Tax

Yesterday, the Progressive Pulse published a blog encouraging the NC Legislature to restore the state Earned Income Tax Credit (EITC) instead of increasing the standard deduction. Their argument is that a NC EITC will help more working poor than increasing the standard deduction. That is correct as far as it goes. Many of the poor in NC owe little or no state income tax so increasing the standard deduction will result in no or little tax savings. On the other hand, an NC EITC would be available to many workers earning less than the standard deduction but still have some earned income.

Some background

The federal EITC was added in 1975 and expanded quite a bit in 1986. For those not old enough to recall, Gerald Ford (R) was president in 1975 and Ronald Reagan (R) was president in 1986. The EITC was expanded and changed by other presidents, most recently during Barack Obama’s terms as president in 2009, 2010, 2013, 2014 and 2015. Quite a few changes for Mr. Obama. It seems the Feds cannot leave the rules alone when it comes to the EITC.

The EITC is designed to encourage people to work by providing a credit for those earning less than a certain amount. The certain amount varies based on the number of children, if any, and marital status. The law is quite complex with many other requirements I will not get into here. The maximum credit for 2015 is $6,242 for a married couple filing a joint return with three children. That is a nice chunk of change for someone earning between $13,850 and $23,649. A married couple with that income and three qualifying children probably owes no federal income tax so they get all their federal income tax withheld back plus another $6,242. In addition, they could also receive up to $3,000 for having three qualifying children under the age of 17.

You can see why a couple with three children making under $23,650 needs other resources to cover their living expenses. Of course they do not even receive all their gross wages as they have to pay Social Security and Medicare taxes of as much as $1,809. Without the EITC, the fear is they would quit and go on welfare. In effect, the EITC is a reward for not being on welfare. Some argue that the EITC itself is a form of welfare run through the tax code. I am not here to argue that point.

NC EITC better?

So is an NC EITC better at getting money to the working poor than a larger standard deduction? A couple with three children under 17 could make a little over $21,800 in NC and owe no NC income tax. The first $15,000 is tax-free due to the NC married filing jointly standard deduction and the $374 of tax on the next $6,800 ($21,800 – $15,000 standard deduction) is offset by the $375 child credit. In this example, increasing the standard deduction by $2,000 saves this couple no NC income tax. Even at $23,649, the extra $2,000 in standard deduction only saves $102.

If NC adds an EITC of 5% of the federal then our couple with three kids gets $312. Much more than $102 and even more than the nothing a couple with $21,800 in income receives. So NC Policy Watch is correct, an NC EITC will provide more money to more people. The results are even more dramatic if NC makes the credit equal to 10% of the federal and NC Policy Watch suggest.

Why could an NC EITC be a bad idea?

After all that, an NC EITC sounds good if you want to encourage the poor to work. Several possible problems:

1. Does up to $312 annually, tip the scales in favor of working versus welfare for a family of five making as little as $13,850? I really doubt it. On the other hand, they can sure use the $312 which seems to be the argument of those in favor of an NC EITC.
2. To be revenue neutral, someone has to pay more tax to cover the NC EITC. This money does not materialize from thin air. So some other taxpayer has to pay more to cover the credit. On the other hand, if the option is to add a $2,000 standard deduction then someone has to pay the extra tax of as much as $110 ($2,000 * .05499).
3. The big problem with an NC EITC is it encourages fraud. Basing NC’s credit on the federal means NC pays as many fraudulent claims as the Feds. In December 2014, TIGTA estimated that 24% of federal claims were fraudulent or otherwise improper. Human error due to the complexity of the law is probably the largest cause outside of fraud. So if NC sets aside $205 million, as NC Policy Watch suggests, NC will pay out more than $49 million in improper claims. The error rate in the food stamp program was estimated at 4.07% according to this December 2013 NY Times article. Not great but a heck of a lot better than 24%.

Conclusion

Until the federal government gets its act together and brings the improper payment percentage to a reasonable level, how can anyone promote the EITC as a cost-effective way to fight poverty? What do you think?

On December 18, Congress and the President finally dealt with the tax extenders. Congress named the new act the “Protecting Americans from Tax Hikes Act of 2015” or PATH. Congress likes cute acronyms. This is an annual exercise to revive dead or almost dead tax provisions. You can read about 2014’s efforts here and here. Short term tax provisions are Congress’ and the President’s way of making the increase in the deficit look better. After all, the provisions expire so the extra cost only last so long, wink wink.

Congress likes to pretend, for budgeting reasons, that they will not renew the tax extenders. Future deficit projections ignore the tax extender costs once they expire. Few of the extenders ever really expire.

Since most of the tax extenders have risen from the dead repeatedly, Congress is lying to taxpayers about how much they are increasing the national debt. For a change, this time Congress actually made some of the extenders permanent.

Selected tax extenders made permanent

• Enhanced child tax credit – allowing a larger refundable credit for lower-income taxpayers.
• American opportunity credit – increased the old Hope education credit from a maximum of $1,800 each for two years to a maximum of $2,500 each for four years.
• Enhanced earned income tax credit increased for three or more children. Credit phases-out at a higher income.
• Teacher deduction – had expired in 2014, now permanent. Allows elementary and secondary teachers to deduct up to $250 in eligible classroom expenses. Now include professional education costs. Wouldn’t giving the teachers enough money to cover needed classroom supplies and education be a better option?
• Option to deduct sales taxes instead of state income taxes. This really helps taxpayers in the states without a state income tax.
• Tax free distributions from IRAs – taxpayers 70 1/2 or older can exclude up to $100,000 distributed from their IRAs to qualified charities.
• Modified research credit.
• Modified employer wage credit for employees on active duty (e.g. National Guard and Reserve called up).
• 15-year straight-line depreciation of qualified leasehold, retail improvements, and restaurant buildings and improvements. If not renewed, these assets were generally deductible over 39 years.
• Increased Section 179 of $500,000, was to drop to $25,000.
• Made permanent the five-year waiting period to avoid paying tax on converting to an S corporation from a C corporation. It was ten years before the temporary decrease to five.

Temporary extensions through 2019

• Work Opportunity tax credit for hiring long-term unemployed.
• Bonus depreciation is modified to allow 50% for 2015 to 2017, 40% for 2018 and 30% for 2019.

Temporary extensions through 2016

• Tax-free discharge of qualified principal residence debt.
• Allow deduction of qualified mortgage insurance premiums as interest.
• Tuition deduction of up to $4,000.
• Mine safety equipment deduction and mine rescue training credit. Why do we have to pay mine owners to do the right thing?
• Allow shorter 7 year depreciation for motor sports. Really, NASCAR is in financial difficulty?
• Non-business (residential) energy credit for qualified energy-saving expenses, limited to $500 lifetime.

Other notable changes

• Employer must send 2016 W-2s to Social Security by January 31st. Previously, employers had until March 31st if they electronically filed. The idea is to allow IRS to verify wages and withholding earlier to prevent fraud.
• Prohibit taxpayers who did not have a qualifying Social Security number or ITIN from amending returns once they get the appropriate ID number to claim:
  • Thee earned income tax credit.
  • The child tax credit.
  • The American opportunity tax credit.
• Beginning for 2016, taxpayer must have a Form 1098-T to claim education costs.
• Allowing rollovers from other employer retirement plans to SIMPLE IRAs.
• Codified taxpayers’ bill of rights.
• Allow IRS to say when more employers can truncate Social Security numbers on W-2s.

The Congressional Budget Office estimates the ten-year cost at about $680 billion. Source: CBO (see PDF on the linked page for data)

What do you think? Are these tax cuts and credits worth the $680 billion they add to the deficit?