO, IRS, the Treasury Inspector  General for Tax Administration (TIGTA) National Taxpayer Advocate  (NTA), Congressional Research Service (CRS), and Congressional  Budget Office (CBO) on challenges IRS faces to reduce EITC, ACTC,  and AOTC noncompliance and steps IRS is taking to address those  challenges. We also reviewed relevant strategic and performance  documents such as annual financial and performance reports; education  and outreach plans; annual planning meeting minutes; and project  summary reports. We met on a regular basis throughout the engagement  with IRS officials responsible for developing and implementing RTC policy  to determine the scope and primary drivers of RTC noncompliance as  well as the steps IRS is taking to address those challenges. We  integrated information from our document review and interviews to  describe and asses IRS compliance efforts—including steps IRS is taking  to implement specific programs and projects, how IRS’s internal controls  ensure that specific efforts are being pursued as intended, how IRS  monitors and assesses the progress of specific efforts toward reducing  noncompliance, and how IRS incorporates new data to adjust its strategy  as needed. We compared IRS efforts to develop, implement, and monitor  compliance efforts to criteria in Standards for Internal Control in the  Federal Government and federal guidance on performance  management. We also applied the criteria concerning the administration,  compliance burden, and transparency that characterize a good tax  system, as developed in our guide for evaluating tax reform proposals.
To evaluate compliance within the refundable credits, we used audit data  from the National Research Program (NRP) for tax years 2009 to 2011,  the most recent years for which data were available. NRP audits are like  other IRS audits, but they can be used for population estimates of  taxpayer reporting compliance. The goal of the NRP is to provide data to  measure payment, filing, and reporting compliance of taxpayers, which  are used to inform estimates of the tax gap and provide information to  support development of IRS strategic plans and improvements in  workload identification. The NRP audits provide a reflection of the  domestic taxpayer populations through an annual sample of returns  (about 14,000 returns in 2011), which are selected for NRP audits using a  stratified, random sample.
One potential source of nonsampling error comes from NRP audits where  the taxpayer does not respond to the NRP audit, so audit results may not  reflect the taxpayer’s true eligibility for the RTCs. For the calculations in  this report, audit observations within the data that correspond to  nonrespondent filers are given observation weights of zero (i.e., the  observations do not influence the calculations). In contrast, IRS’s  compliance study of the EITC produced high and low estimates for  overclaim rates, where the former assumes the nonrespondents to be  generally noncompliant and the latter assumes the nonrespondents to be  as compliant as the respondent observations.
Data for analysis include amounts reported by taxpayers on their tax  returns and corrected amounts that were determined by examiners. Using  NRP data, we estimated the errors and mistakes individual taxpayers  made claiming the EITC, ACTC, and AOTC on their Forms 1040, U.S.  Individual Income Tax Return. We present the results as a percent of the  credit amounts claimed.
We reviewed documentation on the NRP, interviewed IRS officials about  the data, and conducted several reliability tests to ensure that the data  excerpts we used for this report were sufficiently complete and accurate  for our purposes. For example, we electronically tested the data for  obvious errors and used totals from our analysis of SOI data as a  comparison to ensure that the data set was complete. We concluded that  the data were sufficiently reliable for the purposes of this report. See  appendix II for further discussion of our NRP estimation techniques and  for information about the sampling errors of our estimates.
To assess the impact of selected proposed changes to elements of the  EITC, ACTC, and AOTC, we first identified proposals to improve the three  refundable tax credits through a literature review on RTCs. Our literature  search started with a review of studies and reports issued by government  agencies including GAO, IRS, CRS, CBO, JCT, and TIGTA. We  supplemented this search with academic literature and studies produced  by think tanks and professional organizations. Additionally, we inquired of  agency officials and subject-matter experts for relevant studies.
We then interviewed external subject-matter experts from government,  academia, think tanks, and professional organizations knowledgeable  about refundable tax credits in general and specifically the EITC, ACTC,  and AOTC. We spoke to those with expertise on how IRS administers  RTCs, how low-income taxpayers claim the credits, and how tax  preparers interact with the credits. We conducted interviews to obtain  views of experts on criteria commonly used to evaluate refundable tax  credits and possible modifications to the credit. The experts were from  across the ideological spectrum. The views from these interviews are not  generalizable. Based on these interviews and our review of studies, we  drew conclusions about the likely impact of modifying elements of the  RTC with respect to three criteria we identified for a good tax system:  efficiency, equity, and simplicity.
