The Personal Income Tax Law allows various credits against the taxes imposed by that law, including, in modified conformity with federal income tax laws, an earned income credit against personal income tax, as provided. Existing law requires the Franchise Tax Board to annually prepare a written report regarding the credit and to provide that report to specified legislative committees.

This bill would require the Franchise Tax Board to include in that annual report the number of false or fraudulent claims for the credit. returns claiming the credit that are reduced in part before a refund is issued and the number of returns claiming the credit that are denied in full before a refund is issued.

The Personal Income Tax Law allows various credits against the taxes imposed by that law, including, in modified conformity with federal income tax laws, an earned income credit against personal income tax, as provided. Existing law requires the Franchise Tax Board to annually prepare a written report regarding the credit and to provide that report to specified legislative committees.

This bill would require the Franchise Tax Board to include in that annual report the number of false or fraudulent claims for the credit.

Date of Hearing: April 4, 2016

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Sebastian Ridley-Thomas, Chair

ABPCA Bill Id:AB 1929 (

Author:Brough) – As Amended Ver:March 28, 2016

Majority vote. Fiscal committee.

SUBJECT: Personal income taxes: earned income credit: report

SUMMARY: Requires the Franchise Tax Board (FTB) to include in its annual California Earned Income Tax Credit (EITC) report to the Legislature the number of tax returns claiming the credit where the credit is either denied or reduced in part. Specifically, this bill:

1. Requires the FTB to include in its annual written EITC report to the Legislature, in addition to all other required information, the number of income tax returns that claim the California EITC:
   1. Where the credit is reduced in part before any refund is issued; or,
   2. Where the credit is denied in full before any refund is issued.
2. Makes technical non-substantive changes.
3. Applies to reports required to be submitted by the FTB to the Legislature on or after January 1, 2017.

EXISTING FEDERAL LAW:

1. Allows a refundable EITC to certain eligible individuals. A refundable credit allows for the excess of the credit over the taxpayer's tax liability to be refunded to the taxpayer. The federal EITC amount is based on a percentage of the taxpayer's earned income and is phased out as income increases. The percentage varies depending on whether the taxpayer has qualifying children. Married individuals are eligible for only one credit on their combined earned income and must file a joint return to claim the credit.
2. Requires employers to notify their employees that the employees may be eligible for the federal EITC.

EXISTING STATE LAW:

1. Allows, in modified conformity with the federal EITC, a refundable EITC for the lowest-income Californians for taxable years beginning on or after January 1, 2015.
2. Provides that the EITC is only available for taxable years for which resources are authorized in the annual Budget Act for the FTB to oversee and audit returns associated with the credit.
3. Requires the FTB to report annually to the Legislature the following information related to the California EITC:
   1. The number of tax returns claiming the credit.
   2. The number of individuals represented on tax returns claiming the credit.
   3. The average credit amount on tax returns claiming the credit.
   4. The distribution of credits by number of dependents and income ranges.
   5. An estimate of the number of families who are lifted out of deep poverty by the credit and an estimate of the number of families who are lifted out of deep poverty by the combination of the credit and the federal EITC.

FISCAL EFFECT: According to the FTB staff, this bill will not impact General Fund revenues.

COMMENTS:

1. The Author's Statement. The author has provided the following statement in support of this bill:
   
   "Current law requires the Franchise Tax Board (FTB) to provide a written report to the legislature on specific statistics that measure whether the newly established CalEITC achieves its intended purpose. It is equally as important for the legislature to evaluate the number of improper payments, whether fraudulent or accidental, in the report to determine the effectiveness of the CalEITC. Including this information that the FTB already collects as a measure of whether the credit achieves its intended purpose ensures that the administration of the CalEITC maximizes its potential effectiveness to lift people out of poverty.
   
   "We must make sure the CalEITC is both sustainable and monitored so that it may continue to benefit California's most vulnerable working class. Analyzing additional elements will make CalEITC reports reliable and comprehensive, further proving their effectiveness. It is essential that all aspects of the CalEITC are reported so that the Legislature may find ways to continue tracking its success and identify ways to improve it if necessary."
2. Arguments in Support. The proponents of this bill state that "California must be vigilant to ensure" that improper EITC payments do not occur and argue that "legislative oversight of the state EITC program – and the taxpayer dollars used to pay for the refundable tax credit – will be improved if lawmakers have easy access to important data from the FTB."
3. Federal EITC. The federal EITC is an income tax credit for low- to moderate-income individuals and families. Congress originally approved the tax credit legislation in 1975, in part to offset the burden of Social Security taxes and to provide an incentive to work. To qualify for the EITC an individual must be employed. When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. The EITC is a percentage of the taxpayer's earned income and is phased out as income increases. The EITC percentage varies depending on whether the taxpayer has qualifying children. The federal credit rate varies from 7.65% to 45%, depending on the number of qualifying children.
   
