The Grassroots Corner November 18th, 2024

THE EARNED INCOME TAX CREDIT – UNFAIR TO THE POOR

Image credit: Tax Foundation
 

           People who don’t understand the FAIRtax are often quick to dismiss it as a bad idea claiming that sales taxes by nature are regressive and disproportionally hurt those on the lower end of the income scale.  Here’s a great “what about?” comeback. It involves today’s income tax.

            Today's income tax system tries several ways to be fair to people living near the poverty line, but with little effect. There is no longer a personal exemption; this exemption has now become part of the increased standard deduction. For a married couple filing jointly, the standard deduction is $24,000. Taxpayers can use this deduction instead of itemizing to reduce their income base before calculating their taxes.

            In addition to the standard deduction, there is the Child Tax Credit. This credit is $2,000 per child age sixteen and younger and largely replaces the old exemption.  It’s important to understand the difference between a tax credit and a tax deduction.  A tax deduction reduces the amount of income that’s subject to taxation.  A tax credit directly reduces the amount of tax owed. 

            We now come to another credit, the Earned Income Credit. The previous deductions and credits are available to everyone. The Earned Income Credit instead targets only the working poor. It is a tax credit for low-to-middle-income workers. For the 2024 tax year, the credit for married taxpayers filing jointly with three “qualifying children” is $7,830.

           The credit is "refundable." That is, if that family’s tax obligation is less than $7,380, they are refunded the difference between their tax obligation and $7,380.  But, in order to qualify for the Earned Income Credit, the family’s adjusted gross income cannot be greater than $66,819.  Furthermore, the family can have no more than $11,600 in investment income.  Otherwise, the family loses the entire credit.

           Why shouldn’t taxpayers claiming the Earned Income Credit have more than $11,600 in investment income as long as their total adjusted gross income is $66,819 or less? Isn’t property at work just as valuable to the country as people at work?

            Many people claiming the Earned Income Credit are entitled to less than $7,380. According to TurboTax, a married couple filing a joint return with no “qualifying children” had better not earn more than $25,511 (with the same limitation on investment income), or they would lose this credit. For that couple, the credit is $632.

            So, how much does it cost to pay a tax preparer to claim this credit? Writing recently in Investopedia, Barbara Weltman says the average fee to prepare Form 1040 with the standard deduction, plus a state income tax return, was $220. For the married couple filing a joint return with no “qualifying children,” the preparer’s fee is over one-third, i.e., 35%, of the Earned Income Credit itself.

           Isn’t the Earned Income Credit supposed to help poor working couples instead of paid tax preparers? One would think so. To mitigate the problem of paying preparers, the IRS and several states now offer direct filing programs. These programs bypass paid preparers. Please read the Chairman’s Report from our President, Steve Hayes, from August 23, 2024. However, the taxpayer needs a computer to take advantage of the program. Even at today’s low prices, computers and internet subscriptions often cost more than the Earned Income Credit.

           We have a better idea. The FAIRtax leaves your income alone and features a “Prebate” to untax all lawful US residents up to the poverty level. Applying for the Prebate is easy. The application can be electronic or in paper form. The application does not care how much you make. It only asks how many members of your household are lawful US residents. That’s it. Anybody can fill out the form without paying a tax preparer.

           I want to thank FAIRtax supporter Reginald Callaway from New Zealand for giving me the idea to write about the Earned Income Credit.

           I would love to hear from you about other ways the Internal Revenue Code misfires.
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