TOPICS > Economy

Taxing the Poor

April 15, 2004 at 12:00 AM EDT
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PAUL SOLMAN: If many people think they have issues to resolve around tax time, imagine being one of the working poor. Karen Richburg is a contract worker who set up shows at the Washington, D.C., convention center last year.

She had seven different employers and was near the bottom of the American income ladder. But did her employers withhold enough? Too much?

PAUL SOLMAN: Are you going to have to pay taxes?

KAREN RICHBURG: Oh, I don’t know. I hope not.

PAUL SOLMAN: Even H&R Block told Richburg to get help elsewhere– at a tax clinic at a local library, run by volunteers.

KAREN RICHBURG: You see I’m praying, don’t you? ( Laughter )

PAUL SOLMAN: Yes, I do. Either that, or you’re anxious.

PAUL SOLMAN: It’s tough enough being a low- wage earner these days. Even the median wage in America hasn’t risen since the 1970s. The minimum wage, inflation adjusted, has actually dropped. Yet the working poor, roughly the bottom 20 million taxpayers, pay a lot more than you may think. And that’s what this story’s about — How tough taxes are for low-income America– both the burden of figuring them out and the actual amount of the taxes themselves.

Why do the working poor pay so much? In large part because of the so- called payroll taxes– Social Security and Medicare. New York Times reporter David Cay Johnston. Johnston is author of a recent book on taxes and tax avoidance, “Perfectly Legal.”

DAVID CAY JOHNSTON : You know, we don’t apply the income tax to you if you’re a single person until you make about $6,000 or $7,000 a year. But we tax you on Social Security from dollar one, and it’s a heavy tax. The amount taken out of your check is matched by your employer. That’s really wages you’re giving up. So your effective tax rate on Social Security on the first dollar you earned is 15 percent. That’s a very substantial tax.

PAUL SOLMAN: Especially when you add in the income tax, even at the bottom rate of 10 percent. As a result…

DAVID CAY JOHNSTON : Many, many people who are working class and middle class pay a larger percentage of their income in federal taxes than people who make millions of dollars a year.

PAUL SOLMAN: In theory, of course, federal tax policy is supposed to be progressive– the less you make, the lower a fraction of your income the government takes. But in practice, the tax burden in the U.S. is basically flat, Johnston claims. He writes in his book that counting everything, the top fifth of Americans pay about 19 cents on every dollar in taxes.

The bottom fifth of Americans pay 18 cents. Elena Deheza cleaned houses for several employers last year, but none paid Social Security for her or withheld any from her income. So she’s at the clinic to find out how much she owes.

ELENA DEHEZA: When he gave me my W, It shows it’s not paying my Social Security.

PAUL SOLMAN: This was not an employee W-2, but a 1099, the form the self-employed get, typically showing no taxes withheld. Leaving the legality of this for another day, Deheza is liable for it all, including payroll taxes.

PAUL SOLMAN: How much of her total income will she wind up having to pay in Social Security now?

TAX ADVISER: Medicare and Social Security together for a total payment with this year would be $983.

PAUL SOLMAN: So about $1,000, and what’s your total income roughly?

TAX ADVISER: I have a total income of $10,474.

PAUL SOLMAN: In other words, a 10 percent tax on a barely living wage. Now back in 1975, Congress, worried that taxes made welfare more attractive than low-wage work, enacted the Earned Income Tax Credit, or EITC, a federal tax credit for the working poor that helps offset payroll taxes. But that created even more problems for many lower-paid Americans. For one thing, the EITC moves in mysterious ways, as Karen Richburg has just discovered.

PAUL SOLMAN: Do you qualify for the earned income tax credit?

KAREN RICHBURG: Yes, with no dependents, right?

PAUL SOLMAN: Did you find that when you went to H&R Block or…

KAREN RICHBURG: No.

PAUL SOLMAN: …Jackson Hewitt?

KAREN RICHBURG: No.

PAUL SOLMAN: Brand-new information here?

KAREN RICHBURG: Right. Yes, it is. I was under the impression I might have to pay.

PAUL SOLMAN: For most recipients, says David Cay Johnston, the EITC is a minefield.

DAVID CAY JOHNSTON : You end up, as a result, with all sorts of mistakes, but there’s also some fraud. There were some people who went around and said, “hey, give me 50 bucks, we’ll take the government here for some money.”

PAUL SOLMAN: Taken together, the mistakes and the fraud prompted a congressional effort in the ’90s to cut back or kill the EITC entirely. As a compromise to save the program, congress and President Clinton gave the IRS extra money to audit EITC applicants. The consequence, according to Johnston ?

DAVID CAY JOHNSTON : About one in 47 people who apply for that credit are being audited. Two-thirds of the audits, by the way, result in the people getting the money they sought at the end of the day. But if you’re a millionaire investor in a partnership, your odds of being audited are one in 400, and this just does not make economic sense.

