SPEAKERS CONTENTS INSERTS Tables
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49–502 CC
1998
INTERNAL REVENUE SERVICE'S 1995 EARNED INCOME TAX CREDIT COMPLIANCE STUDY
HEARING
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTH CONGRESS
FIRST SESSION
MAY 8, 1997
Serial 105–26
Printed for the use of the Committee on Ways and Means
COMMITTEE ON WAYS AND MEANS
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BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois
BILL THOMAS, California
E. CLAY SHAW, Jr., Florida
NANCY L. JOHNSON, Connecticut
JIM BUNNING, Kentucky
AMO HOUGHTON, New York
WALLY HERGER, California
JIM McCRERY, Louisiana
DAVE CAMP, Michigan
JIM RAMSTAD, Minnesota
JIM NUSSLE, Iowa
SAM JOHNSON, Texas
JENNIFER DUNN, Washington
MAC COLLINS, Georgia
ROB PORTMAN, Ohio
PHILIP S. ENGLISH, Pennsylvania
JOHN ENSIGN, Nevada
JON CHRISTENSEN, Nebraska
WES WATKINS, Oklahoma
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
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CHARLES B. RANGEL, New York
FORTNEY PETE STARK, California
ROBERT T. MATSUI, California
BARBARA B. KENNELLY, Connecticut
WILLIAM J. COYNE, Pennsylvania
SANDER M. LEVIN, Michigan
BENJAMIN L. CARDIN, Maryland
JIM McDERMOTT, Washington
GERALD D. KLECZKA, Wisconsin
JOHN LEWIS, Georgia
RICHARD E. NEAL, Massachusetts
MICHAEL R. McNULTY, New York
WILLIAM J. JEFFERSON, Louisiana
JOHN S. TANNER, Tennessee
XAVIER BECERRA, California
KAREN L. THURMAN, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records of the Committee on Ways and Means are also published in electronic form. The printed hearing record remains the official version. Because electronic submissions are used to prepare both printed and electronic versions of the hearing record, the process of converting between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process is further refined. The electronic version of the hearing record does not include materials which were not submitted in an electronic format. These materials are kept on file in the official Committee records.
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C O N T E N T S
Advisory of May 1, 1997, announcing the hearing
WITNESSES
Internal Revenue Service, Hon. Michael P. Dolan, Deputy Commissioner; accompanied by Ted F. Brown, Assistant Commissioner, Criminal Investigation; and John Dalrymple, Deputy Chief, Taxpayer Service
U.S. Department of Treasury, Hon. John Karl Scholz, Deputy Assistant Secretary, Tax Analysis
U.S. General Accounting Office, Hon. Lynda D. Willis, Director, Tax Policy and Administration Issues, General Government Division
SUBMISSIONS FOR THE RECORD
American Institute of Certified Public Accountants, statement and attachments
Center for Law and Human Services, Michael A. O'Connor, letter and attachment
Community Tax Aid, Inc., Jeffrey S. Gold, statement and attachments
Community Tax Law Project, Richmond, VA, Nina E. Olson, statement
Joint Committee on Taxation, statement
National Association of Enrolled Agents, Gaithersburg, MD, Judy E. VandeZandschulp, statement
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INTERNAL REVENUE SERVICE'S 1995 EARNED INCOME TAX CREDIT COMPLIANCE STUDY
THURSDAY, MAY 8, 1997
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 10:05 a.m., in room 1100, Longworth House Office Building, Hon. Bill Archer (Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
CONTACT: (202) 225–1721
FOR IMMEDIATE RELEASE
May 1, 1997
No. FC–8
Archer Announces Hearing on the
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Internal Revenue Service's 1995 Earned
Income Tax Credit Compliance Study
Congressman Bill Archer (R–TX), Chairman of the Committee on Ways and Means, today announced that the Committee will hold a hearing to examine the Earned Income Tax Credit (EITC) Compliance Study released by the Internal Revenue Service (IRS) on April 21, 1997. The hearing will take place on Thursday, May 8, 1997, in the main Committee hearing room, 1100 Longworth House Office Building, beginning at 10:00 a.m.
Oral testimony at this hearing will be from invited witnesses only. Witnesses will include, among others, officials from the IRS, the Department of the Treasury, and the General Accounting Office. However, any individual or organization not scheduled for an oral appearance may submit a written statement for consideration by the Committee and for inclusion in the printed record of the hearing.
BACKGROUND:
Under present law, the amount of EITC that an eligible taxpayer may claim depends on whether the taxpayer has one, more than one, or no qualifying children and is determined by multiplying the credit rate by the taxpayer's earned income up to an earned income threshold. The maximum amount of the credit is the product of the credit rate and the earned income threshold. For taxpayers with earned income (or adjusted gross income (AGI), if greater) in excess of the phaseout threshold, the credit amount is reduced by the phaseout rate multiplied by the amount of earned income (or AGI, if greater) in excess of the phaseout threshold. For taxpayers with earned income (or AGI, if greater) in excess of the phaseout limit, no credit is allowed.
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In recent years, Congress has enacted several changes to the credit's eligibility requirements in order to better target the program to low-income workers. In addition, changes have been enacted to enhance the IRS's ability to enforce compliance with the credit, including a provision authorizing the IRS to treat a taxpayer's failure to provide a valid Social Security number for EITC qualifying children as a mathematical error.
Despite these changes, noncompliance in the EITC program remains at high levels. Last week, the IRS released a study entitled ''Study of EITC Filers for Tax Year 1994.'' This study was based on a sample of 1994 returns claiming the EITC and received by the IRS between January 15 and April 21, 1995. The study found that taxpayers erroneously claimed approximately $4.4 billion of EITC, which was 25.8 percent of the total EITC claimed in the 1995 filing season. Adjusting for changes in IRS enforcement practices made for the 1995 filing season, the net error rate would have been 23.5 percent. The study also found that had the procedural changes enacted in the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (P.L. 104–193) been in effect during the 1995 filing season, the error rate would have been 20.7 percent.
In announcing the hearing, Chairman Archer stated: ''The results of the IRS's EITC compliance study are extremely troubling. Despite the Government's best efforts, EITC fraud and errors are still shockingly high. We have an obligation to the nation's taxpayers to ask whether the benefits of delivering the EITC through the tax system justifies the loss of $5 billion a year in fraudulent and erroneous payments.''
FOCUS OF THE HEARING:
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The Committee will receive testimony from Ted F. Brown, Assistant Commissioner of the IRS, Criminal Investigation, regarding the findings of the EITC Compliance Study and the types of fraudulent claims and errors identified by the IRS. The Committee will also hear Treasury officials regarding legislative options recently advanced by the Department for improving EITC compliance, and from the General Accounting Office regarding work they have done on EITC administration and compliance issues.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit a written statement for the printed record of the hearing should submit at least six (6) copies of their statement and a 3.5-inch diskette in WordPerfect or ASCII format, with their address and date of hearing noted, by the close of business, Thursday, May 15, 1997, to A.L. Singleton, Chief of Staff, Committee on Ways and Means, U.S. House of Representatives, 1102 Longworth House Office Building, Washington, D.C. 20515. If those filing written statements wish to have their statements distributed to the press and interested public at the hearing, they may deliver 200 additional copies for this purpose to the Committee office, room 1102 Longworth House Office Building, at least one hour before the hearing begins.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a witness, any written statement or exhibit submitted for the printed record or any written comments in response to a request for written comments must conform to the guidelines listed below. Any statement or exhibit not in compliance with these guidelines will not be printed, but will be maintained in the Committee files for review and use by the Committee.
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1. All statements and any accompanying exhibits for printing must be typed in single space on legal-size paper and may not exceed a total of 10 pages including attachments. At the same time written statements are submitted to the Committee, witnesses are now requested to submit their statements on a 3.5-inch diskette in WordPerfect or ASCII format.
2. Copies of whole documents submitted as exhibit material will not be accepted for printing. Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material not meeting these specifications will be maintained in the Committee files for review and use by the Committee.
3. A witness appearing at a public hearing, or submitting a statement for the record of a public hearing, or submitting written comments in response to a published request for comments by the Committee, must include on his statement or submission a list of all clients, persons, or organizations on whose behalf the witness appears.
4. A supplemental sheet must accompany each statement listing the name, full address, a telephone number where the witness or the designated representative may be reached and a topical outline or summary of the comments and recommendations in the full statement. This supplemental sheet will not be included in the printed record.
The above restrictions and limitations apply only to material being submitted for printing. Statements and exhibits or supplementary material submitted solely for distribution to the Members, the press and the public during the course of a public hearing may be submitted in other forms.
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Note: All Committee advisories and news releases are available on the World Wide Web at 'HTTP://WWW.HOUSE.GOV/WAYS_MEANS/'.
The Committee seeks to make its facilities accessible to persons with disabilities. If you are in need of special accommodations, please call 202–225–1721 or 202–226–3411 TTD/TTY in advance of the event (four business days notice is requested). Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above.
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Chairman ARCHER. The Committee will come to order.
Good morning, everyone, on this beautiful spring day. We are not too far removed from April 21, when the IRS released a study it conducted during the 1995 filing session relating to the level of compliance in the Earned Income Tax Credit, EITC, Program. Their study concluded that the error and fraud rate for the EITC Program was an unacceptably high 20.7 percent and that we are paying out to people who are not legally entitled to it more than $5 billion a year.
The purpose of today's hearing is to learn more from the IRS and Treasury about the high level of fraud and errors associated with the EITC and what more can be done to address this problem.
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I consider the EITC to be a very important program to help low-income working families. This program has long enjoyed bipartisan support, and deservedly so. To protect the long-term future of this helpful program, we have got to stop the fraud and the errors. Hardworking taxpayers will not support welfare programs like the EITC if we cannot get the errors and fraud under control. We have an obligation both to the credit's legitimate recipients and to the Nation's taxpayers to stop this waste.
This is not the first time that this Committee has addressed concerns about the IRS' vulnerability to tax refund fraud and the EITC noncompliance problems. In 1994, the Subcommittee on Oversight held two hearings to examine the issue. In part, due to concerns raised at those hearings, the IRS put into place a revenue protection strategy during the 1995 filing session which was designed primarily to identify returns with questionable claims for the EITC.
Congress has also enacted several changes to enhance the IRS' ability to improve compliance in the EITC Program, including a provision authorizing the IRS to treat a taxpayer's failure to provide a valid Social Security number for EITC qualifying children as a math error. Despite these changes, the EITC remains subject to massive leaks of money.
Treasury has advanced a package of eight legislative proposals for improving EITC compliance. However, until we know more about the root causes of the fraud and errors that were identified by the IRS, it is impossible for the Committee to assess whether the Treasury's proposals get at the real causes of noncompliance to actually make a difference.
