Tax season is upon us, and the country's largest antipoverty program, the earned income tax credit, or EITC, will push billions of dollars into low-income working households in the form of tax returns. It's the biggest financial windfall of the year for many Americans, a chance to pay off debt, get a new transmission, replace the water heater, replace a dishwasher or TV or maybe even start a savings account. But, for most families, it will just mean catching up on bills.
As unemployment lingers, wages stagnate, and income inequality rises, more families have come to rely on their tax refund as a significant income source. About one in five filers now receive the EITC, or about 28 million returns in 2010, the most recent information available. This represents the highest percentage since the program began in the 1970s, according to a Brookings report.
Tax returns, including the credit, lifted six million Americans out of poverty last year, according to the Center on Budget and Policy Priorities, making it more important to low-income households than WIC or SNAP, formerly known as food stamps.
The EITC effect
The credit can return as much as 40 percent of income, and for a family under the poverty line, $6,000 can be a game changer. Availability for the EITC has expanded over the last couple decades, but promotion from both government and private tax prep institutions have led to rapid use of the credit.
“We find clear evidence that the EITC has significantly reduced poverty rates and income inequality,” Raj Chetty, an economist at Harvard who has studied the subsidy’s effect across cities, told the New York Times. “The program is pulling up the lower end of the income distribution.”
It also seems to have the benefit of making people feel like they are flush with cash — albeit briefly.
Elizabeth Ferrer is community relations manager for Neighborhood Tax Center of Houston, a partner with the federal Volunteer Income Tax Assistance, which offers free-of-cost tax preparation to low-income families.
Neighborhood Tax Center has been very successful in spreading their free-of-cost services, returning $140 million to low-income Houston residents last year. In exit surveys, Ferrer found clients spent the money quickly on necessities — the No. 1 reported use of refund money was rent and utilities, indicating households are using the funds just to get by.
Other top uses were savings and college education, or a major investment like purchasing a vehicle. "What this tells us is that the economy is still not growing," said Ferrer. "People are still not using the money for luxury items."
Getting the refund right
One problem with the credit is the feast-or-famine mentality that it engenders; once it's gone, low-wage workers are back to living paycheck-to-paycheck or living on expensive credit. Meting the money out over time might lend itself to easier and better budgeting. Ferrer says another problem with the lump sum is it can make people think of the refund as a "gift," rather than as their own money.
"They don't see if as coming out of their own wallet; they see it as a big bonus," says Ferrer. She says that she's had clients use other, non-VITA tax preparations franchises and pay hundreds of dollars for the same service. "I have literally had a client (who used a tax prep franchise) say to me, 'What's $500 when I'm getting $6,000 back?,'" says Ferrer. It's $500 that is theirs, she tells them, and for some of these families $500 is a month's rent."
Neighborhood Tax Centers and other federally funded Volunteer Income Tax Assistance Centers are available to individuals based on income and varies by location, but commonly families with children making under $52,000 qualify for free VITA services, and individuals making under $18,000 qualify, as is the case in New York.
VITA partners are key to helping low-income families get their tax returns right, and not only because they avoid the expensive fees other tax prep franchises charge and the predatory loans and practices of untrusted services.
All VITA volunteers are IRS-trained and -approved, while at other franchises just about anyone can be preparing your taxes using common software, says Tamara Lindsay, director of programs for NYC Department of Consumer Affairs Office of Financial Empowerment. She says that at other tax prep places you don't know their credentials."In New York, a hairdresser or a travel agent can become a tax preparer January through April," she says.
There's no reason low-income individuals should get gouged for hundreds of dollars at franchises that do little work. "Our clients' taxes are fairly simple, they don't have a lot of itemized deductions, so it really can take just a few minutes," she says.
A faulty tax return can cause IRS problems down the road, as everyone knows — but an accurate tax return is important for other reasons: buying a house, getting a car, applying for citizenship, applying for public assistance, all of these things require tax returns, Ferrer points out. Applying for college financial aid through the Free Application for Federal Student Aid program requires tax returns, especially from parents.
Ferrer's average client in 2013 made $22,000, and the average refund was $3,800, "that's one and a half months' rent that you're handing to someone," she says.
Tax returns have become such an important antipoverty tool that nonprofits and government agencies are experimenting with ways to make filing taxes easier and faster. Ferrer would like to experiment with mobile tax prep centers, if funding allows.
In New York, VITA programs this year have expanded to include "Virtual VITA" services, where clients can drop off their tax documents and pick them up later, so that clients don't have to skip school or work or find childcare. TurboTax also offers a "Freedom" edition for low-income filers who meet the income requirements.