The Earned Income Tax Credit (EITC) has a hidden and dangerously perverse element to it

In My Humble Opinion
1

At least I find it to be so; maybe someone can explain why it would make any sense to structure it this way (I mean, this is the rare program that seems to be popular among serious thinkers on the left *and *right for the most part; yet I find a glaring problem with it from my POV).

Now, I normally consider it a fallacy when people talk about wanting to stay out of going into the next tax bracket, because they think they will earn less in net. With marginal tax rates, of course, that’s not true–the higher tax gets taken only out of the amount over that line.

But with the EITC, I just discovered, it’s actually true. I have an investment I got in my grandfather’s will: a weird real estate thing that is apparently an obsolete tax shelter. It is basically a share (or half a share, since my sister got half of it) of an apartment building in upstate New York. A company manages the property, collects all the rent and pays for all the maintenance etc., along with fees for themselves; then they distribute the net proceeds among the “partners” in this investment. Anyway, this year said proceeds amounted to $3,226.

So here’s where the EITC comes in. The rules say you can make up to $3,300 net in “passive” investment or real estate income and still get your full EITC. But if you make $3,301, boom: you lose your entire EIC, which for us this year is $3,476. That is so fucked up! This investment fluctuates from year to year, and it just happened to be $75 lower than this cutoff point. Had it in fact been $75 more, it would have been like getting nothing from the investment, *plus *having someone nick $100 from me just to add insult to injury.

So…what the actual fuck??? I understand the basic idea behind not paying out EITC funds to trust fund babies or whatever; but why doesn’t it just start reducing your EITC as it goes above a certain threshold? If it reduced it one to one, it would just make my yearly distribution check worth exactly $3300 if it were to read more than that, unless it got up to nearly $7000 (which would still be sort of annoying but whatever). To make it so a teensy bit more income throws you over a cliff–wow.

If I had seen that it indeed was just past that line, could I have sent some of the money back to the investment company? Sunds bizarre but it came close to being something I would have been fairly desperately interested in trying to do.

2

There are a lot of these catch-22 in state assistance too.

Make $20 washing cars? NO CHECK FOR YOU!

Have a 4 year old car that you need to get to work, and which is a very cheap vehicle? NO CHECK FOR YOU!

Hell why even try crawling out of the pit when one mistep means your kids don’t eat? Better to stay with the meager guaranteed existence.

3

I agree strongly with your complaint, which arises in many forms. All I can think is that many who draft legislation are unable or unwilling to exercise simple mathematical sense.

I don’t know if you’re allowed to reject part of the income, but that question reminds me of signs displayed at Las Vegas casino cashier desks:
“All winnings must be paid in full.”
(Otherwise $1600 keno-ticket winners would ask for just $1499 to avoid an IRS report.)

4

When I was in college and the child support I receive was being recalculated, I had to ask the judge not to raise it past a certain point, or I would have lost Medicaid eligibility. That point was $400-something a month. Because certainly if you’re a single parent with an income of $500 a month you can afford to buy a private policy.

5

I have processed applications for Medicaid eligibility for twenty years and receipt of child support has denied many a mom. The ACA considers this income exempt, so even though Texas isn’t expanding Medicaid, parents with no other income other than child support are now eligible.

6

The tax system is so perverse that we are actually moving out of the house we’ve lived in for 20 years into a more expensive house because we were getting clobbered by the AMT. It was getting to the point where 40% of my income was going to pay taxes, and we STILL owed more come April.

To me, it’s grossly unfair that a family who makes $250k per year and lives in a $250k house should pay tens of thousands of dollars more in taxes vs a family with the same income who lives in a $500k house. But thanks to the AMT, that’s how it works.

So we’re moving into a more expensive house because the government penalizes people for living within their means and not having a bunch of debt.

7

A couple of years ago, my doctor asked me to apply for “indigent” status so he could get the county to pick up the tab for some tests he wanted to run. My income was well within the limits, but my savings was much too high. Apparently, the government wanted me to spend more on booze and hookers.

