Low-income Taxpayers Research Articles

Inertia and Overwithholding: Explaining the Prevalence of Income Tax Refunds

Over three-quarters of US taxpayers receive income tax refunds, which are effectively zero-interest loans to the government. Previous explanations include precautionary and/or forced savings motives. I present evidence on a third explanation: inertia. I find that following a change in tax liability, prepayments are only adjusted by 29 percent of the tax change after one year and 61 percent after three years. Adjustment increases with income and experience, and for EITC recipients, I rule out adjustment greater than 2 percent. Thus, policies affecting default-withholding rules are no longer neutral decisions, but rather, may affect consumption smoothing, particularly for low-income taxpayers. (JEL D14, H24, K34)

Federal-State Tax Interactions in the United States and Canada

The potential for vertical tax competition is strongest when different levels of government share the same base. Because there is greater sharing of common tax bases in Canada than in the United States, we expect vertical tax competition to be weaker in the United States than in Canada. Econometric analysis of US data supports this hypothesis. Taking account of the deductibility-related endogeneity of federal tax burdens by state, federal income tax burdens have no effect on average state income tax burdens. Introducing distributional considerations into the vertical tax competition model, we do find a significant displacement effect for higher income taxpayers, with higher federal burdens associated with lower state income tax burdens in the highest income quintile. For low-income taxpayers, federal and state tax burdens are complementary.

Inflation, impôts sur le revenu et revenu réel disponible

The purpose of this text is to examine how federal and Quebec provincial income tax policies have affected real disposable income of taxpayers in the context of the rapid inflation of the last five years. It finds that the net effect of federal fiscal reform since 1970 has been to make the tax structure more progressive. Low-income taxpayers have benefitted from lower tax rates in real terms but real tax rates have risen for those with incomes above approximately $14,000. On the provincial level, on the other hand, there has been virtually no change in the tax structure except for an increase in the threshold level below which no tax is paid. All, except the very poorest taxpayers (single persons earning less than $2,578 in 1970 or $3,200 in 1974 and married couples with two children earning less than $5,200 in 1970 or $6,300 in 1974), have paid higher taxes in real terms every year from 1970 to 1974. This is true even when provincial family allowances (which the province considers as a tax credit and as a substitute for personal exemptions for children under 16) are deducted from provincial income tax. The net result of federal and provincial tax policies, family allowance payments and deductions for various social security programs is as follows: real disposable income increased for single persons earning less than $4,000 in 1970 ($5,000 in 1974) and for two-children families earning less than $8,000 ($10,000 in 1974); it stayed about the same for single persons earning between $4,000 and $6,000 ($5,000 to $7,500 in 1974) and families earning $8,000 to $10,000 ($10,000 to $12,500 in 1974) in 1970; it fell for those with higher levels of income.

Regressive Tax Rates and the Unethical Taxation of Salaried Income

In a regressive tax system, lower-income taxpayers pay larger percentages of their incomes in taxes compared to higher-income taxpayers. Although most policymakers and citizens view regressive taxation as generally unfair and unethical, the U.S. tax system taxes wage, salary, and self-employment income in a manner that deliberately subjects lower-income taxpayers to marginal tax rates that are greater than those imposed on higher-income taxpayers. As a result, some lower-income taxpayers pay a larger percentage of their income in taxes than higher-income taxpayers. In this essay, we argue that this regressiveness in the taxation of salaried income is unfair and unethical. We then evaluate President Obama’s social security plan, which would retain most of the current tax system’s regressive structure. Finally, we offer two simple alternative proposals that are non-regressive, and thus more fair and ethical approaches to the taxation of salaried income.

