Beware of expanding the earned income tax credit

In a healthy republic there would be no need to explain, to both Democrats and Republicans, why they should not expand a program that misspends more than a fourth of its money.

Yet here we are.

Michigan Gov. Gretchen Whitmer last week announced the expansion of the state’s earned income tax credit (EITC) as the top priority of the state’s new Democratic majority. Michigan is one of many states that piggyback on the federal earned income tax credit by offering credits against the state’s personal income tax. The shrewd governor is getting behind a popular bipartisan plan to push the state’s credit from 6 percent to 20 percent.

There is just one problem. The federal EITC is a magnet for waste, fraud and abuse. The Internal Revenue Service estimates that nearly 28 percent of all earned income tax credit payments, totaling $19 billion a year, are made improperly. Expanding the state program likely will put Michigan taxpayers on the hook for tens of millions in false spending.

Not all of these illegitimate payments are the result of conscious fraud. Because the size of the credit depends heavily on how many dependents live in a household, the definition of proper and improper payments can change as children grow, marriages dissolve, single parents cohabit, and other life events occur. Improper payments result largely from cases wherein the same child is claimed multiple times because of shared custody or other nontraditional living situations, according to a 2019 report from the Tax Foundation.

But to say that not all the improper payments involve malice aforethought is only to say that the program obviously lacks sufficient oversight and controls. The most recent report from the Office of Management and Budget shows total overpayments in the EITC program to have come to $18.9 billion in 2021. Overpayments were 27.76 percent of the program’s total outlays. 

There are ideas for addressing this problem. Then-National Taxpayer Advocate Nina E. Olson recommended in 2019 that the definition of “qualifying child” be revised and that the family-size element be separated from the credit. The Tax Foundation suggests making EITC a per-worker, rather than a per-household, tax credit. Congress could put in place incentive and penalty structures that encourage more recipients to ensure they are not accepting improper payments.

But the bottom line is, right now, the program is so poorly administered it probably should not be continued, let alone expanded.

Unfortunately, Michigan is not alone in looking to enlarge a program that’s rife with misspending. Twenty-seven states offer a refundable earned income tax credit based on the federal model, according to the National Conference of State Legislatures. Only Michigan is presently aiming to more than triple the size of its EITC, but several states are considering enhancements to this or related tax credits.

What explains the popularity of such a flawed program? The earned income tax credit is reserved for low- to moderate-income working individuals and households. Its chief requirement is that the recipient earn money from a job, and it reduces the amount of taxes the recipient owes. If the amount of the credit is more than the earner owes in taxes, that person gets money back. Even those who do not owe any income tax can get money from the program.

The credit has some features that make it superior to other types of public assistance. It is set up to encourage work — the biggest factor in leaving poverty. It also has a phase-out, rather, an in-or-out line, to avoid spikes in tax liabilities as people earn more. Conservatives like its work requirement and its resemblance to a “negative income tax” originally proposed by the late economist Milton Friedman. Progressives see its fairly high earning threshold (the top salary for eligibility is $59,000 per year) as a way of providing public assistance all the way into the middle class. Fans of the universal basic income see it as a step (though, in their minds, an insufficient one) toward that goal.

It’s a mark of Whitmer’s political skill that she is talking up this bipartisan favorite as a thin Democratic majority prepares to take charge in Michigan’s Legislature. Amid a host of less-popular items in the Democrats’ agenda, the earned income tax credit stands out as likely to sail through both chambers.

“I would imagine, early on, we’ll be able to give the working family tax credit — get that done — as well as the retirement tax repeal,” Whitmer told a gaggle of reporters early this month. “So, that’s just the start.”

But the political salability of the program does not justify turning a blind eye to rates of improper payments that are closing in on 30 percent. That level of waste, which would wipe out a private company in short order, can only crowd out many other priorities the new majority will have. Government efforts to help poor households can be better targeted. And a party looking to get a fresh start in leadership should not begin by supporting flagrantly improper payments of taxpayer money.

Tim Cavanaugh is the senior editor for the Mackinac Center for Public Policy, a research and educational institute based in Midland, Mich.