For that reason, I have asked the Joint Committee on Taxation to request the Treasury Department to provide it with all of the underlying data and findings from the IRS study so that it can give this Committee its analysis of the problems and potential solutions. I encourage Treasury to comply as quickly as possible with that request.
Taxpayers have a right to know why EITC is so abused and prone to error. Fixing this valuable program should be a priority both for the Congress and for the administration.
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[The opening statement follows:]
Statement of Hon. Bill Archer, A Representative in Congress from the State of Texas
On April 21st, the Internal Revenue Service released a study it conducted during the 1995 filing season relating to the level of compliance in the Earned Income Tax Credit program. The study concluded that the error and fraud rate for the EITC program is an unacceptably high 20.7 percent, and that we are wasting more than $5 billion a year. The purpose of today's hearing is to learn more from the IRS and Treasury about the high level of fraud and errors associated with the EITC, and what more can be done to address this problem.
I consider the EITC to be a very important program to help low-income working families. This program has long enjoyed bipartisan support, and deservedly so. To protect the long term future of this helpful program, we've got to stop the fraud and errors. Hardworking taxpayers won't support welfare programs like the EITC if we can't get the errors and fraud under control. We have an obligation both to the credit's legitimate recipients and to the nation's taxpayers to stop the waste.
This is not the first time that this Committee has addressed concerns about the IRS's vulnerability to tax refund fraud and EITC noncompliance problems. In 1994, the Subcommittee on Oversight held two hearings to examine this issue. In part due to concerns raised at those hearings, the IRS put into place a revenue protection strategy during the 1995 filing season which was designed primarily to identify returns with questionable claims for the EITC.
Congress has also enacted several changes to enhance the IRS's ability to improve compliance in the EITC program, including a provision authorizing the IRS to treat a taxpayer's failure to provide a valid Social Security number for EITC qualifying children as a math error. Despite these changes, the EITC remains subject to massive leaks of money.
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The Department of the Treasury has advanced a package of eight legislative proposals for improving EITC compliance. However, until we know more about the root causes of the fraud and errors that were identified by the IRS, it is impossible for the Committee to assess whether the Treasury's proposals get at the real causes of noncompliance to actually make a difference.
For that reason, I have asked the Joint Committee on Taxation to request the Treasury Department to provide it with all of the underlying data and findings from the IRS study so that it can give this Committee its analysis of the problems and potential solutions. I encourage Treasury to comply as quickly as possible with that request.
The taxpayers have a right to know why EITC is so abused and prone to error. Fixing this valuable program should be a priority with both Congress and the Administration.
[Prepared Text. Spoken Remarks May Differ.]
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Chairman ARCHER. I now recognize Mr. Rangel for any statement he might like to make on behalf of the Minority, and without objection, all Members will have the right to insert written statements in the record at this point.
[The opening statements follow:]
Opening Statement of Hon. Barbara B. Kennelly, a Representative in Congress from the State of Connecticut
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As a long-time champion of the EITC, and someone who has worked to simplify it as necessary over the years, I firmly believe in this program but fraud and abuse is unacceptable in any form.
Therefore, we must take two steps. First, we must insist that the IRS combat fraud and abuse—something they frankly have not been doing. When the IRS finds a taxpayer has made up a child or falsified income in order to increase the EITC, clear instances of fraud and abuse in anyone's mind, it should do three things—deny the credit, prosecute to the full extent of the law and, tag that return in the computer as a future fraud prevention measure.
Second, we need to get a better handle on where the fraud and abuse occurs. We have worked for years to simplify the credit. We still have an error problem. But for the moment, the outright fraud and abuse seems more serious. Treasury has taken some steps administratively to address this problem. But there may be additional legislative steps we need to take. This is something I intend to work on. Perhaps we should conform the personal exemption and EITC to reduce fraud and abuse.
We must remember that this program only benefits working families. In 1995, the EITC lifted 3.7 million families out of poverty. In fact, there were 2.4 million persons over age 16 who lived in poverty and worked full-time year-round in 1995.
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Opening Statement of Hon. Jim Ramstad, a Representative in Congress from the State of Minnesota
Mr. Chairman, thank you for holding this critical hearing on the administration of the Earned Income Tax Credit.
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The recent IRS study of EIC filers for the 1994 tax year revealed a startling and sobering level of fraud and errors in the EIC program. With the projected cost of the EIC program in FY 1997 at $25 billion, this could amount to between 5 and 6 billion dollars of waste. This is simply unacceptable.
The EIC program was intended to help the working poor, and we need to ensure the EIC meets this mission without costing taxpayers billions of dollars in fraud, abuse, error and waste.
I look forward to hearing about compliance issues from our panel of witnesses today, and to exploring solutions to the high level of fraudulent and erroneous payments in the EIC program.
Again, Mr. Chairman, thank you for your leadership in convening this important hearing.
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Chairman ARCHER. Mr. Rangel.
Mr. RANGEL. Mr. Chairman, I would like to support your opening statement in its entirety. There is no program that I think that this Congress, or no policy has been adopted that has been more effective than the program we are talking about. This is a program about which liberals and conservatives agree, that people who work hard every day should not be getting less than those people who choose not to work or find themselves on welfare.
To encourage this work activity, we have this refundable tax that keeps people with their pride and their family, and encourages them to enter the mainstream without the stigma of having to go on welfare.
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I do not think there is a better supporter of the Internal Revenue Service than I, and I think that a lot of accusations about the EITC have been unfair because nobody likes a tax collector. But this program is so vital. What are the reasons why we find so many mistakes? Why are you so prone to allow people to say that it is fraud and tax cheating? Are there other programs where we find this gap between effective collection of taxes due the U.S. Government? Do you find a large number of people in this particular category making mistakes, whether they are losing money or whether, in this case, they are gaining money?
If you cannot do this job, for God's sake, do not let everything fall on the recipient of the program. Let us know how we can be more effective. I am really concerned, and I have seen large tax shortfalls in other areas, why in this area the language is cheating and fraud, because if that is true, then we may have to take another look at the program. If it is not true, we should take another look at the IRS.
Thank you, Mr. Chairman.
Chairman ARCHER. Thank you, Mr. Rangel.
We do have with us today Michael Dolan, Deputy Commissioner of IRS, representing the Internal Revenue Service, Ted Brown, Assistant Commissioner of Criminal Investigation of the IRS, and John Karl Scholz, Deputy Assistant Secretary for Tax Analysis with the Treasury Department.
Mr. Dolan, I understand that you are our leadoff witness, so welcome to the Committee. We would be pleased to receive your statement.
STATEMENT OF HON. MICHAEL P. DOLAN, DEPUTY COMMISSIONER, INTERNAL REVENUE SERVICE; ACCOMPANIED BY TED F. BROWN, ASSISTANT COMMISSIONER, CRIMINAL INVESTIGATION, INTERNAL REVENUE SERVICE, AND JOHN DALRYMPLE, DEPUTY CHIEF, TAXPAYER SERVICE, INTERNAL REVENUE SERVICE
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Mr. DOLAN. Thank you, Mr. Chairman. I am pleased to be here.
Knowing what an auspicious gathering this was going to be, I added a little more horsepower to my team. I have at my right John Dalrymple, who is essentially the Deputy Chief of Operations and who presides over the full spectrum of areas that I think the Committee will be interested in.
With your permission, I would like to have my formal statement submitted and maybe just recap a few of the points.
Chairman ARCHER. Without objection, your entire written statement will appear in the record, and if you will synopsize verbally and shorten the statement, we would appreciate it.
Mr. DOLAN. For starters, I would make the observation that the formal testimony that the Treasury Department is submitting does an excellent job of laying out the history of earned income credit, EIC, and this Committee does not need any kind of instruction from me on the various developments of EIC, so I am going to proceed from the background that the Internal Revenue Service essentially feels like it has a couple of missions in the area of the earned income tax credit.
On one hand, it is our responsibility to help those who are eligible know their rights and know how to claim the credit. On the other hand, it is our responsibility to ensure that only those who are eligible claim and are granted the credit. Some people have observed that this creates a tension or a dynamic that somehow is inherently dysfunctional.
I think this Committee understands that that is the inherent tension, a constructive tension, in the Internal Revenue Service mission in general: we typically worry about both components that create this tension. On the front end, we worry about education and outreach. We worry about our ability to inform taxpayers of their rights and their obligations so that those who are intent on complying with the law feel equipped to do so. And those who are inclined to game or scheme the system—hopefully—feel deterred from doing so.
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On the back end, then, it is our responsibility to employ enforcement or compliance mechanisms that attempt to detect those instances where somebody erroneously claimed benefits under any provision of the tax law and took an advantage to which they were not entitled.
My formal statement includes some particular references to the kinds of efforts we have made at outreach, and I think you will see some things in the statement with which you are quite familiar. Fortunately we have had the opportunity to work with a lot of civic groups, churches, and many of your offices. Many Congressional offices have helped us on outreach efforts to make sure that taxpayers know about EIC, how to qualify, what the rules of the game are, and, quite frankly, some of the issues that have surfaced over the last 3 or 4 years that have gotten all of the press attention.
The one area that I would say with respect to outreach on the earned income credit—with which we are less than satisfied and continue to look for ways to improve and to take all the help we can get—is in the area of the advanced earned income tax credit. That is a concept where we have found that we want to encourage people to take the advanced EIC. It not only is available to them year round but it also helps on the back end in some of the areas that have been most troublesome to us in the overclaims.
With respect to the enforcement, as this Committee is well aware, an earned income tax credit claim processes through the normal tax processing pipeline just like every other asset of the 100 million-plus individual tax returns that we receive every year. As a consequence, all of the filters and all of the processes of that pipeline work on the earned income tax credit claim just like they do the other provisions of the 1040 and the schedules that are attendant to it.
One of the things we did early on as a result of some experience we had with overclaim is we have done a reasonably vigorous attempt during the last four filing seasons to add to our detection and compliance process elements that we thought, in the first instance, identified the correct returns, because what we want to do is get the correct returns identified and get them through the system and not bog it down.
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Second, we want to identify the returns that, on the face of them, look as if they raise questions.
Third, we want to mine those returns not only for what may or may not be erroneous claims but so we can use that data to establish filters and screens and systematic ways to detect in the future the issues that appear on the face of a return and allow us to deal with them quickly and process them.
Coming out of those efforts have been, by our lights, anyway, a number of enhanced abilities to do two things: Let the good returns flow through quickly and pay appropriate attention to returns that deserve more scrutiny.
