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CBO: Three Things you Probably Didn’t Know About Refundable Tax Credits

Jan. 25, 2013 7:37am Becket Adams

In Depth CBO Report Explores the History & Cost of Refundable Tax Credits

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Rejoice! Tax season is upon us! We’re sure you’re looking forward to breaking out those calculators and crunching some hard numbers (Lord knows we are).

Seriously though, as tax season quickly approaches, we got to thinking: Just what is the story behind refundable tax credits (because that’s the sort of thing we think about)?

It just so happens that the Congressional Budget Office has released a comprehensive review of the “evolution and federal costs of refundable tax credits, their effects on the economy and the tax system, the administrative challenges in providing subsidies, and the transparency of such credits in the federal budget.”

But before we go any further, you’re probably wondering about that “federal costs of refundable tax credits” part.

Let’s dig into this.

“Refundable tax credits differ from other preferences [that lower or eliminate the amount of taxes owed] in a significant way: Whereas other preferences reduce the amount of taxes owed to the government, refundable credits can result in net payments from the government,” Janet Holtzblatt of CBO’s Tax Analysis Division and Grant Driessen, formerly of CBO, explain.

“Specifically, if the amount of a refundable tax credit exceeds a filer’s tax liability before that credit is applied, the government pays the excess to that person or business,” they add.

So, yes, in certain cases, the feds actually pay out more than they take in.

“In the federal budget, the portion of refundable credits that reduces the amount of taxes owed is counted as a reduction in revenues, and the portion that exceeds people’s tax liabilities is treated as an outlay; the total federal cost is the sum of those two components,” Holtzblatt and Driessen add.

Noting that the first refundable credit appeared in 1975 (the earned income tax credit [EITC]), the CBO report goes on to illustrate the exponential rise in the cost and number of these specific credits.

Let’s take a look at CBO’s report on the evolution and cost of refundable tax credits:

1. Total Cost of Refundable Credits: 1975-2010

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“The number of credits peaked at 11 in 2010 before dropping to 6 in 2013,” the report explains. “Their total costs reached a high of $238 billion in 2008.”

“In 2013, the costs will drop to $149 billion,” the report adds, “mostly for the EITC and the child tax credit. By 2018, three more credits will have expired, and the child tax credit and the EITC will have been scaled back.”

The report also claims that the cutback in refundable credits will be offset by new “health-related subsides” brought in via the tax system.

“Starting in 2014, a new refundable tax credit will be available to some people for the purchase of health insurance through newly created exchanges. The cost of that credit will be about $110 billion by 2021,” the report notes, “bringing the total cost of refundable tax credits in that year to $213 billion — roughly the same as the costs in 2009 and 2010, even though the number of refundable tax credits will have fallen by more than half between 2010 and 2021.”

2. Recent Refundable Tax Credits Aren’t Directly Tied to People’s Earnings

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Refundable tax credits nowadays are more focused on subsidizing the cost of health insurance and higher education than they are on earnings.

“Not only have the number and costs of refundable tax credits grown over the years, but the nature of those credits has evolved. Eligibility for the first refundable tax credit — the EITC — was based primarily on the recipient’s earnings, adjusted gross income, and the number of children in his or her home,” the CBO report claims.

“However, many of the newer refundable tax credits are not limited to people with earnings but are instead used to compensate people for expenditures on items such as health insurance and higher education,” the report adds.

3. The Long-Term Effect of Refundable Credits on the Economy & Tax System

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Because credits have a tendency to favor certain goods and services, resource allocation can be heavily biased.

“Credits that decline in value as income rises prompt some people to work fewer hours,” the report notes. “However, credits that increase as earnings rise, such as the EITC at certain income levels, provide an incentive for some people to work more. The EITC also draws people into the labor force by increasing their after-tax income. On balance, the latter effect appears to dominate.”

It continues:

In addition, the growth of refundable tax credits has contributed to a decline in average tax rates among households in the bottom 40 percent of the income distribution. That decline is most notable for individual income tax rates, which between 2007 and 2009 became increasingly negative for low-income households (that is, on average, those households received money back from the federal government instead of owing income taxes). Most of those households, however, pay federal payroll taxes.

Refundable tax credits also affect the administration of taxes. By adding more complicated rules, more tax forms, and more computations, the credits increase the costs incurred by taxpayers in complying with the tax code and by the government in administering those laws.

–

The report goes on to suggest that the goal of issuing refundable tax credits (i.e. “providing income support for low-income households, expanding health insurance coverage, or increasing college enrollment”) might be better achieved through government spending programs such as Supplemental Nutrition Assistance Program (food stamps), the Temporary Assistance for Needy Families program, Medicaid, etc.

Hold on! Hold on! The CBO clarifies its position.

As a cost-cutting measure, the report explains that any decision to replace refundable tax credits with government spending programs would hinge largely on “administrative considerations” (i.e. “the effectiveness in reaching the target population, timeliness, and the ability to ensure compliance with rules”). Basically, a well-run and well-thought-out government program might serve low-income households better than a needlessly complicated and ever-expanding tax system.

And that seems like a fairly reasonable suggestion. It’s either that or reform the tax code (ha-ha).

Question is, are there enough people in our nation’s capital capable of putting together the type of cost-efficient program the CBO suggests?

Click here to read the full CBO report.

Follow Becket Adams (@BecketAdams) on Twitter

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Comments (14)

grickm
Posted on January 25, 2013 at 12:55pm
Ah the joys of redistribution of wealth. I hope all comrades are pleased to be helping the less fortunate. It will have to be self-satisfaction, because the president and his minions won’t thank you, rather call you names and try to take more “for purposes of fairness.”

