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How to Fix the Advanced Earned Income Tax Credit: A Lesson from Health Reform

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Kristoffer Tripplaar/ Sipa Press/File

(Read caption) Individuals can claim various credits on their taxes when filling out their tax return forms, such as the 1040 form shown in this photo. The advanced Earned Income Tax Credit can be very helpful for low-income families who continue to struggle in a tough economy, but only about 3 percent of Earned Income Tax Credit (EITC) claimants take advantage of the advanced credit available to them.

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The Obama Administration has once again proposed eliminating the Advanced Earned Income Tax Credit.

The idea, which the president also raised a year ago, is unlikely to go anywhere, given that not much has changed since the last time it was proposed. The White House would be better off putting its energy into figuring out how to make the advanced credit work, rather than writing it off. One model: the new tax credit contained in the just-passed health law.

While only about 3 percent of Earned Income Tax Credit (EITC) claimants take advantage of the advanced credit, it can be very helpful for low-income families who continue to struggle in what remains a tough economy. The credit undoubtedly provides much needed assistance to folks who are strapped for cash. And it seems counterproductive to take as much as $35-a-week (the maximum advance credit) from the paychecks of those who currently use this option.

Changes to the credit that make it easier and more attractive to use would provide a steady stream of assistance to more families, which might ultimately reduce reliance on payday loans and other high-cost forms of borrowing. Steady cash flow might reduce the day-to-day issues that underlie much instability in low-income communities—for instance scrambling to make the rent or pay the utility bill. And at tax-filing time, recipients wouldn’t be so eager to take advantage of costly refund anticipation products, given that their refunds would be smaller because they’d already have received most of their credit.

Some eligible families may avoid participating in the advance credit program because they fear they’ll be on the hook to pay back a big chunk of money when their total credit is reconciled at the end of each year. And that’s where proponents of the Advanced EITC might want to take a page out of the health care playbook.

The Health Care Tax Credit (HCTC) provides assistance to low- and moderate-income families purchasing medical coverage from the new health insurance exchanges. Families submit proof of eligibility based on tax returns from two years prior to when coverage would begin. The government then pays the credit amount directly to the insurance company which in turn reduces premiums to the consumer.

In the world of the Advanced EITC, the model would look like this: Families would calculate their EITC based on their income from the previous year’s tax return, and advance payments would begin. At the end of the year, taxpayers would reconcile the credits they received with the actual amount they were eligible for. If they had received too much, taxpayers wouldn’t be on the hook for the entire error. Instead, repayment would be capped as it is with HCTC, where families with incomes less than 400 percent of poverty can owe no more than $400. This solution wouldn’t be perfect. It will be complicated for both families and the government to manage. And limiting repayments does open the door to fraud if people don’t have to reconcile the credit entirely on their tax returns. For the EITC, limitation on liability could be capped for families making twice poverty – around $42,000 for a married couple with two children instead of four times poverty. Couples with two kids are eligible for some EITC if they make $45,500 or less. This should reduce the potential for gaming the system.

The Advanced EITC makes a lot of sense. However, GAO has documented compliance problems and it’s underutilized. The chances of eliminating it are slim, so why not improve it?

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