We conducted this performance audit from July 2015 to May 2016 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: National Research Program Error Rate Methodology and Estimates with Sampling Errors
subsections: section_title: National Research Program Error Rate Calculation Methodology
paragraphs: Error rates by credit are computed using National Research Program  (NRP) data. The Child Tax Credit (CTC) is combined with the Additional  Child Tax Credit (ACTC) and shown as an aggregated credit amount for  the CTC/ACTC. The American Opportunity Tax Credit (AOTC) includes  refundable and nonrefundable portions, where the refundable portion of  the credit benefits the taxpayer regardless of the tax liability.
The AOTC estimates combine refundable and nonrefundable portions.  The nonrefundable portion of the AOTC is estimated as the proportion of  total nonrefundable education credits that is from claiming the AOTC.  Eligibility for claiming the different education credits can vary by adjusted  gross income (AGI), filing status, and the year the return was filed.  Statistics of Income (SOI) data were used to estimate these proportions  of AOTC to total nonrefundable education credits. These proportions  were multiplied by NRP total nonrefundable credits values for each tax  return, which estimates the nonrefundable portion of AOTC for that tax  return. Measurement errors for AOTC estimates shown in tables 4  through 8 reflect sampling errors from NRP data only and do not reflect  sampling errors from SOI data, which was used to estimate the proportion  of nonrefundable AOTC claimed from nonrefundable education credits  within NRP data.
The credit adjustment or error is the difference between the credit amount  originally claimed by the taxpayer and the correct credit amount, as  determined by the NRP audit. The net credit adjustments can be  separated into audited returns that received negative and positive  adjustments. Negative adjustments, or credit overclaims, occur when the  taxpayer claimed the credit, but either did not qualify for the credit or the  credit amount originally claimed was adjusted downward. Credit  overclaim amounts represent a potential for revenue loss to the  government, where taxpayers incorrectly claim a tax benefit. Similarly,  positive adjustments, or credit underclaims, occur when the taxpayer  either failed to claim the credit or the credit amount originally claimed was  adjusted upward. Credit underclaim amounts represent a potential  expense for the government, where taxpayers forego available tax  benefits. Using NRP data (2009 to 2011), the annual average credit and  credit adjustment amounts are shown in table 4.
The error rates are computed as the credit adjustment amount divided by  the net credit amount claimed by the taxpayers prior to the NRP audit,  where the credit adjustment may represent all returns claiming,  overclaiming, or underclaiming the credit. These error rates for all credit  claimants are computed for 2011 and 2009 to 2011, as shown in table 5.  The precision of these estimates generally increases when using 3 years  instead of a single year of data. The numbers of overclaim and  underclaim returns as a percent of all returns claiming the credits are  shown in table 6. The overclaim error rates are computed for Schedule C  and non-Schedule C returns and for returns based on the preparer of the  return, as shown in tables 7 and 8.
section_title: Appendix III: Research Findings on the Current Refundable Tax Credits
paragraphs: The following is a summary of the findings in the policy literature of the  effect of the current design of the Earned Income Tax Credit (EITC), the  Additional Child Tax Credit (ACTC), and the American Opportunity Tax  Credit (AOTC) on the effectiveness, efficiency, equity, and simplicity of  these credits. This description can be viewed as a baseline against which  to compare specific proposals that are advanced to improve the credits.  For example, a proposal to change the EITC would be evaluated, at least  in part, on its effect on poverty rates judged against the poverty reduction  under the current EITC structure.
subsections: section_title: Research Has Shown That the EITC Has Increased Employment and Reduced Poverty but Is Complex to Comply with and Administer
paragraphs: The EITC provides financial assistance to a relatively large proportion of  its target population of low-income taxpayers. As mentioned earlier in this  report, the EITC was claimed by about 29 million people in 2013 for an  average amount of about $2,300.These claimants represent over 85  percent of the eligible population – a large participation rate for a  government ant-poverty program.  For example, the participation rate for  TANF recipients is estimated at about 34 percent and 67 percent for SSI  recipients in 2011 and the rate for SNAP was 83 percent in 2012.
One purpose of the EITC is to increase employment among low-income  taxpayers by providing incentives for claimants to become employed or to  increase the hours they work if they are already employed. The empirical  evidence shows that the EITC has had a strong effect on labor force  participation for certain claimants but much less, if any, effect on hours  worked. The EITC has led more single mothers to enter the workforce.   However, the effect on labor force participation for secondary workers (for  example, a spouse of someone already in the labor force) is inconclusive  with studies showing no effect or a small reduction in labor force  participation. In addition, studies have shown that the EITC has little or no  effect on hours worked by credit claimants already in the labor force.