Mr. Rangel, you made a comment, and I think inferred in your comment was we need to be careful about the language we use because people will, I think, sometimes talk about fraud and cheating and overclaim and lots of things in ways that do not actually distinguish the factual difference among returns.
So today, I would like to be very careful in suggesting that most of the data that we put before you in the form of our report and our testimony is characterized as overclaim, not because we are trying to be clever or cute with words, but because below the numbers that represent overclaim amounts there are a number of fairly important nuances and distinctions that become very misleading if somebody jumps to a conclusion that the overclaim amounts all represent fraud or jumps to the conclusion, quite frankly, that it all represents just innocent mistakes.
So there are some significant nuances below the level of the gross number of overclaims. Hopefully, our comments will elucidate and not obfuscate if we seem reticent to apply a label to the overclaims.
I know the Committee is particularly interested in the report that the Chairman mentioned in his opening comments. I would like to provide some context, of which I think the Committee may be aware. That report, as was pointed out, is 1994 tax year information. Those returns, for the most part, were filed between January and April 1995. There have been two filing seasons since then.
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It was also a report that was drawn in the midst of the filing season, and again, I think as Chairman Archer mentioned, in the midst of a filing season where we had taken fairly substantial efforts to correct, particularly, the issue of invalid Social Security numbers. That also was the year, as many of you might remember since you experienced some of the frustration that came with people contacting your offices, that was the year in which we used an all-out campaign to do two things. There were many, many people who, just because of passage of time and reluctance or forgetfulness, did not correct their Social Security numbers. There were people who were married, still in the system with their maiden name. So a tremendous number of Social Security numbers were corrected that year for people for whom there was no ill intention or action at all.
Beyond that, there also were a number of people who, by our after-the-fact analysis, could have only intended to use a Social Security number incorrectly and a number of those cases have now disappeared in the wake of that 1994 campaign.
Subsequently, the 1995 and 1996 tax years have also been processed. In each of those years, we have made incremental improvements that would not be reflected in the 1994 test. Probably the most substantial thing that has occurred in that timeframe is an area that the Chairman referenced and an area where we have to thank Congress, because the technique that we are using this year, called math error technique, which allows us to avoid the long and arduous deficiency process and gives us a much quicker tool to deal with Social Security numbers that appear on their face to be invalid.
That is something we are using, for the first time this filing season. It is, at this preliminary stage, a tool that has been very useful in sorting out instances of erroneous use of Social Security numbers and in allowing us to deal with that much more quickly than under the old system.
Mr. Chairman, I will close with a couple of other comments. Since the 1994 report, as I mentioned, a number of incremental changes have been made that affect the actual base experiences that we were reporting on in 1994. A similar study is being done on the tax year 1995.
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We are complementing that with a series of research efforts in five or six of our district offices. They are taking various subsets of our experience in this and other areas and looking for further refinements to our process to assure us that the claims going through are appropriate.
In addition to the data that is in the report, you can also appreciate that there are other forms of analysis and there is other data that underlie the report. You, Mr. Chairman, make the point that you have asked the Joint Committee to look at that data. Clearly, like any report, there are cuts on that data that can be taken and have been taken in terms of systems changes in place. There are other cuts on that data that, quite frankly, if we were publicly to go into at any great lengths, would probably encourage those we want to discourage—that is, those who are out there who intend to scheme at the margins on this thing.
So I think you will find as the Joint Committee receives and analyzes that data that there are a number of ways to look at the data developed in 1995. Again, I would make the point, that data in the 1994 report was designed to assist us in improving the systems. It makes no pretense about being an authoritative work on EITC, and in point of fact, it is a report that has already generated a fair number of changes in the way we do business.
With that, I think that you will no doubt have some questions. My colleagues and I are quite prepared to respond, but maybe to get on with Karl's presentation and in the interest of the Committee's time, I would at this point close.
[The prepared statement and attachment follow:]
Statement of Michael P. Dolan, Deputy Commissioner, Internal Revenue Service; accompanied by Ted F. Brown, Assistant Commissioner, Criminal Investigation, Internal Revenue Service, and John Dalrymple, Deputy Chief, Taxpayer Service, Internal Revenue Service
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Mr. Chairman and Distinguished Members of the Committee, I appreciate the opportunity to be here today to discuss the IRS' administration of the Earned Income Tax Credit (EITC). With me today are John Dalrymple, Deputy Chief Taxpayer Service, and Ted Brown, Assistant Commissioner for Criminal Investigation.
Congress enacted the EITC in 1975 as a refundable credit available to eligible low and moderate income workers. The amount of the EITC to which a taxpayer is entitled depends upon the taxpayer's earned income and whether the claimant has ''qualifying children.'' The EITC phases out above certain income levels.
Since 1975, Congress has changed the EITC in several ways. These changes have included increasing the dollar amount of the EITC and the income levels at which EITC phases out. More recently, in the Omnibus Budget Reconciliation Act of 1993, Congress simplified the EITC by eliminating the two supplemental credits for health insurance coverage and for taxpayers with children under 1 year of age. The available EITC amounts were also increased and EITC was made available to individuals who do not have children, but otherwise qualify based solely on earned income.
In 1994, Congress denied the EITC to nonresident aliens and prison inmates for any income received for services provided by the inmate while incarcerated. In addition, Congress required taxpayers to provide a social security number for each EITC qualifying child, regardless of the child's age. In the Personal Responsibility and Work Opportunity Reconciliation Act of 1996, Congress altered the income requirements for the EITC and denied the EITC to individuals who were issued taxpayer identification numbers solely for the purpose of receiving Federally funded benefits. Congress also authorized the IRS to treat a taxpayer's failure to provide a valid social security number as a mathematical error, which is a simpler and more efficient procedure than using the examination process.
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The Treasury Department and the IRS have worked with Congress to develop measures designed to ensure that only those taxpayers eligible for the EITC actually receive it. The IRS has used education and publicity in administering the EITC to assure that taxpayers receive the benefits to which they are entitled. At the same time, the IRS has also focused its efforts towards preventing taxpayers from receiving the EITC if they are not entitled to it.
A. Education and Publicity
It has been estimated that between 80 percent and 86 percent of all eligible families actually claimed the EITC in 1990. Through our education and publicity efforts over the past several years, the IRS has made a concerted effort to reach an even larger percentage of eligible families. For example, the IRS currently issues post-filing notices to taxpayers who appear to qualify for the EITC, but do not claim it on their returns. These notices advise taxpayers of their potential eligibility for the credit, and invite taxpayers to apply for the credit by returning the notices, along with certain requested information. In 1996, the IRS sent out over 1.2 million notices to taxpayers with a response rate of 38 percent. Of those responding, 99.7 percent received the credit.
Besides these notices, the Service also pursues other methods of educating taxpayers about EITC and their potential eligibility for the credit. The Service uses brochures, notices, press releases and direct mailings to publicize the EITC. Many of these products are available in Spanish, as well as English. Our publicity and educational efforts occur throughout the year, although we increase our outreach efforts during each filing season.
We are also taking steps to educate the public about the availability of the Advance Earned Income Tax Credit (AEITC) and to encourage employees to consider it. Although the percentage of taxpayers availing themselves of the EITC is high, a much smaller number takes advantage of the AEITC, which is paid out to employees in each paycheck. The IRS sends publications to employers describing both EITC and AEITC, as well as publications for employers to distribute to employees.
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In addition, the IRS has sent Publication 1235, along with the necessary form to file with their employers, to employees who claimed EITC this year and would possibly benefit from the AEITC. This month, we will send out almost 4.7 million copies of Publication 1235. Additional mail-outs are planned for June and September.
To assist taxpayers in properly claiming the credit, the IRS will compute the EITC for a taxpayer upon request. The taxpayer merely writes ''EIC'' on the appropriate line of the yearly tax return and submits the Schedule EIC with the appropriate supporting information. The IRS will then calculate the proper amount of the taxpayer's credit, based on that information.
B. Enforcement Efforts
While we want to ensure that taxpayers receive the EITC if they are entitled to it under the law, we must also guard against ineligible taxpayers from receiving such benefits. To expand our understanding of EITC compliance, the IRS conducted a pilot study of the 1994 filing season of the electronically filed returns on which taxpayers had claimed the EITC. The study was designed to provide information needed to put controls in place quickly for the rest of the 1994 filing season so that the IRS could detect and prevent EITC compliance problems. The study, however, was not statistically valid for the entire EITC population and, therefore, the results were not representative of this filing population.
As a result of the issues identified by the 1994 filing season study, the IRS undertook a second study of EITC, which involved a statistically valid random sample of EITC returns filed throughout the 1995 filing season. A detailed report on the 1995 study is a attached as an Appendix. The sample included 2,046 returns, of which 1,250 were paper and 796 were electronically filed between January 15 and April 21, 1995.
Soon after the taxpayers filed their returns, agents from IRS Criminal Investigation Division made face-to-face contact with the taxpayers to validate their EITC claims. The agents also contacted other parties, such as employers, tax return preparers, family members and neighbors, if needed, to validate the EITC claims. The agents then made initial judgments about the legitimacy of the EITC claims, which were subject to review and to change, if the judgments were found to be in error.
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The study results showed that EITC claims filed during the 1995 filing season contained errors that required adjustments, both upwards and downwards, in EITC. Of the total EITC dollars claimed in 1994, 25.8 percent of the EITC was overclaimed, while 1.7 percent of the EITC was underclaimed for both paper and electronically filed returns. The study further showed an overclaim rate of 26.1 percent for taxpayers claiming qualifying children and an overclaim rate of 15.7 percent for taxpayers not claiming qualifying children.(see footnote 1) Preliminary results from the study provided the IRS with a better understanding of EITC compliance prior to the 1997 filing season. The final study results provide a baseline from which to analyze further studies of the effectiveness of our EITC administration efforts.
Beginning with the 1994 filing season and continuing through this year's filing season, the IRS has developed and implemented numerous initiatives directed towards identifying and preventing erroneous refund claims, including EITC claims. These initiatives include increasing verification of taxpayer social security numbers, screening and monitoring of electronic return originators, delaying refunds in order to allow the IRS additional time to verify EITC claims before issuing refunds and dedicating enforcement resources to identifying fraudulent schemes, as well as examining questionable claims.
In FY 1995, IRS' Criminal Investigation Division identified more than 4,400 refund schemes involving almost 62,000 returns and prevented the issuance of $83 million in refunds. In addition, we initiated 491 criminal investigations involving refund schemes and return preparers. Prosecution recommendations were forwarded on 404 cases and we obtained indictments of 329 individuals and convictions in 300 cases.(see footnote 2) Also in FY 1995, through pre-refund examinations, we prevented the issuance of an additional $425 million in refunds. Thus, in FY 1995, direct compliance efforts prevented $508 million in improper refunds from being issued.