Taxation and the worlds of welfare

Please note that consumption tax data in the paper are estimated from expenditure data in all cases, and are not directly taken from the LIS. The wording of footnote 6 is misleading, as it suggests that the consumption tax data were obtained from LIS for some countries; this is not the case. This is important to note because our method cannot take into account exemptions of consumption tax for lower-income taxpayers, and will overstate the regressivity of consumption tax in such cases. The authors would like to apologize for this error. We have re-estimated the consumption tax results using the LIS’s v14 category, which is defined as ‘All other types of direct taxes such as consumption tax, church tax, poll tax, etc.’ The conflation of consumption tax with other taxes makes this variable of limited use for our purposes, but does allow some insight. This variable is available for several countries, including three of the countries for which we had estimated sales tax from expenditure (France, Switzerland, and the UK). It proves to be regressive for those three countries, to a similar magnitude as in our paper; and it is regressive for all other countries except Norway. These calculations are available from the authors.

Subsidizing Charitable Contributions: Incentives, Information and the Private Pursuit of Public Goals

The charitable deduction has enjoyed relatively little support in the legal academy. Many commentators have asked what it adds to the tax system and, as critics have observed, the deduction obviously does not itself collect tax revenue. Defenders respond that the deduction helps measure income and keeps taxpayers from inefficiently substituting leisure for work, but these points are, of course, contested. Instead of revisiting debates about what the deduction adds to the tax system, this Article focuses on the broader question of what it adds to the pursuit of public goals. The deduction - and any other government subsidy that matches charitable contributions through the tax system (here called charity) - enlists private individuals to pursue public goals in a somewhat unique manner. While in other settings the government delegates implementation but still specifies the goal to be pursued, charitable donors are allowed to select the goal as well. Is it desirable to pursue public goals in this way? This Article analyzes three reasons to subsidize charitable contributions, each responding to a different information or incentive problem that is inherent in the pursuit of public goals. First, the subsidy can counter free-riding by encouraging donors to be more generous. A second objective is to measure and respond to popular preferences about public goals. Subsidized charity can encourage experimentation and competition and can empower minority perspectives that are underrepresented in the political process. Yet subsidized charity also disproportionately represents the views of wealthy donors. The third goal, which is new to the academic literature, is to recruit private donors to monitor the quality of nonprofits, so that the government can piggyback on these quality-control efforts. Since there are three competing rationales for the subsidy, its institutional design can vary depending upon which has priority - an insight that is new to the literature. To encourage generosity, the subsidy should focus on wealthy donors, giving them broad discretion about which causes to support and targeting marginal contributions. Recruiting these wealthy donors as monitors is largely compatible with this program. Yet by focusing on wealthy donors, the subsidy may fail to reflect broad popular preferences. In response, one option is to compensate with other policy instruments, such as government programs, to address the preferences of low-income nondonors. While I find this approach appealing, others could reasonably want subsidized charity itself to be more representative. Toward that end, we can go to extra lengths to persuade low income taxpayers to contribute more (e.g., through extra-generous matches) or, for that matter, to induce wealthy donors to contribute less (e.g., through caps on giving) or to support causes that reflect broad popular consensus (e.g., through limits on which causes are subsidized). Yet the cost of making the subsidy more representative in this way is that it will be less effective at advancing our other goals of encouraging generosity and recruiting monitors.

The Changing Impact of the Alternative Minimum Tax on Horizontal Equity

While prior research (Anderson 1985, 1988) indicates that the Alternative Minimum Tax (AMT) increases the fairness, or horizontal equity (HE), of the federal income tax system, changes in tax laws and the general inability of the AMT system to account for inflation raise serious questions about whether the AMT continues to increase fairness. Burman et al. (2002) observe that the reason many more taxpayers are now subject to the AMT is because of the increasing divergence of the regular tax and the AMT. This divergence subjects more lower-income taxpayers to the AMT, thus resulting in higher total tax liability. Using individual income tax return data for 1992, 1995, and 2000, and both dispersion-based and rank reversal-based measures, this study observes that the AMT still increases HE in many upper income groups, but decreases HE in many lower income groups. Moreover, overall measures of HE indicate that the AMT has a net decreasing effect on HE. There are two implications to these findings. First, it can no longer be assumed that the AMT uniformly improves HE. Second, the AMT generally continues to achieve its intended result at the upper income levels. This result suggests that regulators and legislators wishing to improve the AMT system need to address the causes of low-income taxpayers being subject to the AMT while maintaining the impact on upper income taxpayers.