PAUL SOLMAN: This makes no economic sense, Johnston thinks, because the bottom 20 million taxpayers make so little money, even with the EITC.

DAVID CAY JOHNSTON : If you assume the absolute worst, that every single-earned income tax credit claim is fraud– $6 billion a year.

PAUL SOLMAN: That’s out of an estimated $250 billion in uncollected taxes each year, at a minimum, based on research from the late 1980s. President Bush’s IRS Commissioner, Mark Everson:

MARK EVERSON: Our estimate is that there’s about a quarter of a trillion dollar tax gap every year that’s a combination of underreporting, non-filing, and non-payment.

And that’s probably on the low side, all things considered, because what it doesn’t do is, our research doesn’t address the changes in behaviors that took place during the ’90s– these abusive shelters, the internationalization, the globalization of transactions, these investment banks and accounting firms that are… they’re essentially stateless.

PAUL SOLMAN: Johnston says the amount of uncollected taxes is actually much higher, due to maneuvers by rich taxpayers.

DAVID CAY JOHNSTON: I think we’re now up closer to $400 billion a year that people aren’t paying, so congress is going after this easy target, demonizing the poor and ignoring huge amounts of money that are not being taxed among people with substantial incomes.

PAUL SOLMAN: Of course, when some taxpayers are not paying their share, whether due to bad information or bad motives, the rest of us pay more: — $3,000 per U.S. taxpayer per year, if Johnston ‘s high estimate is the right one. The EITC mistakes and fraud cost each of us, at most, some $75 a year. So then, an obvious question: Why are the working poor still being given so much extra scrutiny if that’s not, to paraphrase bank robber Willie Sutton, where the money is?

NINA OLSON: I think it’s easy. It’s something that the IRS can do with computers.

PAUL SOLMAN: Nina Olson is the national taxpayer advocate, a position that’s part of the IRS.

NINA OLSON: It doesn’t take personnel. Unlike, you know, the middle income where you’re looking at a Schedule “A” charitable contributions, you’re going to have to actually look at the return. You don’t have databases that can do that.

PAUL SOLMAN: So the poor wrestle with a tax system that over- audits them, overwhelms them, and invites exploitation in other ways as well. Anyone can put up a shingle to do your taxes. In poor neighborhoods, almost anyone does, including pawnbrokers and retailers, who will file returns, even lend money against expected refunds, in return for a little business. Like the car dealer Olson drove past one day in Virginia .

NINA OLSON: “File your taxes with the duck. Use your refund for a truck.” I had no sense that he had any skills whatsoever in preparing tax returns, but certainly people were going to go in there. It was his major selling point. You see that over and over and over again.

PAUL SOLMAN: And even the legitimate tax preparers prey on the poor, claims this clinic’s manager, Paul Heimer.

PAUL HEIMER: Now I’m going to show you how much paid professionals that work with low-income people charge.

PAUL SOLMAN: Heimer showed us a 2002 return H&R Block had filed, incorrectly.

PAUL HEIMER: Take a look at this– tax preparation fee: $156. That’s how much he was charged, but this thing is like buying a used car.

PAUL SOLMAN: The clinic amended the return for free, a process that Heimer says took less than an hour. H&R Block’s fee?

PAUL HEIMER: Two hundred and seventeen dollars to file this relatively simple return. Then, they ask them the big question, “Do you want the money tomorrow?” And most people are going to want their money tomorrow. Well, the fee for getting your money tomorrow in what’s called a rapid acceleration loan is almost $90.

PAUL SOLMAN: That was the cost to this taxpayer of borrowing her refund, which included a finance charge of $65.

PAUL HEIMER: This is a loan that they’re getting, so it’s basically they’re paying interest on a loan, somewhere in the neighborhood of between 100 percent to 400 percent.

PAUL SOLMAN: H&R Block responds that it prepared more than 18 million returns last year in the U.S. “There is a human element to tax preparation,” the company says. “But our satisfaction guarantee policy states that if a client is not satisfied with our fees for any reason, the client doesn’t have to accept and pay for the return.”

Comparing itself to free clinics, H&R Block says its preparers have more experience. This defense has not, however, satisfied community organizers like those at Acorn, the nation’s largest advocacy group for low-income families. They’re up in arms, protesting the cost of so-called “refund anticipation loans” made through tax preparers like Jackson Hewitt and H&R Block.

Meanwhile, back at the clinic, Karen Richburg is finally ready for the verdict on her return. So what happened?

KAREN RICHBURG: Because of the earned income credit, I will be receiving a small tax fund — refund.

PAUL SOLMAN: How much?

KAREN RICHBURG: $186.

PAUL SOLMAN: Not enough perhaps to have covered H&R Block’s fee, but a happy ending for one of the 10 percent of low-income Americans who will get free help with their tax returns this year, although it does make you wonder about the 90 percent who won’t.