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In FY 1996, we continued our vigorous compliance efforts to identify and stop fraudulent refund schemes and to pursue questionable claims through pre-refund examinations. In FY 1996, we identified nearly 2,450 fraudulent refund schemes involving 24,000 returns and prevented the issuance of $46.8 million in refunds. We initiated 313 criminal investigations involving refund schemes. Prosecution recommendations were forwarded on 279 cases and indictments were obtained on 290 individuals and conviction in 304 cases.(see footnote 3) Through pre-refund examinations, we prevented the issuance of an additional $864 million in refunds. Thus, last fiscal year, our direct enforcement efforts prevented $932 million in erroneous or fraudulent refunds from being issued.
In this time of declining resources, we must balance our use of enforcement resources to address a myriad of compliance issues, including EITC. However, I assure you that the IRS will continue its programs to detect, investigate and examine questionable EITC claims.
This concludes my prepared remarks. Thank you for allowing us the opportunity to discuss our efforts to improve administration of the EITC. I assure you that the IRS will remain vigilant in its efforts to ensure that only those taxpayers who are earned the credit receive it. My colleagues will be happy to answer any questions you or other Committee Members may have.
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[The official Committee record contains additional material here.]
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Chairman ARCHER. Thank you, Mr. Dolan.
Mr. Scholz, would you like to give us your statement on behalf of the Treasury.
STATEMENT OF JOHN KARL SCHOLZ, DEPUTY ASSISTANT SECRETARY, TAX ANALYSIS, U.S. DEPARTMENT OF TREASURY
Mr. SCHOLZ. I certainly would. Mr. Chairman and Members of the Committee, I am very pleased to have the opportunity to discuss the administration's proposals to improve the earned income tax credit.
Since I have not testified before the Full Committee, let me tell you a little bit about my background. For the past 9 years, I have been an economics professor at the University of Wisconsin-Madison and a Research Associate at the Institute for Research on Poverty. My academic research has, in part, focused on the effectiveness of the EITC and I look forward to working with the Committee on improving the credit.
The administration is strongly committed to the goals of the EITC and will oppose any proposals that reduce the EITC and raise taxes on millions of working families who play by the rules. The credit provides a clear message that work pays——
Chairman ARCHER. Mr. Scholz, if you will suspend for a moment, I would hope that we do not get into political rhetoric in this hearing today. We are here to determine why there is a fraud and error rate in the program, and I would hope that the witnesses and the Members of the Committee will not let this turn into a hearing that involves political rhetoric. You may continue.
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Mr. SCHOLZ. Mr. Chairman, my testimony addresses important sources of noncompliance and I have worded my testimony very carefully to make sure that we do not want to raise taxes on working families who play by the rules.
Mrs. JOHNSON. Will the gentleman yield?
Chairman ARCHER. The gentlelady from Connecticut is recognized.
Mrs. JOHNSON. No one here is interested in raising taxes on the working poor. No one is interested in undermining the EITC. We are interested in the fact that $5 billion is going out every year to people who are not qualified. So for you to start your testimony that way is to say that we have to defend this program against you. You do not. We are for this program, but we want it honest. We do not want to waste $5 billion and we do not want a 25-percent error rate. I think that is the point that we are trying to make to you, and if you will get to how you are going to reform this, that would be useful.
Mr. LEWIS. Mr. Chairman.
Chairman ARCHER. Mr. Lewis.
Mr. LEWIS. If you invited the gentleman here to testify, to speak, he should be given that courtesy and not muzzled and not censored on what he has to say.
Mr. RANGEL. Mr. Chairman.
Chairman ARCHER. I would simply reiterate what I said, which is not political. I do not want these hearings to fall into political rhetoric. I do not want these hearings to be involved in how are we going to increase people's taxes. I do not want these hearings to be involved in even how we are going to solve the problem. We want to know what the problem is and why it is what it is, as the gentleman from New York said in his opening statement, and I would encourage all the witnesses and the Members of the Committee to stick to the purpose of this hearing.
You may proceed, Mr. Scholz.
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Mr. RANGEL. Mr. Chairman? Mr. Chairman, may I be recognized?
Chairman ARCHER. Mr. Rangel.
Mr. RANGEL. Might this not be the appropriate time for us to go vote and then come back?
Chairman ARCHER. I think that is an excellent suggestion. The Committee will stand in recess while we vote, and let us return as quickly as we can.
[Recess.]
Chairman ARCHER. The Committee will come to order.
Mr. Scholz, you may continue.
Mr. SCHOLZ. Thank you very much, Mr. Chairman.
The EITC provides a clear message that work pays and so plays a critical role in public policies directed toward low-wage labor markets. While the U.S. economy has become the envy of the world, labor markets for low-skilled workers in the United States have not performed well over the last 20 years. Between 1979 and 1992, the earnings of a male without a high school degree has declined by more than 23 percent in real terms. Among male workers with a high school degree, real earnings have declined by 17 percent over this period.
The EITC helps the operation of low-wage labor markets by increasing the returns to work and, hence, labor force participation for low-skilled workers. In addition, it helps close the poverty gap by increasing disposable incomes of families. The Census Bureau reports that the EITC lifted 3.7 million persons out of poverty during 1995. The EITC will play an increasingly important role over time in making welfare reform work.
In the public dialog regarding the EITC, some have raised the question of whether the credit is a nontax function of the IRS. Let me be clear. The EITC belongs in the Internal Revenue Code. The credit was created and expanded to offset the overall tax burden of low- and moderate-income families. It continues to play this role as about 85 percent of EITC costs offset the combined Federal income, Federal excise, and Federal payroll tax burden of families receiving the credit.
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In addition, 95 percent of EITC recipients would still file an individual income tax return even if there were no EITC and the IRS would still have to verify much of the same information regarding their filing status, number of children, and income.
Because most EITC claimants would file a tax return even if the credit did not exist, the costs both to the taxpayers and to the IRS of administering the EITC are very low compared to the corresponding administrative costs of other programs. For example, in 1995, the Food Stamp Program cost $3.7 billion to administer. The Aid to Families with Dependent Children, AFDC, Program cost $3.5 billion to administer. Even with these large administrative outlays, the overpayment rates of these programs were between 6 and 7 percent. These figures point to a clear tradeoff between administrative costs and noncompliance in the design of programs targeted to any specific group of taxpayers.
Another advantage of administering the EITC through the tax system is that participation by taxpayers eligible for the credit is higher than participation in many other assistance programs targeted to low-income families. For the EITC to meet the role that Congress and the administration envision, the credit must reach those it is intended to serve. The EITC meets this standard.
Today's hearing has been called in response to the recent release of new IRS data on EITC noncompliance. Deputy Commissioner Dolan has described the major findings of this study. Let me add a couple additional words.
The results provide both good news and bad news. The good news is there has been a significant improvement since the last comparable compliance study, when the IRS found that the EITC error rate was 35.4 percent in 1988. The improvement in EITC compliance to 25.8 percent in 1994 represents the implementation of several sensible compliance initiatives.
Taking into account only one of the steps that has been enacted since 1994, that is the use of the math error procedures Deputy Commissioner Dolan referred to for most children, the net error rate in 1994 would have been 20.7 percent. Other compliance initiatives adopted since 1994 cannot be examined using the data from the study but would bring the noncompliance rate down still further.
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While the EITC error rate has fallen sharply over time, the bad news from the compliance study is clear. The EITC error rate is too high. The administration and Congress recognize that the EITC can best meet its goals of making work pay and lifting families out of poverty by ensuring that only those who are eligible receive the credit.
To better understand the remaining sources of noncompliance, the Treasury Department has conducted its own analysis of the data. We have found the most common EITC error is caused by taxpayers claiming qualifying children who do not reside with them for over half the year.
The second most common error is due to misreporting of filing status among married taxpayers.
The third most common error results from complicated living arrangements, where at least two taxpayers are eligible to claim the child. In such cases, there is an adjusted gross income, AGI, tie-breaker—that is tax law esoterica—where the taxpayer with the higher income is supposed to claim the child. Mistakes in meeting the tie-breaker test result in errors.
Given the insights that arise from the current compliance study, Treasury and the IRS have designed a set of proposals to provide the IRS with new tools to identify erroneous EITC claims while minimizing additional administrative costs to the Federal Government. Our eight-point plan consists of six legislative proposals and two administrative actions. These proposals will help reduce EITC errors by increasing error detection before EITC refunds are paid, by imposing new, more effective penalties on EITC claimants, and by reducing the risk of unintentional errors by well-meaning taxpayers. Very briefly, let me list these initiatives.
To reduce EITC errors by increasing error detection before refunds are paid, we are proposing new due diligence requirements on paid tax preparers. We are asking taxpayers who have lost their EITC through a deficiency procedure to file an expanded schedule EITC to be recertified by the Service. We are proposing that four States be selected for demonstration projects to investigate alternative mechanisms for delivering the credit and determining the effect of those alternative mechanisms on compliance. And last, the IRS has committed resources, significant resources during the 1998 filing season to investigate EITC claims.
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We are increasing penalties for intentional noncompliance by imposing penalties for intentional and fraudulent errors that would result in a taxpayer not being able to receive the credit in subsequent years. We are proposing to institute a continuous levy, so a portion of unemployment compensation and certain means tested public assistance could be levied to bring back part of outstanding tax liabilities, including overpayments of the EITC. Last, to simplify the credit, we have proposed to simply foster child definitions and improve access to the Tax Volunteer Assistance Program.
These eight steps build on our previous efforts that have thus far reduced the EITC error rate from 35.4 to 20.7 percent or less, and I want to emphasize previous efforts, not all from this administration. We ask for your support in enacting these six new legislative proposals which are necessary to further improve noncompliance.
Mr. Chairman, thank you once again for providing me with the opportunity to testify and I will be happy to answer any questions that you or others on the Committee have.
[The prepared statement follows:]
Statement of John Karl Scholz, Deputy Assistant Secretary, Tax Analysis, U.S. Department of Treasury
I am pleased to have the opportunity to discuss the Administration's proposals to improve the earned income tax credit (EITC) and look forward to working with the Committee on this issue.
The Administration is strongly committed to the goals of the EITC and will oppose any proposals which reduce the EITC and raise taxes on millions of working families who play by the rules. The goals of the EITC are to make work pay and to lift workers out of poverty in the most efficient and administrable manner possible. With its message of ''work pays,'' the EITC helps reduce dependency on welfare and increase reliance on jobs.
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Economic Conditions Among Low-Wage Workers
To understand the role of the EITC, a couple of facts about the labor market for low-skilled workers in the United States are useful.