The Failure of Education Tax Incentives

Federal aid to higher education has shifted over the last decade from direct subsidies to tax incentives. There are three types of Pigouvian subsidies designed to subsidize price: Nonrefundable tax credits and a deduction for tuition reduce the price of tuition; a deduction for interest on education loans lowers the cost of borrowing; and the tax-exemption of the earnings on education savings plans increases the return to saving. These tax incentives can be justified on either efficiency or equity grounds. If they increased investment in higher education, they would enhance efficiency by correcting for positive externalities. If they helped to eliminate disparities in the distribution of education consumption, they would increase equity. The paper develops models to test predicted taxpayer response to the most important education tax incentives. It concludes that the structure of the incentives is such that there will be no change in behavior in response to the subsidies. Those for who demand for education is most elastic (low income taxpayers) cannot use the incentives, those for whom demand is somewhat elastic (middle income taxpayers) will not use the incentives, and those for whom demand is inelastic (wealthy taxpayers) will reap the benefits in the form of increased consumption. The design of the credits also precludes a distributional change in education investment.

Tax Policy Reform and Economic Performance in New Zealand

New Zealand's tax system is relatively simple and transparent by international standards. But there may still be scope for reducing the costs of taxation. This paper develops a stylized model for New Zealand to evaluate the effects of reducing higher-income tax rates. The results suggest that a reduction in higher-income tax rates would improve New Zealand's long-run economic performance if it were financed by a decline in (non-productive) government spending and/or increases in revenue from other less distortional taxes. Despite the reductions in the higher-income tax rates, higher-income taxpayers would continue to pay a larger proportion of the tax burden than lower-income taxpayers.

The Courts and Public School Finance: Judge-Made Centralization and Economic Research

This paper explores for economists how the school-finance litigation movement, which began with Serrano v. Priest in 1971, ought to be characterized in economic models. Its primary message is that this has become a national movement, not one confined to individual states. Economists should be wary of characterizing these cases as discrete events in which a state that loses to reform-minded plaintiffs is distinctly different from a state that succeeds in defending its system. I describe numerous instances in which states have attempted to head off defeat in the courts by conceding to reform-demands by the plaintiffs. School finance litigation does make a difference, however. Win or lose, states have been induced to reformulate their state-aid formulas. I show that the most common of these reforms, which focus on differences in tax-base per pupil, have altered the local tax-price for education. This alteration causes the property rich districts to pay more for education. However, the correlation between property rich and income rich is essentially zero, largely because low-income communities are more willing to tolerate the nonresidential uses that lower their tax price. The result is that school-finance reform in most states is likely to reduce the efficiency of local public education because of tax-price distortion but not improve the lot of low-income students and taxpayers in any systematic way.

The Undeserving Poor?: Welfare, Tax Policy, and Political Discourse

Low-income taxpayers are politically unpopular these days. Last summer's child tax rebates were not sent to 12 million low-income families and beginning this year, low-income taxpayers will have to prove their eligibility for tax benefits before receiving them. This Article argues that low-income taxpayers are politically unpopular because of the perceptions held about them. Low-income taxpayers are perceived to be disproportionately Black by both politicians and academics. Politicians recently played the race card by analogizing low-income taxpayer rebates to welfare. Academics simply stated that low-income taxpayers who are eligible for the earned income tax credit were Black and disproportionately benefited from the credit. This Article provides the first comprehensive analysis of low-income taxpayers and shows that twice as many Whites as Blacks are eligible for the earned income tax credit. This Article also shows that the tax benefits available to low-income taxpayers disadvantage low-income Black families when compared with the tax benefits available to middle-income families. This Article concludes by suggesting areas for tax reform that would treat low-income families like their middle-income counterparts.