8

These are good examples of things that frustrate people about government programs certainly.

But isn’t the complaint really just because you fell on the wrong side of the line? And, at some level aren’t all ‘lines’ kinda arbitrary. I mean there must be 15yr olds capable and mature enough to drive, right? There must be a couple of 14yr olds who really should be allowed to marry, etc.

But you can’t run programs or write laws with wiggle room. “But I was only going ten miles over the limit!”, “but she’ll be 16 in 3 months!”, “But I’m only 2 points over the limit!” None of that is going to fly, (with sympathies to those, 2 points over the limit, 2 minutes too late for the meter, only 2 dollars overdrawn!)

Surely you’re outraged about welfare cheats getting benefits they technically don’t qualify for, right? Not seeing how what you’re proposing is a lot different, in my opinion.

9

They can, actually. In most tax issues there is a "phase out’. For example, you don’t go from $1000 in EITC to 0 because you cross a certain earned income threshold, it goes down, little by little until you get to zero.

In this particular case, it doesn’t phase out, likely because few EITC recipients have *any * passive investment income.

OP, You may be able to ask the people running it to pay out the entire amount to your sister this year.

10

No, I don’t think there must be a couple of 14 year olds who really should be allowed to marry.

And I don’t really worry about welfare cheats; almost everyone I’ve know on public assistance needed help.

And I think benefits should be decreased incrementally; there is no need for a hard I/O line, which can discourage “good” behavior.

And I think the AMT is just evil.

11

With my example, the limit just makes absolutely no sense even as an arbitrary limit. A family with an income of $500/month can afford to purchase an individual insurance policy exactly as much as a family making any amount less than that, which is to say, no way in hell. So why should the one family get it and the other not? Obviously there are lots of people making substantially more than that who still can’t afford it, but gradually at higher incomes those families become exceptions. The $500-income family is not an exception. At least that’s partially been remedied now with the ACA, but there was a time when I couldn’t work because I needed a job that provided insurance (which I couldn’t find) or nothing.

12

No, this is a very old fight (goes back to the 1960s, if not earlier), and it’s all about politics, not mathematics.

Any aid program with income-based eligibility can either:

a) phase out gradually as recipients’ income increases, which removes the perverse disincentives being discussed here, or

b) ‘only help those in need’, i.e. have a low ceiling on how much money you can make to be eligible, and either suddenly or very rapidly phase out as you hit or approach that level of income.

All the good-government types recognize the problem with (b), that it equates to a very high tax rate (sometimes >100%) at a very low income level which creates the perverse disincentives to earn more money that we’re talking about here. They prefer designing programs which phase out slowly as income increases. The flip side of this is that people remain eligible for some modest level of aid even after they’re making decent money.

The political problem is, it’s easy to attack programs on the grounds that aid for the poor is going to people who are doing fairly well. It’s fertile soil for anti-government types to do “that’s outrageous!” numbers on, and get their usual crew of dimwitted supporters to where the veins are bulging out of their necks about it. And the good-government types have never had a strong political constituency, so out the window go the gradual phaseouts, and back in come the hard-and-fast ceilings on how much money you can make and still be eligible for aid.

To fix the problem, you’ve got to fix the political problem.

13

MBH and Blackberry, I agree that the situations you describe are similarly unfair. I have described here before how I am still shut out of getting health coverage thanks to a so-called “glitch” in Obamacare, though at least I don’t have to pay the penalty.

Right. I mean, it wouldn’t have shocked me if the cutoff (or at least where it started to be phased out) were lower, like $1,000 or even $500. Though if it were still a cliff there rather than a phaseout, it could then amount to a 300% or 600% tax on that income rather than the 103% maximum it would have hit had my check been $76 greater.

Huh, interesting. You don’t think that has the whiff of tax evasion about it?

