Congress has been obsessed with using refundable credits as a form of “negative income tax” in an attempt to redistribute income to lower earners. It began with the Earned Income Credit, recently added the Additional Child Tax Credit, American Opportunity Credit and Premium Tax Credit and during COVID included the Recovery Rebate Credit and temporarily made the basic Child Tax Credit and Credit for Child and Dependent Care refundable. A component of the so-far unsuccessful Build Back Better legislation is the expansion of refundable credits.
Refundable tax credits are bad tax policy. The main cause of complexity in the Tax Code and tax return errors is the use of the Form 1040 to deliver social welfare and other government benefits, often through the use of refundable credits. And the majority of tax fraud involves refundable credits. The IRS estimates that 21-26% of all EITC claims are erroneous.
I would not necessarily object to credits in excess of tax liability being carried forward to future tax years – but I vehemently oppose all refundable credits. And I actually oppose the existence of some tax credits. That said I must point out that I have always claimed all tax credits to which my clients were entitled under the law over the years, regardless of my personal opinion concerning the appropriateness of the credits.
The one and only purpose of the federal income tax system is to raise the money necessary to fund the government. The US Tax Code must never be used for social engineering, to redistribute income or wealth, or to deliver social welfare and other government benefits.
For many years I have been saying that the Internal Revenue Service, and the tax professional community, should not be required to act as Social Workers and administer and verify government program benefit payments.
I am not saying that the government shouldn’t provide financial assistance to the working poor and college students, provide encouragements for purchasing health insurance, making energy-saving purchases and improvements and other ‘worthy’ actions. What I am saying is that such assistance and encouragements should not be distributed via the Form 1040.
The benefits provided by the Earned Income Tax Credit and the refundable Child Tax Credit should be distributed via existing federal welfare programs for Aid to Families with Dependent Children. The benefits provided by the education tax credits and deduction for tuition and fees should be distributed via existing federal programs for providing direct student financial aid. The benefits provided by the Premium Tax Credit, the energy credits, and other such personal and business credits should be distributed via direct discount payments to the appropriate vendors or direct rebate programs, similar to the successful Cash for Clunkers program of a few years ago, funded by the budget of the appropriate Cabinet departments.
Distributing the benefits in this manner is much better than the current method for many reasons:
(1) It would be easier for the government to verify that the recipient of the subsidy, discount or rebate actually qualified for the money, greatly reducing fraud. And tax preparers, and the IRS, would no longer need to take on the added responsibility of having to verify that a person qualifies for government benefits.
(2) The qualifying individuals would get the money at the “point of purchase,” when it is really needed, and not have to go “out of pocket” up front and wait to be reimbursed when they file their tax return.
(3) We would be able to calculate the true income tax burden of individuals. Many of the infamous “47%” would still be receiving government benefits, but it would not be done through the income tax system, so they would actually be paying federal income tax.
(4) We could measure the true cost of education, housing, health, energy and welfare programs in the federal budget because benefit payments would be properly allocated to the appropriate departments.
So – do you agree?