There has been a striking drop in real wages for unskilled workers, beginning in the 1970s and accelerating over the 1980s. Between 1979 and 1992, the earnings of full-time male workers who had not graduated from high school declined by more than 23 percent in real terms. Among full-time male workers with a high school diploma, real earnings fell by 17 percent over the same period.
This decline in the real wage for many unskilled workers has serious implications. In the United States, it is still possible for a family, containing a worker, to live in poverty. According to the Census Department, there were 2.4 million persons, over the age of 16, who lived in poverty and had worked year-round at full-time jobs in 1995.
Effectiveness of EITC in Making Work Pay and Reducing Poverty
The ETC makes work pay in two ways. Unlike many assistance programs for low-income families, the EITC is limited to working families. Moreover, the credit amount initially increases—rather than decreases—for each additional dollar of earnings. As a consequence, the EITC is different from many low-income assistance programs that are characterized by a reduction in benefits for each additional dollar of earnings. In my work prior to coming to Treasury, I—together with Stacy Dickert-Conlin and Scott Houser—examined the net impact of the OBRA 1993 expansion of the EITC on labor supply. We found that the EITC has a modest, positive effect on labor supply by encouraging individuals to enter the workforce. The EITC also directly increases the disposable income of working families. According to the most recent Census data, the EITC lifted 3.7 million persons out of poverty during 1995.
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By making work pay, the EITC increases the probability that some parents may enter the workforce and perhaps leave the welfare rolls. The EITC, then, plays a key role in our efforts to reform welfare.
Administering the EITC through the Tax System
The EITC achieves the goals of making work pay and relieving poverty by reducing the tax liabilities of low and moderate-income families. Thus, it is improper to characterize the EITC, as some have done recently, as a ''non-tax function'' of the IRS. The EITC was created and expanded to offset the overall tax burden of low and moderate-income families and should not simply be measured as an offset to income and SECA taxes. About 85 percent of EITC costs will offset the combined Federal tax burden of families receiving the credit in 1998.
As these numbers suggest, EITC claimants are taxpayers. If the EITC did not exist, almost all EITC filers would still file an individual income tax return (in addition to paying payroll and excise taxes), and the IRS would still have to process their returns and verify much of the same information regarding their filing status, number of children, and income. In 1998, about 69 percent of EITC claimants will be required to file a tax return because they have an individual income tax liability (before the EITC), owe special taxes, have self-employment income in excess of $400, or their gross income will exceed the filing threshold. In addition, over 25 percent of EITC claimants will file a tax return in order to obtain a refund for overwithheld taxes paid throughout the year.
Because most EITC claimants would be filing a tax return even if the credit did not exist, the direct budgetary costs of administering the EITC are significantly lower than if the credit were provided through another means. The IRS cannot easily disentangle the costs of administering one line on the Form 1040 from other lines on the tax return, and we thus do not have estimates of the costs of administering this particular tax provision through the tax system. We can safely say, however, that the costs are lower than those associated with certain government expenditure programs. For example, in FY 1995, the food stamp program cost $3.7 billion to administer, while AFDC administrative costs were an additional $3.5 billion—nearly 14 percent of the combined costs of these two programs. For these administrative costs, the AFDC program served, on average, about 4.9 million families in a given month, while over 10 million households received food stamps. By way of comparison, the entire IRS budget in FY 1995 was $7.6 billion, and the IRS served over 116 million individual taxpayers and 15 million corporations.
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Taxpayers also benefit from obtaining the EITC through the tax system. Many low-income workers learn about the EITC when they file a tax return to obtain a refund. By claiming the credit on tax returns, EITC claimants do not have to take time off from work to apply for the credit at a government office.
Not surprisingly, then, participation in the EITC tends to be higher than many other assistance programs targeted to low-income families. In my research prior to joining Treasury, I found that 80 to 86 percent of those eligible received the credit in 1990. This high participation rate is striking when compared to the AFDC participation rate of 62 to 72 percent and the food stamp participation rate of 54 to 66 percent. International comparisons also confirm this finding. The United Kingdom has an EITC-like program called the Family Credit. It is administered through the transfer system and directed toward families with children. Official estimates place the participation rate of the Family Credit at around 50 percent. Thus, both compared to cash and in-kind transfers in the United States and comparable work-related benefits in the United Kingdom, the EITC is much better at reaching those who are eligible for the credit.
Notwithstanding these benefits, there are costs associated with operating the EITC, as with other tax provisions, through the tax system. A system based largely on self-assessment will have lower administrative costs than a more bureaucratic approach, but it will also lead to higher noncompliance. Many of us were very concerned when EITC compliance data, from the 1980's, first became available. The Taxpayer Compliance Measurement Program (TCMP), last conducted in 1988, showed that 35.4 percent of the EITC claimed ($2 billion) exceeded the amounts to which taxpayers were eligible.
But the same TCMP also places the problems of the EITC in perspective. Last April, the IRS released a study, based on the 1988 TCMP, showing that the gross individual income tax gap in 1992 was between $93.2 and $95.2 billion. The IRS estimated that the total ''true'' individual income tax liability was between $550.2 and $552.3 billion for tax year 1992. Over 40 percent ($39.1 to $39.9 billion) of the gross tax gap for 1992 was attributable to the underreporting of business income (including self-employment income, partnership income and rents and royalties). About 20 percent ($18.1 to $18.7 billion) of the gross tax gap was due to the underreporting of non-business income. Over 14 percent ($13.5 to $13.8 billion) of the gross tax gap was due to persons who failed to file tax returns. These problems exceed any noncompliance problems associated with the EITC.
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Nonetheless, the Administration and Congress have recognized that the EITC can best meets its goals—of making work pay and lifting families out of poverty—by ensuring that only those who are eligible and deserving receive the credit. Congress took a first step in this direction during the consideration of OBRA 1990, when data from the 1985 TCMP became available. The TCMP data suggested that EITC errors were linked to complicated and unverifiable support and household maintenance tests. OBRA 1990 replaced the support and household maintenance rules for EITC eligibility with simpler age, residency, and relationship tests, lowered the age requirement for reporting a taxpayer identification number for EITC qualifying children, and created a separate schedule to claim the EITC.
This Administration, with the support of Congress, has taken 17 additional legislative and administrative actions to further improve the targeting and operations of the credit. First, Congress has enacted stricter reporting requirements proposed by the Clinton Administration, and the IRS has tightened enforcement of these requirements. Since 1995, the IRS has transcribed the social security numbers of all EITC qualifying children and most dependents, and it has intensified its examination of returns with missing social security numbers. The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (the welfare reform act) contains a Clinton Administration proposal which will enable the IRS to use the simpler and more cost-efficient mathematical error procedures to deny both the EITC and dependent exemptions to taxpayers who fail to provide valid social security numbers. As a consequence of the Uruguay Round Agreement Act of 1994, taxpayers will also be required to provide social security numbers for all dependents and EITC qualifying children without regard to their age on their 1997 tax returns.
Other reporting requirements have also been strengthened. The Uruguay Round Agreement requires the Department of Defense to report to both the IRS and military personnel nontaxable earned income used in the computation of the EITC. The 1996 welfare reform act also authorizes the IRS to treat the omission of self-employment taxes as a mathematical error, if the taxpayer claims eligibility for the EITC on the basis of self-employment income.
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The IRS, with the support of Congress, has also intensified scrutiny of ''questionable'' EITC claims and preparers. For the last several years, the IRS has conducted studies of EITC compliance and has used this information to better identify questionable returns. In addition, the IRS increased scrutiny of electronic return originators (EROs), instituted fingerprint and credit checks on certain new ERO applicants, and eliminated the direct deposit indicator.
Finally, the Administration has consistently supported provisions that would simplify the EITC, opposed provisions that would add significant complexity to the EITC, and has striven to ensure that EITC reforms can be administered. In 1993, the Administration proposed the repeal of two supplemental credits (for children under the age of one and for the purchase of health insurance for qualifying children), arguing that the IRS could not enforce the eligibility criteria for them, and these supplemental credits were subsequently repealed. In 1995, the Administration opposed, on administrative grounds, proposals to base EITC eligibility on child support payments and hours of work. The Administration's proposal to deny the EITC to undocumented workers, included in the welfare reform act, was also designed in a manner which could be administered by the IRS.
Analysis of EITC Compliance Study for Tax Year 1994
The combined effects of these efforts cannot be fully measured at this time, since several key steps did not take effect until the 1997 filing season and another step—the requirement that all children, regardless of their age, have a social security number—will not be fully implemented until the 1998 filing season. Today's hearing, nonetheless, has been called in response to the recent release of new IRS data on EITC noncompliance for tax year 1994.
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The Criminal Investigation (CI) Division of the IRS conducted this study of compliance among 2,046 taxpayers who claimed the EITC on tax returns filed and accepted by the IRS between January 15 and April 21, 1995. CI Special Agents visited a random sample of EITC claimants, shortly after they filed their paper or electronic tax returns. Taxpayers (and often their employers, tax return preparers, family members, and neighbors) were interviewed at length and asked to produce verification that they met the EITC eligibility criteria. While the Special Agents made initial judgements about the legitimacy of the EITC claim, these judgements were reviewed—and sometimes changed—in subsequent review by Examination staff who had access to other sources of independent information (such as the Forms W–2 and 1099 sent by employers and other payers).
The study found that of the $17.2 billion claimed in EITC between January and April 1995, $4.4 billion, or 25.8 percent of total EITC claimed, exceeded the amount to which taxpayers were eligible. The overclaim rate among EITC claimants was slightly higher among paper filers (26.1 percent) than for electronic returns accepted by the IRS (25.3 percent). Noncompliance was found to be much higher among filers who claim EITC qualifying children than for those EITC claimants without qualifying children. Among those who claimed EITC qualifying children, the overclaim rate was 26.1 percent, while the overclaim rate was 15.7 percent for those who did not reside with a qualifying child. IRS enforcement practices, in place during the 1995 filing season, reduced the estimated net overclaim rate from 25.8 percent to 23.5 percent. If the IRS had been able to treat a taxpayer's failure to provide valid social security numbers for EITC qualifying children over the age of one as a mathematical error on 1994 tax returns, the net overclaim rate would have been reduced further, to an estimated 20.7 percent.
While EITC noncompliance remains at unacceptably high levels, the study's results do show significant improvement since the late 1980s, the last time that the IRS examined a comparable group of taxpayers as part of the TCMP. The improvement in EITC compliance since 1988 reflects the implementation of many, but not all, of the steps described earlier.
