Tax Fairness and Simplification for the Working Poor

1. Tax Fairness and Simplification forthe Working Poor Presentation to President’s Advisory Panel on Federal Tax Reform New Orleans, March 23, 2005 Mark Moreau Low-Income Taxpayer Clinic Southeast Louisiana Legal Services

2. Earned Income Credit Complexities • 2004 Major Reforms greatly simplified EITC • Remaining problems: Amount of Credit and Differing Treatment • Married filing separate • Head of household • Earned income and AGI definitions for community property states • Joint and shared custody • Lawsuit recoveries (problem not limited to EITC)

3. Is the Earned Income Credit Sufficient? • Reduces poverty • Do all workers escape poverty? • Who is left behind? • “Official” poverty does not measure real poverty • “Official” poverty threshold understates poverty - standard should be about 45% higher • Upper EIC income limit is about 183% of poverty for family of 4 • 200% poverty needed for life’s basic necessities

4. Minimum wage workers have different poverty results after the EIC Left below “official” poverty threshold:

5. Above “official” poverty threshold:

6. EIC Problems in Community Property States • Each spouse must include one-half of other spouse’s income in her income • Amount is included in AGI for EIC phase out, but it does NOT count as “earned income” for EIC calculation • Example 1: Wife makes $20,000, Husband makes $50,000 • Wife’s AGI is $35,000--$10,000 plus $25,000 • Wife ineligible for Earned Income Credit—loses $3,000 plus • Example 2: Wife makes $10,000, Husband makes $40,000 • Wife’s AGI is $25,000, but her “earned income” (and real income) is only $10,000 • As a result, wife loses $2,023 of her EIC refund - This reduces her income to $11,987 or 74% of poverty

7. Domestic Violence -- Leading Cause of Female Poverty • Many don’t get EIC when they need it. • No EIC if they left spouse after July 1 • Also, victims in 9 states (30% of US population) lose EIC unless divorced by December 31 • Victims in other states may lose EIC if they can’t qualify for head of household

8. Tax Code Wipes Out Lawsuit Recoveries • Assume taxpayer with $14,000 wages that wins a modest consumer case, $3,000 damages and $7,000 attorney fees • Adds $10,000 to income even though never received the attorney fees and can’t deduct them • Result: The $3,000 recovery is taxed at a 56% rate • American Jobs Creation Act of 2004—a partial fix of problem • Fixed the problems created by attorney fees for civil rights cases • But, did not fix the problems for consumer protection lawsuits and certain other lawsuits

9. Perceptions of Tax Unfairness Earned Income Credits drained by the “system” Tax return preparation fees Refund anticipation loans Seizure of refunds by creditors in some states (federal law could exempt) Difficult audit process by IRS The major complaint from working poor is: The difficulty of the IRS correspondence audit procedures IRS procedure does NOT work for this low-income population

10. Can the Earned Income Credit be Simplified? • Yes, it already has been • Possible reform: Consolidate various deductions and credits into one unified credit • Head of household and dependency exemptions are complex and irrelevant to many taxpayers under EIC income limits • Can low-income taxpayers do their own returns? • Maybe, but there are serious functional literacy problems • I-CAN tax return software has been successful (written in 5th grade English) • 98% of users find I-CAN easy to use