Errors in earned income tax credit payments cost Illinois taxpayers millions

J. Scott Moody

J. Scott Moody is currently CEO of State Budget Solutions, a national think tank focusing on state pension reform and state dependency on the federal government.

J. Scott Moody
September 16, 2014

Errors in earned income tax credit payments cost Illinois taxpayers millions

The earned income tax credit, or EITC, is meant to give a helping hand to working families. Unfortunately, the EITC is a troubled program that fails to live up to expectations. In a recent Illinois Policy Institute study, I found that the combined federal and state EITCs can create effective marginal tax rates in excess...

The earned income tax credit, or EITC, is meant to give a helping hand to working families. Unfortunately, the EITC is a troubled program that fails to live up to expectations.

In a recent Illinois Policy Institute study, I found that the combined federal and state EITCs can create effective marginal tax rates in excess of 20 percent. Perversely, the EITC actually creates a large incentive to not work, contrary to its original goal.

And that’s not all. The error-prone program likely ends up costing Illinois taxpayers around $100 million each year in improper payments.

Recently, the IRS reported that the EITC is plagued by compliance errors that result in overpayment. The IRS audited taxpayer returns that filed for the EITC between tax years, or TY, 2006 and 2008. They found the following:

“The most common error made is income reporting, occurring on two-thirds of returns with known errors; on half of returns with known errors, income misreporting is the only error. Qualifying child errors are the second most frequent type of error, appearing on 30 percent of overclaim returns where the errors are known. Despite occurring only half as often, qualifying child errors account for by far the most dollars of overclaims.”

And how much money are we talking about?

“In TY 2006-2008, the estimates of the overclaim percentage are 28.5 percent (lower estimate) and 39.1 percent (higher estimate) . . . averaging over returns filed for TY 2006-2008, an estimated 23.7 million taxpayers claimed an annual total of $49.3 billion in ETIC . . . total overclaims for TY 2006-2008 are estimated to be $14.0 billion (lower estimate) or $19.3 billion (higher estimate).”

To put these numbers into context, in TY 2012 the federal EITC doled out $62.2 billion. So, using the higher estimate, Uncle Sam erroneously sent up to $25 billion in EITC to unqualified taxpayers.

Illinois’ EITC is calculated as 10 percent of the federal EITC, so any errors on the federal forms carry over to the state. In 2012, the federal EITC in Illinois was worth $2.5 billion, so the 10 percent state EITC was worth $250 million. Assuming the errors found in the IRS study are constant across states, these EITC compliance errors cost Illinois taxpayers up to $100 million.

Overall, the disincentive to work and costly compliance errors show that the EITC is simply too flawed a vehicle to assist Illinoisans that really need the help. Families would be better off if the money used to fund the state EITC were used to lower the personal income tax rate or to increase the personal exemption.

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