Giving Up on the Advanced Earned Income Tax Credit

President Obama’s budget would eliminate a small but meaningful program for low-income families – the Advanced Earned Income Tax Credit (AEITC). A far better idea would be to expand the program. This credit allows eligible families to receive a portion of their Earned Income Tax Credit (EITC) throughout the year through a reduction in tax withholding, so they don’t have to wait until they file their tax returns to get the extra cash. In 2009, the program could boost a family’s take-home pay by up to $35 a week.

True, few eligible families—three percent at most– take the advanced credit, but is that really a reason to trash it? Low-income families face liquidity constraints that could be reduced – at least partly – by receiving the EITC throughout the year, rather than as a lump sum when they file their taxes. Stephen Holt, an EITC expert, finds that though many eligible individuals say they prefer a lump-sum payment, they often pay for a refund-anticipation loan so they can get the money as quickly as possible . That suggests that timeliness matters to them.

And, as pointed out by Joann Weiner in Tax Notes (February 16, 2009) – expanding the AEITC would be ready-made stimulus (albeit small). The program benefits only families with income below roughly $35,000 if they have one child or $40,000 if they have more. Since it’s also doled out in small chunks, it seems likely that any payments made via the AEITC are spent quickly. And isn’t this exactly what the doctor ordered for the economy?

OMB Director Peter Orszag says that the program does not work well. OK, why not fix it and increase the number of takers instead of, as the administration’s new plan would do, precipitate  a painful decrease in their take-home pay – just when they’re trying to figure out how to make ends meet?  AEITC came under fire in a 2007 GAO report, but that study raises many questions about the amounts received by recipients that have not yet been answered. On balance, it’s unclear if we really know enough about the program to abolish it. And no study has examined how the AEITC benefits users. Shouldn’t that figure heavily into the decision-making process?

Some steps the IRS could take toward fixing the credit would be to improve awareness – of both employers and workers – about the program and its requirements. Lack of awareness is an oft cited reason for why people don’t receive it and might also contribute to reporting errors among those who do.  Advocates and potential recipients could also be educated about the benefits of a steadier income stream in alleviating household stresses. Low-income households say they prefer receiving the credit as a lump-sum, but the sour economy may have changed that preference. If the administration does decide the AEITC just can’t work, perhaps it could hold its horses at least until the recession ends. This proposal has poor timing written all over it.

Most families currently getting the AEITC would also benefit from Making Work Pay. But Making Work Pay would offset less than half of the potential decrease in their take-home pay. That new credit is being distributed through reduced withholding. If the administration can get Making Work Pay out quickly and relatively accurately, why can’t it do the same for low-income families through the AEITC?