   In order for a taxpayer to qualify for the federal EITC in 2016, an individual's adjusted gross income must be less than $47,955 ($53,505 filing jointly) with three or more qualifying children; $44,648 ($50,198 filing jointly) with two qualifying children; $39,296 ($44,846 filing jointly) with one qualifying child; and $14,880 ($20,430 filing jointly) without a qualifying child. The maximum credit amount currently is $6,269 for taxpayers with three or more qualifying children; $5,572 for taxpayers with two qualifying children; $3,373 for taxpayers with one qualifying child; and $506 for taxpayers with no qualifying children.
   
4. California EITC. The Governor's 2015 May revise of the State budget included the first ever state EITC, which is refundable and focuses on the state's lowest income individuals. The state EITC was enacted into law in 2015 and is intended to complement the federal EITC to allow a greater benefit per household. Similar to the federal EITC, the California EITC is established as a refundable credit against personal income taxes owed based on earned income. However, unlike the federal government, California excludes self-employment income from the definition of "earned income" and only workers with earnings subject to wage withholding qualify for the credit.
   
   The California EITC is available for tax returns filed for wages earned in 2015. A credit amount is calculated according to specified percentages of the earned income based on the number of qualifying children. For 2015 tax year, the credit percentage is 7.65% for individuals without qualifying children, 34% for individuals with one qualifying child, 40% for individuals with two or more qualifying children, and 45% for individuals with three or more qualifying children. The maximum 2015 income limitation for both the adjusted gross income and earned income may not be more than $6,580 for individuals with no qualifying children, $9,880 for individuals with one qualifying child and $13,870 for individuals with two or more qualifying children. Finally, the amount of investment income, such as interest, dividends, royalties, and capital gains, may not exceed $3,400 for the entire tax year. Thus, unlike most other state EITCs, California's credit only reaches a portion of workers who are eligible for the federal EITC.
   
   The California EITC is expected to benefit approximately 825,000 families and two million individuals. This program, however, is operative only for taxable years for which resources are authorized in the annual Budget Act for the FTB to oversee and audit returns associated with the credit.
5. Implementation of the California EITC. The FY 2015-16 Budget included $22 million for the FTB to implement the credit and conduct public outreach efforts, which is important because the credit targets workers whose earnings are so low that they likely do not ordinarily have to file taxes. The FTB is working with a large external partnership that includes 24 state agencies, United Way, AARP, and the Golden State Opportunity Foundation. Together, the partnership has built an external clearinghouse for all EITC information – CalEITC4Me.org, which is supported by the public affairs firm Dewey Square. The site includes a Voluntary Tax Assistance finder as well as a calculator that determines how much you can get back from the federal and state EITC. Additionally, the FTB has aggressively pursued media coverage in local markets across the state; produced brochures and other promotional materials; and sent those materials to more than 100 organizations, ranging from nonprofits to tax preparers.

On March 10, 2016, the FTB released data identifying that 201,700 individuals have already claimed the California EITC. Of the individuals claiming this credit 26,000 are first-time filers, meaning they had no existing state tax liability and filed a tax return for the sole purpose of claiming the California EITC. To date, $100 million in California EITC has been claimed. While it had been projected that 600,000 individuals would claim the credit, the FTB was pleased with the results as there was still one month remaining for individuals to file their tax returns prior to April 15, 2016.

1. EITC: Encouraging Workforce Participation. Increasing the number of individuals who enter the job market reduces the unemployment rate and generally improves economic conditions. According to the California Budget Project, the EITC encourages and rewards additional work by providing a larger credit as workers' earnings increase. As an example, a single mother with two children earning $7,500 in 2014 is eligible for a $3,000 credit; if she earns twice as much, she will qualify for the maximum credit of $5,460. As such, she receives a larger credit by working more.^[1] Several studies have shown that the federal EITC has raised labor force participation rate of single mothers by at least seven percentage points^[2]. Other studies show that the federal EITC causes one out of every ten individuals who would normally be out of the labor force to start working^[3]. Most studies have shown a significant increase in labor force participation of unmarried mothers. In fact, one study showed that more than 60% of employment gains made by single mothers, when compared to mothers without children, was due to the EITC^[4]. Additionally, a separate study focused on employment among California women who received cash assistance at some point between 1987 and 2000. The study found that more than three-quarters of the employment gains between 1991 and 2000 for women with several children relative to those with only one child was attributable to the expansion of the EITC^[5].
   
