Tax Delays, Loan Sharking, and the Working Poor

January 27, 2006By Michael Leachman

Low-income working families across Oregon are busy filling out their income tax returns well ahead of the April deadline. That’s because through outreach efforts and word of mouth they know that they are eligible for the Earned Income Credit, or EIC.

About one out of seven taxpaying families in Oregon – those working in the lowest wage jobs – benefit from the EIC.

Unfortunately, the Internal Revenue Service is focusing a disproportionate share of its resources on harassing EIC recipients. That’s bad for low-wage working families and for Oregon’s economy.

The EIC is a significant economic catalyst in Oregon. For the 2002 tax year, the federal EIC pumped $338 million into Oregon’s economy. Those federal funds help the local economy, particularly in poorer, rural parts of the state.

The tax credit also helps stabilize over 200,000 Oregon families working for low wages. It is well established that the credit succeeds as an incentive for families to work more. The credit also offsets the regressive payroll and excise taxes these families pay.

The EIC enjoys a long history of bipartisan support. Presidents Ronald Reagan, George Bush, Sr., and Bill Clinton all lauded the tax credit and pushed for its expansion.

But the IRS administers the EIC as if it holds a grudge against low-wage workers.

Earlier this month, the IRS’ own internal watchdog issued a report revealing that each year the IRS is freezing the refunds of hundreds of thousands of taxpayers without informing the taxpayers what is going on. The refund freezes last for an average of nine months. Ostensibly, the IRS freezes the refunds as part of the IRS’s efforts to find fraud.

Usually these low-wage taxpayers did nothing wrong. The IRS’s internal watchdog report estimated that two out of three taxpayers with frozen returns were due their full refund, and four in five were due at least a partial refund.

These IRS-initiated delays have a significant impact on low-wage families. On average, the report found, frozen refunds equal more than 25 percent of the taxpayer’s annual income.

EIC recipients who receive a “rapid refund” loan from a tax preparer are hit particularly hard by the IRS’s misguided enforcement. Rapid refunds are essentially high-interest short-term loans. Ordinarily, these loans are paid off - along with hefty fees for the tax preparer - when the IRS sends the refunds. When the IRS freezes a refund, though, the taxpayer remains liable for repayment of the loan.

Instead of exacerbating the problem, the IRS should be doing what it can to protect low-wage working taxpayers from the high costs of “rapid refund” schemes. The National Consumer Law Center estimates that one out of every three EIC recipients pays high-interest “rapid refund” fees, at a total cost of $900 million in 2004 alone.

The EIC should be simplified so that it is easier for taxpayers to understand and for the IRS to evaluate, and refunds should be more timely issued. In 2004, the Bush Administration submitted a proposal to Congress to simplify the EIC, but Congress failed to act. The IRS is exacerbating the problem with its overzealous refund freezes.

The IRS offers free electronic filing, typically for taxpayers with incomes under $50,000 annually. Unfortunately, commercial tax preparers are allowed to advertise “rapid refund” loans on the electronic filing sites accessed through the IRS web site. The IRS does not even warn taxpayers of the usurious nature of “rapid refund” loans accessed through their site.

The Earned Income Credit is a crucial and successful tool of federal economic and social policy. It should not be a tool of harassment, or a vehicle to extract high-interest loans from our lowest paid working taxpayers.