By David Cay Johnston
NEW YORK, April 26 Each year the Internal
Revenue Service receives tax returns that show more income than
was actually earned, in some cases twice the actual earnings.
That seems bizarre at first blush. After all, why would
anyone tell the tax man they made more than they did?
The answer is that Congress has created an incentive for the
poorest of the working poor to report more than their actual
incomes. Doing so can be worth more than $3,000 to impoverished
working parents under a form of negative income tax known as the
Earned Income Tax Credit that sends government money to the
But it is not the working poor themselves who make up phony
numbers. The problem is with unscrupulous income tax preparers,
the IRS Taxpayer Advocate, Nina E. Olson, and others who work
with the poor tell me.
Ginning up nonexistent income lets dishonest tax preparers
charge larger fees and helps attract new clients as word spreads
of their success at getting big refunds.
Just last month the Justice Department sued to shut down
what it characterized in court papers as a nationwide chain of
tax fraud mills that reported inflated incomes and often did not
tell people it was filing tax returns for them.
Asked about the allegations, Instant Tax Service general
counsel Todd Bryant said they were baseless, with a handful of
problem cases mischaracterized as the norm.
The IRS and the Justice Department identified a problem with
tax preparers inflating incomes years ago.
Abusive tax preparers have been found at big firms as well
as underground operations. Failing to get tough on the abusers
makes it hard for the vast majority of honest preparers to
prosper, as clients who know nothing about the complexities of
tax naturally gravitate toward whoever has a reputation for
getting the biggest refunds.
A PROBLEM THAT'S FIXABLE
Congress could fix the problem of exaggerated incomes and at
the same time help end America's shameful No. 1 ranking among
modern nations in child poverty. Sadly, I don't expect that,
given the focus in both parties on tax cuts for corporations
and, among Republicans, on more tax cuts for the rich. Indeed,
across the country anti-tax Republicans have called for ending
the Earned Income Tax Credit.
Milton Friedman, the Chicago School economist and Nobel
Prize winner, devised the negative income tax concept decades
ago. Friedman demonstrated that people on welfare who go to work
could be worse off because of taxes on their earnings. Properly
applied, Friedman's negative income tax idea can ensure that
working makes people better off.
President Ronald Reagan hailed the Earned Income Tax Credit
as "the best anti-poverty, the best pro-family, the best job
creation measure to come out of Congress." He was right. Last
year it lifted 3.3 million children, and an equal number of
adults, out of poverty.
Now consider a family with three children that earned $6,000
last year. That may seem extreme, but that was the average wage
for a third of American workers in 2010, as I reported in
This family will get $2,711.
However, the family's check more than doubles, to $5,751,
when a tax preparer falsely inflates their income to $12,800, as
you can test at this website.
Why does the family making $12,800 get more than twice as
much as the $6,000 family? Because Congress set the maximum tax
credit for a family with three children at wages of $12,800 to
DEVIOUS TAX PREPARERS
The problem of inflated incomes is not with conniving poor
people, but with devious tax preparers, everyone I asked about
Nancy Abramowitz, who runs the American University
Washington College of Law's tax clinic for poor people, said she
could not recall any individuals who had inflated their own
income to increase the tax credit. "It's always unscrupulous
preparers," she said.
Since employers verify wages, tax preparers usually inflate
incomes by creating a phony Schedule C, the tax form used by
many small businesses, because it is not verified except in an
Here are four ways Congress and the IRS can fix this:
* Congress should lower the threshold for securing the
maximum credit for families with children from $12,800 to the
average wage of the bottom third of workers, currently about
* Congress should pay for the prosecution of as many corrupt
tax return preparers as it takes to stop this fraud, including
$3,000 rewards to taxpayers who turn in corrupt preparers. Any
action by the IRS, not just convictions, should generate a
reward check. The reward I propose equals the maximum fraud loss
from a single case, making it cost-efficient provided Congress
requires the IRS to be generous, not stingy, in rewarding
* Congress should delay tax credit refunds for 45 days after
a tax return is filed. Olson, the IRS taxpayer advocate, told me
that speeding refunds encourages fraud. The United States is
unusual in trying to refund money instantly, instead of taking
time to make sure payments are proper before cutting checks.
* For the next few years the 40 percent of IRS
correspondence audits that now deal with the Earned Income Tax
Credit should concentrate on faked Schedule Cs that inflate
The focus should be on making work rewarding, not on hurting
the working poor.