Issues, Challenges and Opportunities: Low-Income Taxpayers and the Tax Code Presentation to the President’s Advisory Panel on Federal Tax Reform David Marzahl, Executive Director Center for Economic Progress

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

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

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

5 Tax Counseling Project: 2004 Tax Filing Season Statistics –21,300 tax year 2003 returns completed; 2,700 prior year returns –90% obtained a refund; 10% owed tax –Average refund $1,500; median refund $791 –Average refund for families - $2,508; median refund $2,489 –60% claimed EITC (refundable) –23% claimed Child Tax Credit (refundable) –5% claimed the Saver’s Credit –4% claimed one of the Education Tax Credits –3% claimed Dependent and Child Care Tax Credit Refundable tax credits have a substantial impact on low-income taxpayers; non-refundable tax credits much less so Taxpayers with dependents receive large tax benefits from child- related tax credits

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

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

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

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

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

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