Insights from Behavioral Economics Can Improve Administration of the EITC

Abstract

The IRS is a non-traditional but key player in delivering social benefits to the nation’s working poor. In fact, it administers one of the nation’s largest anti-poverty programs: the earned income tax credit (EITC). The EITC is generally praised for its role in reducing poverty and incentivizing low-wage work. While the credit has bipartisan support, the IRS continues to face strong criticism over EITC compliance issues. The IRS has generally focused on tax return characteristics in identifying and preventing erroneous EITC claims. We believe that adding an additional focus on taxpayer characteristics may offer new opportunities to improve EITC compliance (and perhaps other areas where there is systemic noncompliance). To supplement existing approaches and build on insights that derive from a taxpayer rather than tax return-centric model of compliance, we argue that the IRS should draw from insights from the field of cognitive psychology. Cognitive psychology research, often grounded in insights associated with research in behavioral economics, suggests that by increasing psychological costs and the perceived likelihood of detection, people may be more truthful. We offer specific proposals for further exploration. We note that the approach has potential application in other areas of the tax law, but focus on the EITC because of its broad importance as a matter of national policy, the longstanding and persistent criticism of stubbornly high EITC error rates and the limitations of the IRS’s current approach addressing EITC compliance.