But couldn’t they address this political issue while making it more mathematically sensible by starting the phaseout well below where the cutoff currently is? I don’t think I’d be bothered if my EITC was half of what it is, or even a third, and only fluctuated a bit as those investment checks varied. Heck, I think I’d even be okay with it being nothing, as long as I didn’t feel I had arbitrarily landed super close to a line that almost screwed me and easily could do next year (the investment has not only fluctuated but has had an overall trend of rising–as rents rise, presumably).

Just seems like they could get through to the right wingers by describing it as a capital gains tax rate of potentially over 100%. Especially since, as I noted, the EITC tends to be one of the few entitlements that generally is supported on the right. The right wingers hate to see inheritance taxed, as well; and since the actual inheritance tax has an exemption of something like $1 million, they don’t have many other examples they can point to of someone who is getting a huge effective inheritance tax based on a much smaller inheritance (I don’t know how to value this particular investment, since when I inquired I was told that people had sold them for roughly three or four times the yearly payout–which seems insane and desperate/exploitive to me–but it is surely somewhere in the <$100,000 range in any case).

14

There’s your problem, right there.

I mean, have you been watching what’s going on this past five years? Obama has made every effort to get through to right wingers in a whole bunch of different ways, on a host of issues. It was what he brought to the table, this (unfortunately insane) belief that he could get past the partisan gridlock and bring the two sides together. And you see what it’s gotten him - and us.

There is no getting through to right wingers. Especially not on any aid programs for the less fortunate, which they just want to shrink as much as possible, and destroy them if they can.

15

But as this article notes, there are all kinds of Republicans at least claiming to be big fans of the EITC:

Chait does go on to snark:

But they are certainly on the record as supportive to a much greater degree than for any other aid program I can think of. And what I’m proposing is not even an expansion (which they say they are for), but just a revenue-neutral shift to a phaseout instead of a cliff.

BTW, one little oddity I noticed: on the 1040 and on IRS web pages, they just call it the “EIC”. *Everywhere *else it is the EITC. Does the IRS not like to use the word “tax”? Silly if you ask me.

16

Anyone who rebutts the argument that increased earnings can’t be harmful because of marginal tax rates doesn’t understand the tax code. There are lots of these situations - even with phaseouts. A lot of phaseouts are over a tight range so much so they may as well not be phaseouts at all.

The EITC would be great if it was in conjunction with the reduction of other transfer payments. It was envisioned to be a replaeent of other programs, not an add on.

17

Bone, you can you give examples of the “lots of situations” you refer to?

18

It looks like the EITC has a shallow enough phaseout that you are always better off with more **earned **income (within a few tens of dollars, at least). So at least it was on someone’s mind when the credit was constructed. However, the investment income cutoff is as steep as it can get. It looks like a difference of a dollar of investment income could make the difference between a credit of >$6k or $0.

I suppose the idea is that if you have such substantial investments, but low income, you should just liquidate the investments. And maybe that makes sense. But I agree that this rule is implemented in a stupid way, especially in light of how carefully the EITC is constructed to avoid this sort of wall.

19

Interesting point about liquidating, Ruken. I guess I’m in an unusual position in that I did not choose to obtain this investment, but it is not traded on any kind of market. The only people likely to buy it are other holders of shares of the same thing, who are apparently quite predatory in what they are willing to pay (hell, if I had the money to do so, I’d love to buy up more shares at that price and get a 25% or more yearly return with very little downside or risk).

But even for someone who has more conventional investments, why would policymakers want them to liquidate? Isn’t saving and investing considered healthy for the economy? As someone upthread noted, these rules seem to incentivise a “hookers and blow” (or at least “strippers and liquor” if we are going to keep it legal) lifestyle over a frugal one.

20

You certainly have an illiquid investment. I agree that disincentivizing savings doesn’t seem so prudent. However, I know that if I were to quit or lose my job for one that pays $15k, I would need a lot less help than someone who normally makes that much and has less saved up than I do.

So if I were making policy, and wanted this program to cost $X billion, I’d probably put some sort of investment limiter in so that the folks who need more help get it. Just not how they have it now. I’m not entirely sure what would be ideal, but this isn’t it.