The Poor and Tax Compliance: One Size Does Not Fit All

This article examines the scope of the low income taxpayers' compliance problem. It also reveals why in a period of remarkably low levels of government tax compliance activity, the IRS compliance effort toward lower-income taxpayers has been particularly vigorous. The article examines in greater detail noncompliance with respect to the earned income tax credit, and, building on the work of sociologists Robert Kidder and Craig McEwen, explores the likely causes of the high levels of noncompliance. The article examines some of the policy implications of noncompliance among lower-income taxpayers. In particular, it argues that the government is not vigilant enough to root out intentional abuse. The government dedicated few resources on the ground to identifying purposeful taxpayer abuse. IRS reform and budgetary pressures resulted in remote correspondence-based compliance initiatives staffed by low-level IRS employees. At the same time, the positive assistance that Congress and the IRS have put in place are not sufficiently targeted to lower-income taxpayers, nor are they appropriately balanced with the IRS's traditional deterrence measures.

The elasticity of taxable income: evidence and implications

A central tax policy parameter that has recently received much attention, but about which there is substantial uncertainty, is the overall elasticity of taxable income. We provide new estimates of this elasticity which address identification problems with previous work, by exploiting a long panel of tax returns to study a series of tax reforms throughout the 1980s. This identification strategy also allows us to provide new evidence on both the income effects of tax changes on taxable income, and on variation in the elasticity of taxable income by income group. We find that the overall elasticity of taxable income is approximately 0.4; the elasticity of real income, not including tax preferences, is much lower. We estimate small income effects of tax changes on reported income, implying that the compensated and uncompensated elasticities of taxable income are very similar. We estimate that this overall elasticity is primarily due to a very elastic response of taxable income for taxpayers who have incomes above $100 000 per year, who have an elasticity of 0.57, while for those with incomes below $100 000 per year the elasticity is less than one-third as large. Moreover, high income taxpayers who itemize are particularly responsive to taxation. Our estimates suggest that optimal tax structures may feature tightly targeted transfers to lower income taxpayers and a flat or even declining marginal rate structure for middle and high income taxpayers.

The Impact on Efficiency and Distribution of a Base-Broadening and Rate-Reducing Tax Reform

We analyze a base-broadening, rate-reducing, and simplifying tax reform, which may be revenue-neutral, or which may keep the average tax rates constant. Such a reform generally improves efficiency under reasonable conditions but not necessarily if the average tax rate is calculated on taxable incomes or if revenue-neutrality refers to aggregate tax payments only. In most cases, an efficiency-improving reform probably increases inequality unless the marginal rate reduction greatly affects low-income taxpayers. So in some cases, there might be a utilitarian case for increasing, rather than reducing the marginal tax rate.

The effects of tax rates and enforcement policies on taxpayer compliance: A study of self-employed taxpayers

This paper presents an econometric analysis of taxpayer compliance, exploring its relationship with audit rates, penalties if detected, tax rate schedule, income level, and sources of self-employment income. Using data drawn from theAnnual Report of the Commissioner of Internal Revenue Service [IRS, various] and theData Book [IRS, various] for 1980 to 1995, the audit rate and penalty rate are both effective deterrents to noncompliance. The effectiveness of these two policy instruments depends upon the individual's level of income. It seems the higher the income level, the more effective these instruments are. In general, compliance increases with the level of income but at a decreasing rate. It is also found that individuals tend to comply less as the marginal tax rate rises. Again, such tendency is more pronounced for high-income taxpayers than for low-income taxpayers.