2. Additional Benefits. In addition to increasing labor participation, the EITC provides a long list of benefits to low-income families. Specifically, studies have shown that low-income students perform better in school when families' incomes are boosted by the federal EITC. The EITC may result in increasing completion rates for high school and college. Other studies have also shown an increase in academic achievement and an increase in college attendance^[6]. Additionally, the EITC may help offset the disproportionate cost that low-income families pay in state and local taxes.^[7]
3. Annual Reporting Requirement. On September 29, 2014, Governor Brown signed into law SB 1335 (Leno), Chapter 845, Statutes of 2014, which added R&TC Section 41. SB 1335 recognized that the Legislature should apply the same level of review used for government spending programs to tax preference programs, including tax credits. Thus, Section 41 requires any bill introduced on or after January 1, 2015, which creates a new tax credit, to contain specific goals, purposes, and objectives that the tax credit will achieve. In addition, Section 41 requires detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives so-identified.
   
   As required by Section 41, the California EITC law, which was enacted in 2015, expressly stated the purpose of the credit. Specifically, the purpose of the California EITC is to reduce poverty among California's poorest working families and individuals. To this end, the California EITC requires FTB to prepare a written report to measure whether the credit achieves its intended purpose. The report must include an estimate of the number of families who are lifted out of deep poverty by both the federal and the California EITC as well as by the state credit alone. The report must also include the number of tax returns claiming the credit as well as the number of individuals represented on these tax returns, the average credit amount, and the distribution of credits by number of dependents and income ranges. This report is required to be submitted to several legislative committees, including this Committee.
4. What Does this Bill Do? This bill proposes to expand the EITC reporting requirement to include information on the number of returns claiming the EITC that was either reduced in part or denied in full before any refund is issued.
5. Federal EITC Overpayments: Fraud or Unintentional Errors? While the federal EITC program has been shown to increase work, reduce poverty, lower welfare receipt, and improve children's educational attachment,^[8] concerns have been raised about the EITC's error rate. The United States (U.S.) Government Accountability Office reports that, in fiscal year 2014, the Internal Revenue Service (IRS) made payments of $65.2 billion for the EITC.^[9] According to the IRS, an estimated 27.2%, or $17.7 billion, of these payments were improper.^[10] The IRS has reported that improper payments are a mix of unintentional mistakes and fraud.^[11]
   
   Complexity "has remained a key factor contributing to improper payments" in the federal EITC program.^[12] The U.S. Treasury Department estimates that 70% of the EITC improper payments "stem from issues related to the EITC's residency and relationship requirements, which are complex; filing status issues, which can arise when married couples file (often following a separation) as singles or heads of households; and other issues related to who can claim a child in a non-traditional family arrangements."^[13] The Center on Budget and Policy Priorities notes that analysis of "IRS data by Treasury experts and studies by outside researchers suggest that most EITC overpayments do not result from intentional action by tax filers"^[14] and actual overpayment rate is likely lower that IRS estimate.^[15]
6. Federal Efforts to Reduce Improper Payments. The IRS has taken various steps since 2010 to reduce EITC errors, including a major initiative to combat EITC errors by paid return preparers. As explained by the IRS National Taxpayer Advocate Nina Olson, the "low income population is vulnerable to unskilled and unethical preparers" and the single "most useful step Congress can take to improve EITC compliance and reduce the Improper Payments is to enact a regulatory regime that requires unenrolled preparers who prepare returns for fee to demonstrate minimum levels of competency."^[16] Ms. Olson suggested that Congress explicitly authorize the IRS "to require unenrolled return preparers to take a competency test and fulfill annual continuing education requirements as a condition of preparing tax returns for compensation."^[17] In addition, the GAO report recommended: (a) moving the W-2 filing deadlines to January 31 to facilitate the use of earnings information in the detection of EITC noncompliance, and (b) broaden IRS's authority to systematically disallow certain erroneous EITC claims with unsupported wages.
   
