David Marzahl, Executive Director Center for Economic Progress

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

2. Center for Economic Progress • 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 • 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 consumersto mainstream financial services