The EITC affects efficiency directly because it changes the behavior of  workers that claim it and indirectly because it is funded through the tax  system where tax rate differences can also change taxpayer behavior.  However, the size of these effects, if any, has not been measured. As  described in our 2012 report, a full evaluation of the EITC or any tax  expenditure would require information on the total benefits of the credit as  well as its costs, including efficiency costs.
When examining the impact the EITC has on fairness or equity, research  has tended to focus on how the credit affects poverty rates and tax  burdens among different groups of recipients. The EITC has also been  shown to be effective in reducing the percentage of low-income working  people living in poverty. Nearly all studies that we reviewed show that the  EITC has had a substantial effect on reducing poverty on average among  all recipients and particularly those with children. For example, the U.S.  Census Bureau found that in 2012 the refundable tax credits reduced the  poverty rate by 3 percentage points for all claimants and by 6.7  percentage points for claimants with children. However, studies show a  much smaller effect on poverty for childless workers. A Congressional  Research Service analysis found that in 2012 the EITC reduced  unmarried and married childless workers’ poverty rates by 0.14  percentage points and 1.39 percentage points respectively. These  differences in the effect on poverty rates are not unexpected given the  much smaller credit amounts available for childless workers.
The effect of the EITC on vertical equity can be judged based, at least in  part, on the distribution of the credit’s benefits by income level. As figure 4  earlier in this report shows, EITC claimants have lower incomes than the  population of claimants for the other refundable tax credits. As Figure 4  also shows, a greater share of EITC benefits goes to lower-income  taxpayers.  More than half (62 percent) of the EITC benefits go to  taxpayers making less than $20,000.
The EITC’s effect on horizontal equity depends on whether its eligibility  rules and the credit rates that apply to different types of taxpayers are  viewed as appropriate. For example, the current credit has very different  rates for taxpayers with and without children (for 2016, a maximum of  $503 for childless workers vs. a maximum of $6,242 for families of three  or more children). The result is that the EITC benefits mostly families with  children and provides very little benefit to childless workers. This  difference in credit amounts may reflect, in part, judgements about  horizontal equity because larger families may be viewed as having  greater costs to achieve the same standard of living than smaller families.  However, some studies have shown that differences in EITC benefits may  overstate the difference in costs between childless and other families. For  example, one study estimated the credit’s benefits in terms of the  reduction in effective tax rates and found that benefits were considerably  larger for households with children compared to those without even after  family incomes were adjusted to account for family size. When the study  compared families with incomes equivalent to $10,000, it found that  effective tax rates range from -1.47 percent for a married couple with no  children to -39.21 percent for a head-of-household return with two  children, a difference of more than a third of income  Concerns have been raised that the credit may provide unintended  incentives that discourage people from marrying to avoid a reduction in  their EITC (the “marriage penalty”). The marriage penalty occurs when  married EITC recipients receive a smaller EITC as married couples than  their combined EITCs as single tax filers. The EITC can create marriage  penalties for low-income working couples who qualify for the EITC if,  when they marry, the combined household income rises into the EITC  phase-out range or beyond, reducing or completely eliminating the  credit. However, while limited, the research on this issue indicates that  the EITC’s effects on marriage patterns are small and ambiguous. In  addition, a marriage bonus is also possible when two very low-income  people marry and their earnings increase but not enough to put them into  the phase-out range of the credit.
The EITC is a complicated tax provision that is difficult for taxpayers to  comply with and IRS to administer. As explained earlier in this report, the  difficulties arise from the EITC’s complex rules and formulas. In particular,  as described above, the rules that determine whether a child qualifies the  taxpayer to claim the credit are a major source of most of the taxpayer  compliance burden. However, the participation rate for eligible taxpayers  is relatively high when compared to other antipoverty programs and  administrative and compliance costs are likely to be lower for the EITC.
section_title: The CTC/ACTC Provides Financial Assistance to Families with Children but It Is Complicated to Comply with and Administer
paragraphs: The CTC was created in 1997 as a nonrefundable tax credit for most  families to help ease the financial burden that families incur when they  have children. Since then, the amount of the credit per child has  increased and the current ACTC was introduced to make the CTC credit  partially refundable for more families. The current structure of the  CTC/ACTC also subsidizes the costs of rearing children by the $1,000  per child credit and employment by the ACTC’s phase-in income range  which increases the amount of credit as the taxpayer’s earned income  increases.