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To better understand the remaining sources of noncompliance, we have conducted an analysis of the data. We have found that the most common EITC error is caused by taxpayers claiming qualifying children who do not reside with them for over half the year. Among taxpayers with children, such errors account for about 39 percent of overclaimed EITC amounts. Under current law, taxpayers are required to reside with their qualifying children for at least six months or a full year, depending on the relationship of the child. Taxpayers fail the residency test for many different types of reasons. For example, divorced parents who share the custody of their children might both claim the EITC because they both feel the child lived with them for over half the year. At the other extreme, a taxpayer may claim a child with whom he or she has never resided.
A second common error is due to misreporting of filing status among married taxpayers. Filing status errors account for about 31 percent of overclaimed EITC amounts among taxpayers with children.(see footnote 4) Sometimes, separated couples do not understand that they must still file as married persons if they have not yet obtained a legal separation. In other cases, married couples, who are still living together, do not file either a joint return or a ''married filing separate'' return.
The third most common error results from complicated living arrangements. In such situations, a child lives with more than one adult who appears qualified to claim him or her for EITC purposes. However, about 18 percent of overclaimed EITC amounts result when, in such households, the caregiver with the lower AGI claims the child. In some cases (although it is difficult to quantify), the other caregiver was, in fact, qualified to claim the EITC but did not. The study does not account for the offsetting errors which occur because the taxpayer's relative, with the higher AGI, did not claim the EITC when he or she was eligible.
Even among EITC claimants without qualifying children, many errors are caused by the misreporting of family structure. Among these taxpayers, about 40 percent of overclaims are attributable to the misreporting of filing status among married taxpayers. However, most errors among EITC claimants without qualifying children are due to the misreporting of income.
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While we can identify the sources of EITC errors in this study, we do not know from the study the extent to which the EITC, itself, is the root cause of the noncompliance on the part of the taxpayers. By misreporting filing status, child dependents, and income, taxpayers may be able to reduce their tax liability through other provisions in addition to the EITC. Because this study focused only on EITC claimants, it does not isolate the effect of the EITC on noncompliance, or the extent to which higher income taxpayers are benefiting from misreporting their income or family circumstances.
The study does provide evidence that the refundable nature of the credit does not induce ineligible individuals to enter the tax system simply to claim the credit. As I have discussed, 95 percent of EITC claimants have a reason other than the EITC to file a return. The overclaim rate among those with a positive pre-EITC tax liability is nearly three times larger than the rate among those who did not have a tax liability. The data thus suggest that noncompliant EITC claimants do not enter the tax system merely to claim the credit.
While the results of this study are not fully applicable to the current EITC, the study does point to the need for new approaches. Many types of EITC errors are difficult to detect with the current IRS enforcement tools, such as matching of information reports and Social Security Administration records to tax returns. Our proposals are designed to provide the IRS with new tools to identify erroneous EITC claims while minimizing additional administrative costs to the Federal government.
Legislative and Administrative Proposals
The Treasury Department's eight-point plan contains six legislative proposals and two administrative actions. These proposals will help reduce EITC errors by increasing IRS's ability to detect errors before EITC refunds are paid out, by imposing new, more effective penalties on EITC claimants, and by reducing the risk of unintentional errors by law-abiding taxpayers.
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Proposals to Improve the Flow of Information Prior to Release of EITC Claims
Due diligence requirements for preparers—About half of earned income tax credit (EITC) claimants use a paid preparer to complete their income tax returns. As a consequence, tax preparers can play a key role in helping working families file accurate tax returns. While there is little significant difference among returns prepared by the taxpayer and those prepared by a paid preparer, the error rate does differ depending on the type of preparer consulted by the taxpayer. Noncompliance was much lower among taxpayers who went to a preparer who was either a certified public accountant, lawyer, enrolled agent, or a representative of one of the large nationally-recognized organizations. It was higher among those who sought other types of preparers.
Under our proposal, the responsibilities of paid preparers, with respect to potential EITC claimants, would be clarified. Preparers who do not fulfill certain due diligence requirements would be subject to cash penalties ranging from $50 to the full amount of an EITC overclaim. The proposed penalties would be in addition to the penalties imposed on preparers and taxpayers under current law. The proposal would be effective for taxable years beginning after December 31, 1997.
Recertification—When questions arise about EITC claims, the IRS generally must follow deficiency procedures to determine the accuracy of the taxpayer's return. While deficiency procedures protect taxpayers' rights, they can be time-consuming and relatively expensive when compared to the amount of tax at issue.
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Under the proposal, a taxpayer who has been denied the EITC as a result of deficiency procedures would be ineligible to claim the credit in subsequent years unless he or she provides evidence of his or her eligibility for the credit. To demonstrate current eligibility, the taxpayer would be required to meet evidentiary requirements established by the Secretary of the Treasury. Failure to provide this information when claiming the EITC would be treated as a mathematical or clerical error. If a taxpayer is recertified as eligible for the credit, he or she would not be required to provide this information in the future unless the IRS again denies the EITC as a result of a deficiency procedure. Ineligibility for the EITC under the proposal would be subject to review by the courts. The proposal would be effective for taxable years beginning after December 31, 1997.
Demonstration Projects—The Treasury Department is seeking legislation permitting it to select four states to experiment with alternative ways of providing the EITC throughout the year. Under the proposal, the four states could provide advance payments of the EITC to wage earners through state agencies rather than employers for a three year period. States would be required to verify eligibility for the EITC before paying out the credit. Effects on advance payment participation and compliance would be studied by Treasury. Applications would be submitted by the states to the Treasury Department during 1998 for demonstration projects to begin in January, 1999.
Earmarking of IRS Resources—Using information from the EITC compliance studies and other ongoing pilot projects, the IRS will continue to develop and use profiles of potentially erroneous EITC claimants. These profiles will be used to identify questionable EITC claims during the 1998 filing season. The IRS will expand the number of questionable EITC claims that it investigates during the 1998 filing season. Refunds associated with these claims will be delayed until the investigation is complete. Out of its current appropriations request, the IRS is earmarking 550 full time equivalent staff persons for this intensified effort during the 1998 filing season.
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Increasing the Penalties for Intentional Noncompliance
New Penalties for Intentional and Fraudulent Errors—Existing civil penalties have a limited deterrence effect against ineligible taxpayers repeatedly claiming the EITC. Denying subsequent eligibility to claim the EITC to taxpayers who have recklessly, intentionally, or fraudulently claimed the EITC in the past should help ensure that only those who are eligible for the credit receive it.
Under the proposal, any person who fraudulently claims the EITC would be ineligible to claim the EITC for a subsequent period of ten years. In addition, any person who erroneously claims the credit and such error is due to the reckless or intentional disregard of rules or regulations would be denied eligibility for the EITC for two subsequent years. The sanction under the proposal would be in addition to civil and criminal penalties imposed under current law. In addition, the sanction would be subject to review by the courts. The proposal would be effective for taxable years beginning after December 31, 1997.
Continuing Levy—The IRS does not generally find it cost-effective to recoup overpayments of the earned income tax credit (EITC) or impose monetary penalties on noncompliant claimants. To some extent, these efforts are hindered by the exemption from levy of certain types of income prevalent among EITC claimants. By removing these exemptions, this proposal would make it more likely that the IRS would recapture overpayments.
In our FY 1998 budget, the Administration proposed that certain exemptions be partially lifted from the levy. Under the budget proposal, Federal workers' compensation payments, annuity or pension payments under the Railroad Retirement Act, and benefits under the Railroad Unemployment Insurance Act would no longer be fully exempted from levy. The proposal would change the exempt amount of Federal wages, salaries, and other income to a flat 85 percent exemption. The proposal would provide for ''continuous'' levy on non-means tested, recurring Federal payments.
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Under the EITC initiative, unemployment benefits and means-tested public assistance would no longer be fully exempted from levy for any purpose. Up to 15 percent of these benefits would be subject to levy. The proposal would also provide for the option of a ''continuous'' levy on these payments. Treasury would work with affected Departments and state agencies to design the mechanisms appropriate for each program. If necessary, conforming changes would be made to the laws and regulations governing public assistance to ensure that there would not be offsetting changes in these benefits to compensate for the levy. The proposal would apply to levies issued after December 31, 1997.
As under current law, taxpayers would be allowed to apply for relief from a levy if they can demonstrate that they are suffering significant hardship as a consequence.
Reduce Unintentional Errors
Simplification of Foster Child Rule—Under current law, a taxpayer is eligible to claim the earned income tax credit (EITC) if he or she resides with a son, daughter, or grandchild for over half the year. EITC qualifying children also include individuals who reside with taxpayers for a full year and for whom the taxpayers ''care for as the taxpayers' own children.'' All EITC qualifying children (including foster children) must either be under the age of 19 (24 if a full-time student) or permanently and totally disabled.
The foster child'' rule is confusing to both taxpayers and the IRS. Clarifying the definition would eliminate unintentional errors by taxpayers and provide better guidance to the IRS. In addition, the definition of a foster child for EITC purposes would be conformed to the dependency exemption definition proposed as part of the Administration's simplification package.
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Under the proposal, a foster child would be defined as a child who (i) is under the age of 19 (24 if a full-time student), (ii) is cared for by the taxpayer as if he or she were the taxpayer's own child, and (iii) either is the taxpayer's niece, nephew, or sibling or was placed in the taxpayer's home by an agency of a state or one of its political subdivisions or a tax-exempt child placement agency licensed by a state. The proposal would be effective for taxable years beginning after December 31, 1997.
Improve Access to Taxpayer Assistance—In 1996, 1.9 million low-income taxpayers receive assistance preparing their tax returns from over 47,000 volunteers in IRS-sponsored VITA (Volunteer Income Tax Assistance) facilities. The IRS provides training materials and tax forms to 8,300 sites. The IRS also provides software for electronic filing and lends computer hardware to selected sites. These VITA efforts will be continued and strengthened as part of the Administration's commitment to volunteerism. The Treasury Department is contacting businesses and tax professional organizations to make sure that they are aware of the need for VITA volunteers, computers, facility sites, and outreach assistance. By improving access to free taxpayer assistance and electronic filing, these efforts will help reduce the risk of unintentional errors.
This concludes my remarks. We look forward to working with you toward the enactment of these provisions. Thank you once again for providing me with the opportunity to testify. I would be pleased to answer any question that the Committee may have.
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—————
Chairman ARCHER. Thank you, Mr. Scholz, and thank you, Mr. Dolan. Thank you for also being here, Mr. Dalrymple and Mr. Brown.
Mr. Dolan, I would like to try to get a little better understanding of the parameters of your study. The study indicates that your sample was selected from returns that were actually accepted by the IRS. However, the IRS electronic screens are designed to automatically reject electronic returns with invalid or missing Social Security numbers or mismatches between the qualifying children's Social Security numbers and their dates of birth. Do you know what percentage of the returns were rejected during the time period that this study was conducted?
