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A tax loophole for common folks

Some 25 percent of eligible filers don't use the Earned Income Tax Credit. The IRS is trying to reduce errors in the program.

By Ron SchererStaff writer of The Christian Science Monitor / March 17, 2004


Not enough people are as honest about their taxes as Larry Featherly, an unemployed man who badly needs cash so he can get his car fixed, find a job, and move out of his parents' house.

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Mr. Featherly volunteers that his two teenage daughters are in foster care. This admission means that Featherly will not get as much back from the government's main antipoverty program for working people, called the Earned Income Tax Credit (EITC). Instead of being eligible for up to $4,000 from the government, he will get $836.

"My goal is to get my kids back," he says while watching two students from nearby Colgate University prepare his return.

The accuracy of returns such as Featherly's - especially on the issue of children living with their families - is now at the heart of a debate over the $36 billion program for 21 million Americans. Despite efforts to fix the problem, the Internal Revenue Service believes there are still errors, either unintentional or fraudulent, in this program.

It is now experimenting with a pilot program to try to cut down on the mistakes. President Bush, in his budget proposal, suggests simplifying the program in yet another effort to improve it.

Yet advocates of the EITC say if there is any mistake, it is the fact that some 25 percent of the people who are eligible for the program don't apply - perhaps because they don't know they are eligible.

"We are basically running a social-services program without the administrative infrastructure," says David Williams, the EITC director at the Internal Revenue Service (IRS) in Washington. "We are administering the largest means-tested, antipoverty program."

A target for cuts

Last week, in part because of concerns about the error rate, the Senate Budget Committee voted to lop 10 percent off the program, a vote reversed by the full Senate. The House, in its version of the budget, has yet to tackle the program. "The House has said it would like $8 billion out of program cuts or tax increases," says John Wancheck, outreach coordinator for the earned-income credit at the Center on Budget and Policy Priorities in Washington. "When you look at places for cuts, Medicaid and EITC are at the top of the list."

This is not the first time the EITC has been under scrutiny. The IRS looked at 1999 returns and concluded that the error rate was about 30 percent. In 2001, Congress made changes to the program in an effort to cut down on the problem. No one knows if they've worked. Mr. Williams says, "What I would say is that [the error rate] is lower and hopefully significantly lower than the 1999 study, but one of the reasons it remains high and sticky is that our entire economic base shifts rapidly."

This is particularly true, he points out, among low-wage earners. He says they frequently change jobs and move to find work. They also tend to have a high rate of family issues.

Yet even the IRS admits the rules are confusing. Last week at a Monitor breakfast, IRS Commissioner Mark Everson said, "I was in a conversation with someone yesterday - it is tough for a lot of people to figure out if they qualify or not."

To try to remedy the problems, the IRS runs what Williams terms "a very robust" audit of people who use the program. As soon as it finds out about "income tax preparation mills," which specialize in fraudulently preparing returns, it busts them.