The CTC/ACTC provides financial assistance to a relatively large number  of people in its target population of families with children. According to our  analysis of IRS data, the CTC/ACTC was claimed on about 36 million  returns in 2013 for an average amount claimed of $1,537. The credit  supplies up to $1,000 per child in assistance which may be a significant  amount for lower income taxpayers but becomes a decreasing  percentage of income as income increases toward the phase-out  threshold of $110,000 for taxpayers who are married and filing jointly.
There is currently little research evaluating the impact of the CTC/ACTC  on how taxpayers respond to the wage incentives. The ACTC encourages  work by providing a wage subsidy of 15 cents for every dollar of earnings  above $3,000 until the credit maximum of $1,000 per child is reached.  Because both the ACTC and EITC subsidize earnings over the same  income range, researchers find it difficult to isolate the ACTC’s effects on  employment from the similarly structured but larger subsidy provided by  the EITC In the absence of any evidence concerning the effectiveness of  the credits, no conclusions can be drawn about its effect on efficiency.
The conversion of the CTC into the broader partially refundable  CTC/ACTC may affect judgments about vertical equity by changing the  income distribution of tax credit benefits from what it would be under the  CTC alone. The ACTC concentrates more of the benefits of the  CTC/ACTC among lower income households. Because the ACTC is  refundable and the refundability threshold has been reduced to $3,000,  more lower income filers with no or very low tax liability can qualify for the  ACTC than qualify for the CTC. As figure 11 shows, the ACTC  significantly increases the availability of the tax benefit for lower income  taxpayers with children.
However, according to our analysis of IRS data, the combined  CTC/ACTC does not provide as great a share of benefits to lower income  taxpayers as the EITC. About 22 percent of the CTC/ACTC is claimed by  taxpayers with less than $20,000 in income whereas 62 percent of EITC  is claimed by taxpayers in this income range. The difference may be due  in part to differences in the phase-in rates and ranges. The ACTC phases  in at 15 percent beginning when earnings exceed $3,000 while the EITC  has no phase-in threshold and can have a phase-in rate as high as 45  percent depending on the number of children. The EITC benefits are  more front-loaded for lower income taxpayers than the CTC/ACTC  benefits.
Views differ on the effect of the CTC/ACTC on horizontal equity.  Some  argue that these families should get this tax relief because the additional  children reduce their ability to pay relative to families or individuals  without children. Others, however, regard children as a choice that  parents make about how they use their resources and horizontal equity  requires that people with the same income pay similar taxes. Their view is  that parents have children because they get satisfaction from this choice  and that subsidies are no more warranted for this choice (on an ability to  pay basis) than any other purchase the parents make. This disagreement  highlights that, although the credit may promote a social good by  providing assistance to families with children, the equity of this approach  is still a matter of judgment.
The CTC/ACTC shares the complexity of the EITC and other tax  provisions directed toward children and families which derives  from the  rules for determining whether a child qualifies for the tax benefit. Like the  EITC, the CTC/ACTC has relationship, age, and residency requirements  that contribute to complexity. Applying the rules can be complicated  because the CTC/ACTC rules may be similar but not always the same as  the EITC. For example, the EITC requires that qualifying children be  under 19 years old (or under 24 and in school) and the CTC/ACTC  requires that the qualifying children be under 17 years old. To further  complicate matters, the CTC/ACTC adds a support test to the age  residency and relationship requirements. Furthermore, these family  centered provisions are currently structured very differently and the  amount of the tax benefits change with changing circumstances. The  benefits can change when the parent marries, has an additional child or  the child gets older, or their income changes.
section_title: The AOTC Provides Assistance for Educational Expenses but Its Effect On College Attendance Is Unknown and It Is Complicated to Comply with and Administer
paragraphs: The AOTC provides financial assistance to students from middle-income  families (like its predecessor the Hope credit) who may not benefit from  other forms of traditional student aid, like Pell Grants. But the AOTC,  through its refundability provisions, also expands financial assistance to  students from lower income families. Under the AOTC, claimants can  receive up to $2,500 per student in credits for qualifying education  expenses with up to $1,000 of the credit being refundable. The AOTC  was claimed on about 10 million returns in 2013. The Protecting  Americans from Tax Hikes Act of 2015 made the AOTC a permanent  feature of the tax code, replacing the nonrefundable Hope credit.