Mr. DOLAN. Mr. Chairman, I am going to ask Ted Brown to comment. But you are exactly right. There were a number of returns that would have been rejected electronically. We do not have a way to systematically follow each of those rejected returns to see when or if they came back in on paper.
However, based on the parameters of the study, the fact that the study did, encompass returns filed through April 15, our assumption is that one of three things happened. Somebody corrected the Social Security number and it came back in electronically, they were bogus and did not come back in at all, or they attempted to come back in on paper. If they had come back in on paper, the statistical sample would have accounted for that population as a part of the group that was studied in 1994.
As to your specific question on a percentage, I am not sure whether Ted has that or not.
Mr. BROWN. Mr. Chairman, we do not count the number of returns that are rejected, so I cannot give you a percentage, because returns can be resubmitted repeatedly. We count occurrences, how many times we have a reject. That would run about 14 to 15 percent of the attempts to file a return electronically during 1995.
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Chairman ARCHER. And you had no flag or tickler placed on the electronic rejections to determine whether they came back on paper filings, is that correct, or did you have such a thing?
Mr. BROWN. No, sir. We cannot track an electronic return that is rejected and comes back in on the paper side.
Chairman ARCHER. And as I understand, Mr. Dolan, what you said preliminarily, if a return that had been rejected electronically did come back in writing on paper during the window of your sampling, you would have picked that up, is that correct?
Mr. DOLAN. It would have been part of the universe from which the sample was drawn, correct.
Chairman ARCHER. But if it came back after that window closed, then you would not have any data on that?
Mr. DOLAN. That is an accurate statement. However, I think if we showed the demography of the return filing patterns, I think there is a reasonably good inference that most EIC refund claimants are going to come in on or before April 15.
Chairman ARCHER. There were a rather significant number of electronic returns that were rejected and not taken into consideration in this study, are you confident that the results of the study capture the full level of potential errors in the EITC?
Mr. BROWN. Yes, sir, other than the group that might have decided not to refile and that is your only exposure to something that would not be included in the sample.
Chairman ARCHER. But this 14 percent that you mentioned, would that not possibly have augmented the number of errors?
Mr. BROWN. The first issue, Mr. Chairman, is that that is an occurrence count. So, for example, the taxpayer submits a return and it is rejected for an error. They think they have corrected it. They try it again. It is rejected again. So we can have multiple occurrences from the same taxpayer, so that tends to make that number higher than it is in reality.
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Chairman ARCHER. Mr. Brown, I am going to move on to a little different approach. Can you elaborate on exactly what types of erroneous claims your study identified and can you give us a breakdown of the types of fraud and error that the IRS detected by their root cause?
Mr. BROWN. Mr. Chairman, we have a lot of different data about the makeup of this sample. Sometimes when you get down to very specific subcategories, the statistical validity of the sample falls away because the numbers get very small, so that is one caveat.
Beyond that, we have tried to analyze the data to look at and determine if there are patterns based upon filing status, based upon income levels, based upon the number of children that were claimed, and based upon the types of income that were reported. We have used that data to attempt to redirect our enforcement efforts, our audit programs, as well as our screens.
My concern is if I get too specific, I may disclose some of our capabilities as well as some of our vulnerabilities. For that reason, perhaps the Joint Committee, after they have analyzed the data, may have better answers than I could give you today. If that is not sufficient, I would be willing to come back in and give you some of the examples.
Chairman ARCHER. Inasmuch as we have asked the Joint Committee to look at the raw data and to develop the kind of responses for us that my question solicits, it might be best not to do that here publicly today. However, I will say that it is my common sense opinion, not backed by any technical expertise, that if someone wants to commit fraud on this program, that there is an underground grapevine that most clearly permits them to understand how to do it without your giving them a road map. That has been the experience that we have seen in an awful lot of programs, but I will not push that any farther.
Mr. BROWN. Thank you.
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Chairman ARCHER. Mr. Brown, what are the qualifications of the special agents who conducted the investigation in this study?
Mr. BROWN. Most of our special agents, they are all college graduates. The majority of them are accountants by training, but we also have attorneys and former revenue agents, former law enforcement officers. After they are hired, they are sent through about 6 months of training at our Federal Law Enforcement Training Center in Brunswick, Georgia, where they get an introduction to law enforcement techniques as well as specialized training on our techniques to prove tax fraud and money laundering.
The agents that were selected, my work force is very experienced. Most of them are very experienced agents around the country, so they are experienced investigators.
Chairman ARCHER. So they are experienced in investigating fraud issues?
Mr. BROWN. Yes, sir. These are criminal investigators.
Chairman ARCHER. Based on their training and experience, did the special agents who conducted this study and investigation reach a conclusion in each case in which erroneous payments were identified about whether the mistakes were simply errors due to the complexity of the Code or whether they were intentional fraud?
Mr. BROWN. We asked the agents during their field contacts to categorize each case and to make a subjective assessment as to their reaction to the facts as they identified them. The first and the simple one was that the return was correct, and at the other extreme was that they simply could not develop enough information, they could not locate the taxpayer, they could not locate appropriate witnesses to make a determination.
In those cases in between, we asked them to classify that the error either was due to misunderstanding, error, or some mistake by the taxpayer or that, in their opinion, subjectively, that the error was due to an intentional nonadherence to the law.
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Chairman ARCHER. And based on your training and experience, what percentage of the overclaims were simply error and what percentage were intentional fraud?
Mr. BROWN. Again, as Mr. Dolan mentioned earlier, we did not use the term ''fraud'' during this study. We did use the term ''intentional,'' because as a criminal investigation——
Chairman ARCHER. Let us take fraud out of it and say intentional.
Mr. BROWN. In the classification of the cases, it was about 50 percent due to error and about 50 percent classified as intentional by the investigators.
Chairman ARCHER. Thank you very much. I have one last question for Treasury and then I will yield to my colleague, Mr. Rangel.
Mr. Scholz, in your new proposals, what you are suggesting is that they would help to reduce the amount of overpayment. If enacted, what level of error rate would this bring the noncompliance down to?
Mr. SCHOLZ. It would bring the noncompliance down a significant amount. It is a very difficult question to answer that you asked because we do not know what the current error rate is because of steps that have been adopted since the 1994 has been taken. In particular, we have new math error procedures for primary and secondary taxpayers and the Social Security number requirement and math error procedures for children under one. So this makes it very difficult to know what the current noncompliance rate is.
What adds to and compounds the difficulty is at least two of our significant noncompliance proposals are directed at tax preparers and are deterrence proposals for taxpayers and there is very little out there in existing academic or policy literatures that would allow us to base an estimate.
We, Congress and the administration, do have a track record, though, when we say that these proposals will reduce the noncompliance rate significantly and the track record is bringing the noncompliance rate down from 35.4 percent to the current 20.7 percent that would be the noncompliance rate if the math error procedures that we could model were incorporated.
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Chairman ARCHER. So you believe that if your current proposals were adopted, that there would be an additional significant amount of reduction in the error rate, is that correct?
Mr. SCHOLZ. I do, Mr. Chairman.
Chairman ARCHER. And how would you define significant? What percent would you put on the term ''significant''? What range of percent, if you cannot be totally accurate?
Mr. SCHOLZ. I can bound the effect. I can tell you that I have a strong feeling that it is going to be lower than 20.7 percent, and beyond that, it would be inappropriate for me to hazard a guess for the reasons that I just said. We do not know what the existing noncompliance rate is. We do not have any objective basis upon evidence from the policy literature or the academic literature on the effects of these noncompliance rates. So it is very, very difficult. It would be, in fact, irresponsible for me to give you a point estimate of what I think the effect of these proposals would be.
Chairman ARCHER. I assume that you have looked carefully at the study that has been done by Mr. Brown under Mr. Dolan's supervision——
Mr. SCHOLZ. Yes, sir, we surely have.
Chairman ARCHER [continuing]. And that you have the benefit of all of that analysis.
Mr. SCHOLZ. That is correct.
Chairman ARCHER. You, therefore, know probably more than we do at this time. Have you seen the raw data, also?
Mr. SCHOLZ. Yes, sir, we have.
Chairman ARCHER. So you have even more information than the Members of this Congress have or that we will even have at the end of this hearing today but which will be turned over to the Joint Committee for their evaluation.
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Based on that information, which is not even available to us today, at this moment, you have no ability to determine what your proposals will do to reduce that error rate other than to say that it will be significant?
Mr. SCHOLZ. We certainly do, because we have designed the particular proposals with the knowledge that we have from extensive analysis of the data that underlies the IRS study. So we know, for example, that tax returns prepared by the large national tax preparation community have lower noncompliance rates. Our proposaal to require due diligence on EITC claims among professional tax preparer proposal was generated by this fact, and we are asking other tax preparers to take the same kinds of steps that the large national tax preparers take.
Every single one of our six legislative proposals and two administrative proposals is generated by the knowledge that we have gained from looking at this noncompliance study. That is why I am confident when I sit here and tell you that there will be a significant reduction in the error rate as a consequence of adopting our proposals.
Chairman ARCHER. After saying all that, I was hoping I could get you to draw a conclusion from that. Significant, then, might be one-half of 1 percent, is that correct?
Mr. SCHOLZ. Significant—that would not be significant, Mr. Chairman.
Chairman ARCHER. That would not? What about 1 percent?
Mr. SCHOLZ. That probably would not be significant, either.
Chairman ARCHER. What about 2 percent?
Mr. SCHOLZ. That would probably not be significant, either, Mr. Chairman.
Chairman ARCHER. What about 3 percentage points?
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Mr. SCHOLZ. It starts to get hard.
[Laughter.]
Chairman ARCHER. So that is beginning to enter the range of what you would consider significant, 3 percent. So we would be able to anticipate that if your proposals were enacted, that we would at least reduce the rate to 17.7 percent, at a minimum.
Mr. SCHOLZ. As you know, Mr. Chairman, the world does not stop when you adopt some proposals, so there are lots of other things happening in the economy. There are lots of other things happening with IRS enforcement efforts. The EITC is getting larger because of the steps that you and the administration took in 1993 and all of those things make it very, very difficult to make the statement that you have just made. We do not know what the noncompliance rate is right now. The credit has gotten somewhat larger. That would tend to possibly increase——
Chairman ARCHER. No. I understand that it is not easy to do this, but you have an expertise that no Member of this Committee has, both from your academic background and the fact that you have done an intensive study of this investigation report. I am simply asking you to try to give us the benefit of that expertise and that study and tell the Committee what we might expect if these proposals are adopted.
