What more can the IRS do to get taxpayers to comply with tax law? One ideas that goes beyond traditional audits and penalties is to explore the possibility of using behavioral economics as an additional administrative tool for tax provisions like the Earned Income Tax Credit (EITC).
Research on applications of behavioral economics to social policy has shown that behavioral approaches can get taxpayers to report earnings more honestly, to save more of their tax refunds, and to pay owed taxes. What if applying these same insights from behavioral economics could improve the administration of the EITC? That is the question posed in a new article in the University of Virginia Tax Review. A focus on taxpayer characteristics, and an understanding of what drives individual decision-making, may offer new opportunities to improve EITC compliance.
The article details the behavioral insights behind each of the examples above, and others, and suggests how they might be tested as methods to improve EITC administration and compliance efforts. In this post, we preview a few background themes of the article.
Why Does the EITC Matter?
The EITC is a benefit administered through the tax system that is generally applauded for helping to reduce poverty and incentivize low-wage work. It’s estimated that one in five taxpayers claim the EITC and approximately 44% of all filers with children receive the EITC. Importantly for taxpayers, the tax credit is refundable, meaning that the IRS will refund the taxpayer any excess of the credit amount over the taxpayer’s tax liability for the year. Which makes it an expansive credit both in terms of the numbers of taxpayers that qualify and in terms of the budget.
This year alone, more than 27 million low-income working families and individuals, who often live paycheck to paycheck, will receive a financial boost from the EITC. It a sizable tax time windfall for families, with the average EITC claimed in 2013 being approximately $2400. The EITC is often called the nation’s largest anti-poverty program as it has been shown to have a major effect on lifting people out of poverty.
In terms of dollars, taxpayers claimed $68.1 billion in EITC in 2013, with most of that (87%) refunded to taxpayers.
What’s the problem?
The EITC has broad importance as a matter of national policy, yet the IRS also suffers criticism for the stubbornly high overclaim or improper payment rate. Despite the IRS’s traditional compliance efforts (i.e. audits and penalties), overclaim rates remain at approximately 25% of all claims.
For 2015, the estimated dollar value of improper payments was approximately $15.6 billion. This puts the integrity of the program at risk. EITC compliance and the reasons for non-compliance are varied, as described in the paper:
“The EITC compliance problem is best understood as a variety of different problems along a continuum running from good faith unintentional mistakes stemming from complex family arrangements and confusing legal rules to intentional cheating in the form of misreporting income or a qualifying child’s residence or relationship.”
Despite this challenge there are upsides to administering this benefit through the tax code. The EITC has a high rate of claims among eligible taxpayers (almost 80% overall and higher for those with two or more qualifying children), and low- administrative cost relative to other social welfare programs. This is in part due to its administration by the IRS, rather than being delivered as a social welfare program with the attendant costs.
However, the limitations of the IRS’s traditional approach at addressing EITC noncompliance suggests new tools should be considered.
Adding a New Tool to the Compliance Toolbox
This year the IRS has included behavioral nudges around compliance in its key communication messages for the annual EITC Awareness Day on January 26th. EITC Awareness Day is a coordinated, one-day media blitz with the goal of reaching taxpayers who may be eligible to claim credits, including the EITC. Compliance messages for EITC Awareness Day include the following:
- EITC errors can cost you. Choose your tax preparer wisely.
- Avoid EITC errors. Know if your children qualify.
- Don’t let errors filing for refundable creditscost you time and money.
How these messages will affect EITC compliance for this season is unknown. What is clear is that the traditional audit and penalty approach to addressing EITC noncompliance has its limits in terms of its ability to meaningfully move the needle toward greater compliance and that new tools are needed. The forthcoming paper offers suggestions for testing on two new approaches: 1. Utilizing data for targeting and verification, and 2. Utilizing behavioral economics techniques.
Each new approach tested, whether those undertaken for EITC Awareness Day or those proposed, should be evaluated using three specific criteria:
- the effect on tax compliance,
- the effect on eligible taxpayers’ willingness to claim the tax benefit, and
- the overall cost/ burden the measure entails for government and the entire tax ecosystem.
In offering this proposal we draw on the work of many writers and thinkers and seek to enhance the integrity of tax administration and the EITC program. We hope that you will check out the full paper in the University of Virginia Tax Review and share your comments with us.
Book, Leslie M.; David R. Williams; and Krista A. Holub. “Insights from Behavioral Economics Can Improve Administration of the EITC” Virginia Tax Review Volume 37, Issue 2 (2018): 177-242.
 Authors: Leslie Book, Villanova University School of Law; David Williams, Intuit; and Krista Holub, Intuit. The paper represents our views alone and not those of the institutions for which we work.