Measuring the Effect of the EITC on Marriage Penalties and Bonuses

In 2000, the EITC will increase marriage penalties by at least $3.1 billion (10.4 percent) and reduce marriage bonuses by $439 million (1.5 percent). Over half of EITC-related marriage penalties will be attributable to couples who currently re ineligible for the EITC because their income is above $30,000. However, estimates of marriage penalties and bonuses are very sensitive to assumptions regarding a couple's living arrangements and custody agreements if they do not file joint returns. Recent proposals to provide marriage penalty relief through the EITC are well-targeted to lower-income taxpayers but vary in their ability to reduce marriage penalties.

Social Tax Policies Directed at the Working Poor: The New York State Experience

Major changes in federal and state welfare systems have created new opportunities for the development of innovative social policies aimed at low-income individuals who desire to work. New York State, which had one of the most generous earned income tax credits and child and dependent care credits among the states, is now using federal funding through the Temporary Assistance to Needy Families program to finance enhancements in these tax cred- its. The authors demonstrate the impact of the combined income tax credits on low-income taxpayers. The results show that over the past seven years, effective tax rates have decreased markedly and become negative for these taxpayers. In effect, New York pro- vides direct cash rebates to working poor families, and these tax subsidies are among the largest of all the states.

TAX EVASION IN THE PRESENCE OF NEGATIVE INCOME TAX RATES

* Abstract - This paper examines the impact of marginal tax rates, which incorporate the earned income tax credit (EITC) as it existed in 1988, on the reporting of income by low-income taxpayers. We generally find that misreported income is not affected by tax rates, except for proprietors. Negative marginal tax rates, which occur in the phase-in range of the EITC, do not appear to affect the amount of income overreported, irrespective of the source of income. Furthermore, the amount of income underreported does not appear to be affected by the relatively high marginal tax rates which occur in the phase-out range, except for proprietors. Even in the case of proprietors, the effect on the understatement of income is modest.

The Effect of Increased Tax Rates on Taxable Income and Economic Efficiency: A Preliminary Analysis of the 1993 Tax Rate Increases

The 1993 tax legislation raised marginal tax rates from 31 to 36 percent on taxable incomes between $140,000 and $250,000 and to 39.6 percent on incomes above $250,000. This paper uses recently published Internal Revenue Service (IRS) data on taxable incomes by adjusted gross income (AGI) class to analyze how the 1993 tax rate increases affected taxable income, tax revenue, and economic efficiency. Our estimates are based on a difference-in-difference procedure that compares the growth of taxable incomes among taxpayers with AGIs over $200,000 with that of incomes of lower income taxpayers. We use the NBER TAXSIM model to adjust for interyear differences in the composition of the two taxpayer groups. The results show that high-income taxpayers would have reported 7.8 percent more taxable income in 1993 than they did if their tax rates had not increased. Because of the high threshold for the increase in tax rates, this decline in taxable income caused the Treasury to lose more than half of the extra revenue that would have been collected if taxpayers had not changed their behavior. The deadweight loss caused by the higher marginal tax rates (including the effects on labor supply and on consumption of goods and services favored by deductions and exclusions) is approximately twice as large as the $8 billion in revenue raised by the 1993 tax rate. Several possible statistical biases could cause the estimated effect of the tax changes to either underestimate or overestimate the true long-run effect. The paper concludes with a discussion of these problems and of plans for future analysis.

The Earned Income Tax Credit: Its Effect and Its Significance

Initially a program to relieve the burdens of the social security tax on low-income taxpayers, the Earned Income Tax Credit (EITC) is rapidly becoming a major income support program for the working poor and their families. This article discusses the effects of the EITC on the income status and work incentives of welfare families in New York City and Texas, assesses the distributive effect of the EITC, and investigates the extent to which the EITC helps welfare families escape poverty through work. It then places the EITC in a broader policy perspective, describing its ripple effects on this country's treatment of the working poor versus the nonworking poor, support of children, and attempts to cope with the increasing disparity in the incomes of high-wage and low-wage workers.