Earned Income Tax Credit

While dealing with some client income tax issues today, I happened to cruise through the instructions for the Form 1040, the main federal individual income tax form. This includes instructions for the earned income tax credit, a tax credit available to the working poor, which is a leading cause of tax audits.

It is complex. How complex? The instructions fill pages 46 to 59 of the instruction book (14 pages including the table). The basic analysis takes six steps with twenty-one numbered sub-steps (in addition to the steps on the work sheet and a three part test that has to be analyzed in one of the steps and carrying over the worksheet result to the main tax form). There are two worksheets. One of the worksheets has three parts with six steps. The other has four parts with five steps. There is a full page plus an additional quarter page of definitions and special rules. The seven page table (some entries in which require footnotes) has six credit numbers per modified income range from which the taxpayer must select the proper number. There is nothing in the instructions that explains the formula that drives the table so people can understand the incentives created for them by the earned income tax credit.

This isn't primarily a matter of poor technical writing on the part of the drafter of the tax form. Tax forms are, as technical writing goes, among the better written documents out there. But, the relevant provisions of the Internal Revenue Code are quite complex.

By comparison, the instructions for the dreaded alternative minimum tax, which is widely derided as a source of tax code complexity, take just a page and a half, including a worksheet that takes up almost an entire page.

If a provision of the tax law relating to insurance companies or publicly held corporations or vacation homes is complex, that's fine. Those taxpayers can afford to hire accountants and lawyers to figure it all out for them, tend to be sophisticated themselves, are relatively small in number, and have considerable tax savings at stake.

But, the earned income tax credit impacts tens of millions of taxpayers, who are by definition low income (the maximum earned income to get any credit is $38,348 for a married couple with two children, $36,348 for a single person with two kids, $34,000 for a married couple with one kid, $32,000 for a single person with one kid, $14,120 for a married couple with no children, and $12,120 for a single person with no kids) who tend not to be sophisticated, and who rarely have huge dollar amounts at stake. The maximum credit, for a married couple with two children, is $4,536 who have between $11,300 and $16,850 of earned income.

I am all for helping working poor taxpayers with tax credits, like the earned income tax credit and the work opportunity tax credit. And, I am well aware that tax credits shift a bigger share of the benefit to lower income people than tax deductions.

But, I am also a firm believer that we can provide comparable economic benefit to this group of taxpayers without the administratively cumbersome system we have in place now. And, while it is beyond the scope of this post, the earned income tax credit phaseout has the econmic effect of imposing some of the highest marginal tax rates faced by anyone on the working poor, which is also bad policy.

We have many tax provisions that all aim, at least in part, to cushion the impact of federal income taxes on modest income families. They include the standard deduction, the additional standard deduction, personal exemptions, head of household filing status, married filing jointly status, the per child tax credit, the additional child tax credit, the child and dependent care expense credit, the credit for the elderly and disabled, and the work opportunity tax credit.

The tax code does not have to be this complex to get us to roughly the same place in terms of tax liabilities. Also, reform of these provisions has the ability to dramatically reduce tax complexity for a large share of taxpayers, with a very low revenue impact, because the lowest income 50% of taxpayers has a quite small share of the income of all taxpayers and pays a smaller share of federal income taxees.