Utilization of Income Tax Credits by Low-Income Individuals

Abstract

The Internal Revenue Service—a sub-agency that exists to collect revenue—has the task of administering and enforcing a wide array of social policy: from subsidies for college and child care expenses, to creating jobs in depressed areas, and assisting welfare recipients with employment. While these new or expanded credits represent a new paradigm in the delivery of social policy, little is known about who uses these programs and, equally important, who does not use these programs. Understanding utilization is a key to understanding how effective this means of transferring income is and whether we are reaching the targeted populations. This paper provides a framework for thinking about utilization of tax credits among low-income individuals, supported by existing research on credit utilization. With the existing data, it appears that utilization is by far the largest for the EITC, possibly because it is the oldest of these programs, the only refundable program, and the best targeted at low-income individuals. Utilization is low among low-income individuals in some tax credits because low-income individuals are not eligible. A redesign, including reducing complexity and administrative burdens or making these programs refundable, would result in the programs reaching those that they are ostensibly targeted towards. Conditional on being eligible, one common factor associated with increasing participation in many of these programs is a high benefit to cost ratio and sophistication with the tax system, whether that be through the use of a paid préparer, higher education levels, or experience with the tax system. Policymakers should think creatively about reducing filing burdens to increase participation, such as through wider use of electronic filing.