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Roger RoyseRoyse Law Firm, PC

Palo Alto, San Francisco, Los Angelesrroyse@rroyselaw.comwww.rogerroyse.comwww.rroyselaw.comSkype: roger.royse

Twitter @rroyse00

IRS Administration of Social Welfare Policy

Overview• The U.S. tax code contains over $1 trillion of expenditures

designed to encourage certain behavior among taxpayers, e.g., to encourage spending, saving, and working

• With most tax expenditures, taxpayers declare their own eligibility as opposed to direct spending programs which require agency approval

• Tax expenditures take many different forms– Exemptions and “above-the-line” deductions (54%)– Itemized deductions (30%)– Refundable tax credits (15%)– Non-refundable tax credits (1%)

IRS Administration of Social Welfare

• Exemptions– Employer health insurance (policy = provision of health insurance through the workplace)– 401(k) contributions (policy = retirement saving)

• Deductions– Interest on home loans (policy = home ownership)– Charitable contributions (policy = charitable giving)– Bonus depreciation (policy = capital expenditure)

• Deferral – Foreign source income (policy = promote competitiveness of US companies overseas)

• Preferential rates– Lower capital gains tax rates (policy = mitigate double tax, provide for inflation)

• Credits– Earned Income Tax Credit (EITC) and Child Tax Credit (CTC) are by far the largest credit (policy = to encourage

working and lift people out of poverty)– Also:

• Investment tax credits for expenditure on certain energy-efficient assets – most expired at the end of 2013 but may be renewed

• Adoption tax credit – nonrefundable credit of up to $12,970 • American Opportunity Tax Credit – credit of up to $2,500 per qualifying student ($1,000 of which is

refundable)

Forms of Tax Expenditure

Earned Income Tax Credit• Implemented to encourage and reward work • Provides an additional incentive to leave welfare if unemployed or for low-wage

workers to increase their hours• Credited with significantly raising employment among single mothers in 1990s• Maximum available credit is between $487 and $6,044 depending on income level

and number of childrenTax Credits Under the Affordable Care Act (ACA)• Implemented to lower the number of Americans without health insurance

(estimated at 48 million people)• Provides a system of refundable tax credits and tax credits paid directly to health

insurance providersAdditional Child Tax Credit• Provides a refundable credit where the full CTC is in excess of the income tax liability• Capped at lower of (i) 15% of income over $3,000 or (ii) the unclaimed CTC

Use of Refundable Tax Credits to Implement Social Welfare Policies

• The EITC has been successful at lifting people out of poverty, but the system suffers from high levels of fraud

• An estimated $13 billion in wasted payments were made in 2012 (and $133 billion over the last ten years)

• The rate of fraud in the system is between 21%-25% of payments – 75% of the fraud relates to problems authenticating the number of

“qualifying children,” which requires a complicated facts and circumstances analysis

– 25% of the fraud relates to problems verifying the levels of income• The IRS is subject to an Executive Order to reduce fraud in the

EITC system and must undergo annual Government Accountability Office (GAO) audits on EITC fraud levels

Earned Income Tax Credit

• The ACA has two different tax credits: – (1) Advanced Premium Tax Credit (APTC) - payable directly to the health insurance provider– (2) Premium Tax Credit (PTC) - refundable tax credit that must be claimed on the tax return

• The IRS has three key roles in the implementation of the ACA:– (1) determine eligibility for tax credits;– (2) calculate the APTC; and– (3) reconcile the PTC and APTC with the taxable income on the taxpayer’s return

• The GAO audited the IRS system and determined that the software was working well to determine eligibility and the amount of credit available – However, the audit found fraud detection mechanisms were lacking and there was no overall

fraud mitigation strategy in place• Many politicians and commentators are concerned that the EITC experience could be

repeated with the ACA tax credits– May be even harder to detect fraud because ACA looks to “Household Income,” which can be

estimated when claiming the APTC and may be different from what is reported on the final tax return

– Likely to be a big issue in 2015 when the 2014 tax returns are filed

Affordable Care Act Tax Credits

Solutions to Fraud Problems• Limit credits to verifiable information?

– Probably unworkable– Could use third parties to verify information but this would reduce participation

• Split the credits between the amount dependent on financial information and non-financial information – Could help to better target fraud prevention efforts– E.g., EITC fraud is mainly based on number of children so this part of the credit

could be split out to help target investigations• Request additional data on the tax return

– The GAO audited the IRS National Research Program and stated that the IRS is not fully utilizing the information it already collects

– The GAO concluded that in certain areas, e.g., expense data on individual tax returns, additional IRS spending to improve data analysis would bring in enough extra revenue to justify the expense

Conclusion

• EITC Compared to Food Stamps– 1/5 of Food Stamp budget is admin costs– Low error rate– Food Stamp application takes 5 hours– 47% participation of eligible low income workers (vs. 80% to 90%

EITC participation)(Source: Urban Institute)

• IRS Focus on Enforcement vs Delivering Social Benefits– Low cost of delivery but high cost of non-compliance– High Penalties

Additional Thoughts

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