Why We Run Subsidies through the Tax System

By :: April 19th, 2010

I disagree with former IRS Commissioner Don Alexander. Sometimes the IRS is the best, most efficient agency to administer a subsidy. And if we want to encourage low-income families to work—a key premise of welfare reform—refundable tax credits make a lot of sense.

It’s no secret. Working families with children receive a substantial amount of assistance from credits delivered through the personal income tax system. The largest of these—and the ones most likely to remove low-income workers from the income tax rolls—are the Making Work Pay credit (MWP), the Child Tax Credit (CTC), and the Earned Income Tax Credit (EITC). Only one, the EITC, concentrates on low-income families. Almost all EITC benefits go to families with incomes below $30,000 and in 2010, all of its assistance will go to families with earnings below $48,500. The CTC helps married couples with two children with incomes as high as $150,000 – and a married couple won’t see their MWP phased out entirely until their combined income tops $190,000.

We don’t have to deliver benefits through the tax system. Show me a tax credit and I can design a spending program to do the same thing. But sometimes the tax system is the best delivery mechanism. For starters, it’s administratively convenient. The IRS has relatively reliable information on earnings (the foundation for all of these credits) provided by employers so it is easier for the IRS to determine eligibility than another agency. It costs much less to run these programs than to operate traditional welfare. Unless your goal is to maximize bureaucracy, you should be cheered by this advantage.

Second, it is much easier for working families to claim tax credits than to apply for traditional welfare. Virtually all of the recipients would file income tax returns even if the credits did not exist (for example, to claim refunds of over-withheld income taxes) so they’re already in the system. And there’s no need for someone to miss a day of work standing in line at the welfare office. Finally, the negative stigma attached to traditional welfare programs doesn’t exist with EITC, CTC, and MWP credits because the benefits are not limited only to low-income families and there is no invasive interview as a prerequisite for receipt. The result: More eligible families receive the EITC than Temporary Assistance for Needy Families (the program enacted in 1997 that replaced the previous welfare program) or Supplemental Nutrition Assistance Program (SNAP - formerly Food Stamps). 

Finally, remember that the EITC enjoys bipartisan support because it encourages people to work—particularly low-income single mothers. It has roots going back to the Nixon-era debates over providing a guaranteed minimum income. With their similar structures—initial benefits increasing with earnings—the refundable portion of the CTC and the MWP further contribute to this incentive. When we’ve found a government program that succeeds, it makes good sense to stick with it rather than redesigning a spending program to do the same thing.

The credits are not perfect. For one thing, unlike SNAP benefits, refundable credits come in a lump sum once a year, while working families might benefit from more regular boosts to their income. And the error rate on the EITC is higher than for traditional welfare programs. Simplifying eligibility rules and clamping down on fraudulent return preparers would help here.

It might be controversial that a fair number of people don’t owe income taxes after credits. But a big driver to this for working-age people, the existence of refundable tax credits for low-income individuals, makes good policy sense.