If we are only going to get 1 percentage point, we have not made a whole lot of progress. I am trying to understand what you mean by significant, and I think that the record will show now that you think significant is a minimum of a 3-percentage point reduction. I appreciate your giving us the benefit of that conclusion.
Now, let me further ask you, and then I am going to yield to the gentleman from New York, what do you believe is a reasonable target for EITC compliance? What would you accept as a reasonable error rate?
Mr. SCHOLZ. Compliance initiatives——
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Chairman ARCHER. Please, just give me your opinion as to a number that you would accept. I know that you have all this background of knowledge, but I want to know what you would accept as a reasonable target for EITC compliance, where you could rest easy and say, now this program is one that we think has got an error rate that is acceptable.
Mr. SCHOLZ. Mr. Chairman, I, like you, have a goal of trying to reduce the EITC noncompliance rate as far as we possibly can with sensible, cost-effective steps.
Chairman ARCHER. But where would you rest easy? What would your target be, where you would rest easy and say, now we have a program that is defensible and an error rate that is defensible and I am satisfied with it?
Mr. SCHOLZ. Just as with my professional career, I never rest easy, Mr. Chairman. I am always trying to improve, and compliance initiatives have to be the same.
Chairman ARCHER. Mr. Scholz, you are not answering my question.
Mr. SCHOLZ. I am trying to, Mr. Chairman.
Chairman ARCHER. You are saying that you want it to be as good as possible, and that is very vague, but with your background and your experience and your knowledge on this subject, what would you personally accept as a target for noncompliance that you believe would be defensible? Just give me a percentage figure.
Mr. SCHOLZ. It is a number that does not——
Chairman ARCHER. If it is zero, say zero and we will keep working toward that goal, but——
Mr. SCHOLZ. We will always strive to zero, Mr. Chairman. There is no question about that.
Chairman ARCHER. No. But what do you——
Mr. SCHOLZ. But it requires a careful balancing of the benefits of the program with the costs, and the costs are part of this noncompliance problem that we are all so frustrated about.
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Chairman ARCHER. Clearly, there is some point where you believe we need to get before you will be comfortable that we have an error rate that is acceptable.
Mr. SCHOLZ. To be honest, Mr. Chairman, I will never be comfortable when taxpayers are receiving dollars——
Chairman ARCHER. We cannot get to zero. We know that.
Mr. SCHOLZ [continuing]. When taxpayers are receiving dollars that are inappropriate, and so noncompliance initiatives are an evolving thing. They are incremental. You always find problems and you go and attack them and you try to attack them in a sensible, cost-effective manner. That process will never stop. It has not stopped in any single area of the Tax Code. I am sure my colleagues from the IRS would assure you of that. There is not one single area——
Chairman ARCHER. Let me see if I can just synthesize this. You would not be satisfied with the significant reduction that you say your proposals would give the country.
Mr. SCHOLZ. Those would be a major policy achievement and then there would be new compliance initiatives. We would continue to study the problem and we would continue to do it better.
Chairman ARCHER. So you would not be satisfied with what your proposals will produce?
Mr. SCHOLZ. I would call it a major policy achievement and one that we should seek because the proposals are low cost and they promise to do a lot of good.
Chairman ARCHER. I yield briefly to the gentleman from Florida.
Mr. SHAW. Mr. Chairman, I just want to inject here that, you are trying to get an answer from an economist. Economists do not give answers.
Chairman ARCHER. I thank the gentleman for his observation.
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Mr. Rangel.
Mr. RANGEL. Dr. Scholz, when you described your background, you indicated that you were new in testifying in front of Committees?
Mr. SCHOLZ. I have testified a couple of times, but never with so many Members present.
Mr. RANGEL. Most of your background has been academic?
Mr. SCHOLZ. That is correct.
Mr. RANGEL. As an economist, have you ever heard the expression, dynamic scoring?
Mr. SCHOLZ. I certainly have.
Mr. RANGEL. That is pretty creative, is it not?
Mr. SCHOLZ. Dynamic scoring?
Mr. RANGEL. Yes.
Mr. SCHOLZ. I suppose it depends on what context, Mr. Rangel.
Mr. RANGEL. But it is subjective. It allows economists to reach conclusions that we want to reach here. You are new, but we have to do better in our assumptions because they are based on things that are not in your control, are they?
Mr. SCHOLZ. The best and most capable scoring would be based on things that are objective and do come from, either the academic or policy literature.
Mr. RANGEL. Let us see, now, Mr. Dolan, you have been around a long time. Can we do better in our assumptions as to bringing this rate down more than 2 or 3 percent?
Mr. DOLAN. I liked it better when you were asking Mr. Scholz a question like that. [Laughter.]
Is your question whether we think these proposals can bring it down or what it would take to bring it down?
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Mr. RANGEL. Who is in charge of administering this program at the IRS?
Mr. DOLAN. The Commissioner and I are.
Mr. RANGEL. I mean, directly hands on, you are?
Mr. DOLAN. I am sorry?
Mr. RANGEL. Are you hands on, directly involved?
Mr. DOLAN. Well, I think the accountability clearly is with me, Mr. Rangel.
Mr. RANGEL. The accountability is with the President of the United States. I am trying to find out——
Mr. DOLAN. I am not trying to obfuscate.
Mr. RANGEL. No. No. I am just trying to find out. The recommendations have come from Treasury. You have evaluated them. I assume you agree. Both of you are reading from the same page as to what can be done to correct a situation that looks like a hemorrhaging of overclaims. You have targeted it. On your own, you figured something was wrong, so you had your study. You evaluated somehow whether it was fraud or mistakes and you created some way that you think you can close this gap in order to save what many of us believe is a very, very good program. Is that correct?
Mr. DOLAN. That is correct.
Mr. RANGEL. So with all of your creativity and all of the safeguards, are we suggesting that the best we can look forward to is bringing this down from 25 to 23?
Mr. SCHOLZ. May I answer that, Mr. Rangel? As I mentioned in my oral statement, with just the math error procedures that the Committee and Congress and the administration supported in last year's welfare reform law, the error rate would be 20.7 percent. The error rate has come down from 35.4 percent in 1988 to 20.7 percent with the 1994 data. More initiatives have already been adopted. We have proposed another set and we think those error rates will come down further, significantly.
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Mr. RANGEL. Well, we have a problem with the word significantly, but what do you tolerate with other taxpayers' groups? Is there a group identified as individual self-employed proprietors that you categorize as having specific problems in overclaims? Mr. Dalrymple.
Mr. DALRYMPLE. Mr. Rangel, I can answer that. We have a 17-percent overall tax gap. That is the overall tax gap, roughly. Wage earners are basically in the 98-percent turnstile. They are 98-percent compliant. When you start talking about sole proprietors, which I think you asked the question about, it is in the range of 56- or 57-percent compliant. I hope that answers your question.
Mr. RANGEL. So the noncompliance is what is left?
Mr. DALRYMPLE. The noncompliance would be about 42 percent.
Mr. RANGEL. Did you do a study on that?
Mr. DALRYMPLE. We have done several TCMP studies around that.
Mr. RANGEL. Are you doing things to correct it?
Mr. DALRYMPLE. We are doing all kinds of things to try to correct that.
Mr. RANGEL. Do you have any assumptions to what improvement is going to be made in that? Are you an economist?
[Laughter.]
Mr. DALRYMPLE. I do have a degree in economics, yes, sir. I am almost sorry to have said that, Mr. Rangel.
[Laughter.]
Mr. RANGEL. Well, you never can be wrong with this Committee. Everyone needs their own economists and I thought they sent the wrong team here.
Mr. DALRYMPLE. Part of the $405 million revenue initiative several years ago was to address specifically that particular market segment.
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Mr. RANGEL. We are constantly trying to improve the system, and in order to have confidence in the system, people have to believe that they cannot beat it. It is very important that you try to evaluate this overclaim problem as to which people are deliberately cheating on the U.S. Government and which are not educated enough to understand the complexity in the 39-page information sheet that some people have to read in order to take advantage of it. We ought to find out how many people are so frightened of the darn thing that they do not even apply for it, as well.
I think it would help us in our thinking if you could tell us the delivery of services or benefits to poor people. It is my understanding, since the delivery administration system is already locked in with these working people, that the overall cost of the program is dramatically lower than the delivery of food stamps and other benefits. If you find reason to be so tolerant of the 42 percent, then we ought to have the same type of understanding with the EITC. We have to constantly report to this Committee and the Congress and the American people what we are doing, how can the Congress assist you to make certain that programs and the tax collection system and a voluntary system works.
I want to thank the IRS for initiating their own study to see how they could do better and I join with the Chairman and Mrs. Johnson in saying, the program is not in jeopardy. The program is good. But in order for the program, which costs a lot of money, to continue to succeed, it cannot carry the political burden of having people believe that either people are deliberately cheating or the IRS cannot do the job or come up with a solution.
I gather that the complexity of the lives of hard working, low-income people, the taking the credit for children that may be living with grandmothers and other people, have caused a great problem. I, for one, think that we have to, if we cannot explain the complexity of the problems because the Tax Code is really something that is designed for lawyers and not taxpayers, that we should spell out in no uncertain terms that those people who intend to take advantage of this credit better know what they are doing under penalty and they had better have some pamphlets in the community.
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I do not have anything in my Congressional offices except the regular forms. We have to do a better outreach job. All of the Congressional offices, especially those with large numbers of poor people, should have special people assigned with literature to let our people know. We will attempt to help you prior to income tax day. We can help those people that are locked into the system. Please ask the Congress to help you to resolve this program and not allow it to fall victim to criticism, some deserved and a lot not deserved.
Dr. Scholz, before you come back to the Committee, let us discuss some of the things earlier about how we make assumptions around this place. Thank you.
Chairman ARCHER. Thank you, Mr. Rangel.
Mr. Shaw.
Mr. SHAW. Thank you, Mr. Chairman.
I would like to go back to Dr. Scholz. He seems to be a favorite target this morning. I would like to ask you in the questions that I am going to ask you, as painful as it might be, if you could give me brief yes or no answers, as would be appropriate to the question.
The first matter that I want to go into, according to the Congressional Budget Office, CBO's, latest figures, we expect the total cost of the credit to be $25.7 billion in 1997. Do you agree with that figure?
Mr. SCHOLZ. Yes, I do.
Mr. SHAW. Second, the IRS study shows the 25 percent of the benefits paid by this program are wasted in the sense that they are paid either in fraud or in error. Now, this was the study, I believe, that Mr. Dolan referred to, is that correct? This is the 1994 study?
Mr. SCHOLZ. What year are you talking about?
Mr. SHAW. I know you want to try to get this back to 20.7 percent, but the only study that has been completed with fresh data is 25 percent, is that correct?