7. What is the Urgency? This bill, if enacted, will take effect on January 1, 2017 and will apply to the FTB annual reports starting in 2017. Currently, the FTB tracks the number of returns claiming the EITC that are "adjusted or denied before refund" in the aggregate. The changes proposed by this bill to the EITC program would require FTB to modify its existing information systems to report the number of "adjusted" claims and the number of "denied" claims separately, rather than as one combined number. In light of the recent enactment of the California EITC and ongoing federal efforts to reduce the improper EITC payments, the Committee may wish to consider whether the imposition of the reporting requirement proposed by this bill would be premature and whether its implementation should be delayed to later years.
   
8. Technical Amendments. Committee staff suggests the following technical amendments:
   

AMENDMENT 1

On page 5, line 5, strike out "that are" and insert:

where the credit is

AMENDMENT 2

On page 5, line 7, strike out "that are denied" and insert:

where the credit is

1. Related Legislation. AB 1847 (Mark Stone) would expands the employee notification requirement relating to the federal EITC to include a reference to the California EITC. AB 1847 will be heard by this Committee today.
2. Prior Legislation. SB 80 (Committee on Budget and Fiscal Review, Chapter 21, Statutes of 2015) established the refundable California EITC for taxable years beginning on or after January 1, 2015.
   

REGISTERED SUPPORT / OPPOSITION:

Support

California Taxpayers Association

Opposition

None on file

Analysis Prepared by: Oksana Jaffe / REV. & TAX. / (916) 319-2098

1. California Budget Project, a state EITC: making california’s tax system work better for Working families, December 2014. ↑

2. See Jeffrey Grogger, The Effects of Time Limits, the EITC, and Other Policy Changes on Welfare Use, Work, and Income Among Female-Headed Families, Review of Economics and Statistics, 2003; and Jeffrey Liebman and Nadda Eissa, Labor Supply Response to the Earned Income Tax Credit, Quarterly Journal of Economics, 1996. ↑

3. The President's Proposal To Expand the Earned Income Tax Credit, Executive Office of the President and U.S. Treasury Department, March 2014. ↑

4. Bruce D. Meyer and Dan T. Rosenbaum, Welfare, the Earned Income Tax Credit, and the Labor Supply of Single Mothers, The Quarterly Journal of Economics (2001). ↑

5. V. Joseph Hotz, Charles H. Mullin, and John Karl Scholz, Examining the Effect of the Earned Income Tax Credit on the Labor Market Participation of Families on Welfare, National Bureau of Economic Research Working Paper (December 2005). ↑

6. Gordon B. Dahl and Lance Lochner, The Impact of Family Income on Child Achievement: Evidence From the Earned Income Tax Credit, American Economic Review (2012); and Raj Chetty, John N. Friedman, and Jonah Rockoff, New Evidence on the Long-Term Impacts of Tax Credits, Statistics of Income Paper Series (November 2011) ↑

7. California Budget Project, A STATE EITC, citing the analysis conducted by Institute on Taxation and Economic Policy. ↑

8. Council of Economic Advisers, The War on Poverty 50 years Later: A Progress Report, January 2014, Table 2, page 27. ↑

9. GAO, Testimony before the Senate Committee on the Budget, U.S. Senate, Government Efficiency and Effectiveness, March 4, 2015, p.35. ↑

10. Id. ↑

11. Id., p. 37 ↑

12. Id., p. 35 ↑

13. Department of the Treasury, Agency Financial Report (AFR), FY 2014, p. 198. ↑

14. Center for Budget and Policy Priorities, R. Greenstein, J. Wancheck, and C. Matt, Reducing Overpayments in the Earned Income Tax Credit, December 1, 2015, p.4 (citing J. Holtzblatt and J. McCubbin, Issues Affecting Low-Income Filers; H. Aaron and J. Slemrod, The Crisis in Tax Administration, Brookings Institution Press, November 2002; and J. Liebman, Noncompliance and the EITC: Taxpayer Error or Taxpayer Fraud, Harvard University, November 1995). ↑

15. Id. ↑

16. Written Statement of Nina Olson, National Taxpayer Advocate Hearing on IRS Oversight before the Subcommittee on Financial Services and General Government Committee on Appropriations, U.S. House of Representatives, February 26, 2014, pp. 46-47. ↑

17. Id. ↑