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Inform
Posted on January 25, 2013 at 10:20am
Below $30k a year, the average federal tax rate is negative because of refundable tax credits. You have a whole boat load of people freeloading (47.9%), with a large crowd of them getting paid not to contribute and most of the tax burden is placed on a small subset of the population. 15 million people have a zero tax liability for ALL taxes, including federal payrol and local. We need to switch to a flat tax and make the system fair.
http://www.youargue.com/index.php/discussions/browse/24-a-fair-tax-is-a-flat-tax.html

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- watashbuddyfriend
  Posted on January 25, 2013 at 10:52am
  I still hold out for a Fair Tax whereby Gross Income of the Individual, and/or Business is Taxed, ignoring any, and all expenses, and exemptions! I hope you understand that Corporations DO NOT pay income taxes, but they do collect them and pass onto the Fed to be squandered? Remember, Corporations pass the income taxes they collect onto YOU and ME, in the price of their goods and/or services.
  
  Report this comment
- Elena2010
  Posted on January 25, 2013 at 11:58am
  Unless you are a single person, like me, in which case you still owe them money! I earn around $24K, have some small investments, and still end up writing a check to the spendthrifts.
  
  Flat tax, no deductions, is inherently a fair tax.
  
  Report this comment
JimmyP
Posted on January 25, 2013 at 10:13am
Oddly enuf, there is no mention of the extent of tax fraud in the area of the Earned Income Credit.

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- objectivetruth
  Posted on January 25, 2013 at 12:02pm
  There isn’t enough room in a book to detail it all.That also wouldn’t cover the higher cost to cities and towns in investigations for ID Theft,Mail Theft,SSN Fraud.Lets not forget robbery murder exc that also go up in tax season.Oh and drug sales and prosecutions.I mean its a cash cow for all concerned but the tax payer.Most of you have no clue how much money is actually spent on the resulting frauds.The cities and counties simply ask for reimbursement.
  531 tax code needs to be instituted now.No more refundable credits no more credits.All it would require at the end of the year is a information form.Both of individuals and business’s.Business would still need to file a schedule c for information purposes and to determine their true tax owed.For small owners.Most large owners pay estimated taxes already.If they overpaid then the overpayment would be refunded or used as carry over which is what they do now.
  Btw The 531 plan all but eliminates the ability and urge to evade taxes.I would also make it so that those who start business’s and are afraid to file their taxes due to local over regulations could declare that and pay them without the record being forwarded to their locales.They would have to prove that its a problem with overregulation though.Sorry there isn’t enough room to explain it totally here.
  
  Report this comment
jungle J
Posted on January 25, 2013 at 10:11am
Refundable tax credits nowadays are more focused on subsidizing the cost of health insurance and higher education than they are on earnings.

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NoMoMrNiceGuy
Posted on January 25, 2013 at 8:13am
We CANNOT keep this up. Hang on kids it is about to get bumpy !

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SamIamTwo
Posted on January 25, 2013 at 8:12am
?Question is, are there enough people in our nation’s capital capable of putting together the type of cost-efficient program the CBO suggests??

You had to ask? With Obama contracting out, adding 250K more feds and plussing up the IRS by 17K, yeah they have enough people to do whatever anyone can think of…especially with grant money and hard line contracting out to their favorite coos.

The question is will they…

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CatB
Posted on January 25, 2013 at 8:12am
Welfare given out through the IRS. They failed to mention how many ILLEGALS get these “credits” .. I would like that number. I think that would be the staggering one.

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- glckgrl
  Posted on January 25, 2013 at 12:15pm
  Yes, at the local extension office, there is a flier urging illegal immigrants to file for food stamps and to get help with a place to live, even if they do not have identification or a job, and their identity will be kept confidential. Strange, isn’t it?
  
  Report this comment
Perspective
Posted on January 25, 2013 at 8:08am
I have said for many years now that it’s bullhockey that someone can receive more money back from the IRS than they paid in. You see that is called REDISTRIBUTION OF WEALTH! It’s just done on the sly so we the people don’t notice. How I learned about it was one year my wife told me I had been doing our taxes wrong. I asked what she meant and she told me that a couple we were friends with were receiving several thousands of dollars as a refund while we were slated for refund of a little over $400. I wondered how this could be since the husband didn’t work at all and the wife was a teachers aid who made around $20k. I told my wife there was no way I did them wrong but she persisted.My stepfather had become a HR Block preparer that year si called him over to check my return.He confirmed that I had done them correctly so I asked him how it was that someone who surely didn’t pay in that much could receive such a large refund.He told me that due to TAX CREDITS a lot of people got back more than they paid in because of how the tax credits work.I don’t have a problem with people who make less paying less but I have a severe problem with them receiving money back THEY DIDN’T PAY IN. You see that money comes from the pockets of those of us who do pay in.Once again,we already have redistribution of wealth through tje IRS,it’s just many people don’t realize it.

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- texan_conservative
  Posted on January 25, 2013 at 10:10am
  Finally, someone who sees what is going on.
  
  I can attest to this fact. Nobody believes me when i tell them I get back considerably more than i pay in.
  
  In 2011 I paid in about $400 in income tax. After my earned income credit for just having a child, i got back almost $2000. I have seen this same scenario with my friends also. Were all young, and do not make a lot of money. My friend has 2 kids and a wife. He pays next to ZERO taxes. He paid in too much first off, he paid in about $800. He got back almost $4000 dollars.
  
  I have been calling talk radio stations and suck for a while telling this story. People do not know this is going on. IT IS REDISTRIBUTION of wealth. One guy pays in $2500 in taxes and gets nothing back or even owes money at the end of the year, the next guy gets that money in the form of a “gubment” check.
  
  It has been going on for a very long time.
  
  Report this comment
- Inform
  Posted on January 25, 2013 at 10:23am
  Liberal policies like these will be the down fall of our country.
  
  Report this comment

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