The effectiveness of the AOTC in getting financial assistance to its target  population depends in part on the incidence of the credit. The AOTC’s  benefits may be shifted to the educational institutions if the colleges and  universities respond to the availability of the AOTC by increasing their  tuition. We identified no current research on this institutional response to  the AOTC but there is evidence that institutions have not raised tuition in  response to the Hope and Lifetime Learning Credits. However, recent  research indicates that colleges may react by reducing other forms of  financial aid provided by the colleges so that the credit claimants receive  no net benefit from the credits. In contrast to the other education credits,  the AOTC may also affect tuition if its refundability makes it more  available to lower income claimants. If these students attend schools like  community colleges with more scope to raise tuitions because their tuition  is initially relatively low, they may face increased tuition and a reduced  effective value of their AOTC. In this case, if tuitions rise, the cost of  college for students ineligible for the AOTC would go up.
To the extent that the AOTC reduces the after-tax cost of education, it  provides a benefit that may influence decisions about college attendance.  A goal of education tax benefits like the Hope Credit has been to increase  college attendance and the AOTC shares some of the education cost  reducing features of this credit that could increase attendance. Research  on education credits has not focused on the AOTC because, due to its  relatively recent enactment, data are less available for the AOTC than  other education credits like the Hope and Lifetime Learning Credits.  Studies have shown some but not a large impact on college attendance  due to these credits and other education tax incentives. For example, a  study found that tax-based aid increases full-time enrollment in the first 2  years of college for 18 to 19 years old by 7 percent and that the price  sensitivity of enrollment suggests that college enrollment increases 0.3  percentage points per $100 of tax-based aid. The AOTC shares features  with other education credits related to the timing of the credit that may  limit its effectiveness in promoting college attendance. The AOTC may be  received months after education expenses are incurred, making it less  useful for families with limited resources to pay education expenses.  However, the refundability of the AOTC has made it more accessible to  lower income households where it may have a greater impact on college  attendance than the Hope Credit. Research indicates that students from  lower income households are more sensitive to changes in the price of a  college education than higher income households when deciding whether  to attend college.
If the AOTC can be shown to influence attendance decisions it may also  affect efficiency by increasing an activity with a positive externality.  Education would have a positive externality if the benefit to society of  increased productivity and innovation that is due to a more educated  populace is greater than the benefit to the individuals who make the  college attendance decision and consider only their private benefit. When  this is the case, the result may be under-investment in education from a  social perspective. By lowering costs, the credit may increase the private  return to investment in education, bringing it closer to the social return.
The conversion of the Hope Credit into the partially refundable AOTC  may affect judgments about vertical equity by changing the income  distribution of tax credit benefits. The refundability of the AOTC has  increased the share of the credit’s benefits received by lower income  filers when compared to its predecessor, the Hope Credit. According to  our analysis of IRS data, about 20 percent of the AOTC in 2013 was  claimed by filers making less than $20,000 per year. In the case of the  Hope Credit in 2008 (the last year this credit was in effect) only about 6.8  percent of the credit was claimed by taxpayers earning less than $20,000  per year. As mentioned above, this shift to lower income taxpayers also  has the potential to make the credit more effective and efficient. The  effect on horizontal equity as in the case of the child credits described  above depends on judgements about whether taxpayers should pay  different taxes based on decisions about whether or not to attend college.
The complexity of the AOTC is derived largely from its relationship to  other education tax preferences. The AOTC is one of a variety of  education tax benefits that students or their families can claim which  include the Lifetime Learning Credit and the tuition and fees deduction.  These tax preferences differ in terms of their eligibility criteria, benefit  levels, and income phase-outs. The value of the tax benefit also depends  on the amount of student aid taxpayers or their children receive. Evidence  indicates that due to this complexity, taxpayers may not know which  education tax preference provides the most benefit until they file their  taxes—and calculating the tax benefit of each provision can “place  substantial demands on the knowledge and skills of millions of students  and families. In addition, as described in our 2012 report, filing for  AOTC is complex enough to raise concerns that some taxpayers choose  not to claim a tax benefit like the AOTC or are not claiming the tax  provision that provides the greatest benefit.
section_title: Appendix IV: Comments from the Internal Revenue
section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contacts:
section_title: Staff Acknowledgments:
paragraphs: In addition to the contact named above, Kevin Daly, Assistant Director,  Susan Baker, Russell Burnett, Jehan Chase, Adrianne Cline, Nina  Crocker, Sara Daleski, Catrin Jones, Diana Lee, Robert MacKay, Ed  Nannenhorn, Jessica Nierenberg, Karen O’Conor, Robert Robinson, Max  Sawicky, Stewart Small, and Sonya Vartivarian made major contributions  to this report.