#183 Summer 2016 — Financial Well-Being

Financial Inclusion Begins With Our Tax Code

Changes to the tax code, and tax programs that support low-wage earners, will strengthen gains made in the asset-building field.

For many Americans, tax time is met with dread, as they scramble to file before the deadline, trying to pay as little tax on their earnings as possible. These tend to be people with assets: home mortgages—sometimes second home mortgages—businesses, investments, and savings.

For another group of Americans, tax season is a time of relief. The tax refund is often the largest single amount of money they will receive in the year, and is used to pay off or make a substantial dent in debt accumulated throughout the year, add money to a savings account, or make a large purchase in cash to avoid using credit.

The irony of this is that the first group is actually being treated better by the tax code. Many of the tax programs that higher-income earning Americans take advantage of to offset or delay the costs of homeownership, college, savings, or inheritance are simply not available to low-income earners. The programs are accessed via deductions, exclusions, and deferrals, which tend to be employed by individuals with income over $200,000 and those who itemize deductions on their tax returns. The amount of benefit these programs confer also tends to fluctuate along with a household’s tax rate.

Tax policy reform advocates say that while there is nothing wrong with tax programs that encourage people to save for their future, go to college, or build wealth, they should not exclude the segment of the population that needs them the most.

In the absence of a fundamental overhaul of the nation’s tax code (which most economists say is necessary but unlikely), these advocates are on a mission to expand access to asset-building tax programs so that a greater number of Americans can take advantage of them.

“The primary way that the federal government invests in asset building is through the tax code. There is no larger source of investment for individuals to build wealth than these tax programs,” says Ezra Levin, associate director of government affairs at the Center for Enterprise Development (CFED), which launched its “Turn It Right Side Up” campaign in 2014 to shine a light on tax code inequities that affect homeownership, investments, higher education, and retirement. According to Levin, CFED would “like to see [elements of the tax code] reduce inequality and expand opportunity, rather than the opposite.”

A Deduction in Need of Reduction

The nation’s relationship with homeownership began in earnest in the 1930s, when the Federal Housing Administration and the Federal National Mortgage Association (Fannie Mae) began insuring 30-year mortgage loans. Consumer attraction to credit and the government’s promotion of homeownership proved to be a winning combination, and rates in both areas went up. Changes made to the tax code in 1986 took away people’s ability to claim consumer debt (such as credit card interest) on their tax returns, but left the interest paid on mortgages deductible. The amount of mortgage debt taxpayers can claim the interest on is capped at $1 million for first and second homes.

Proponents of the Mortgage Interest Deduction (MID) say it encourages homeownership, and the commonly held belief that homeownership makes residents more invested in the health of their community strongly influenced politics, in essence cementing the deduction as a permanent element of the tax code.

But economists have criticized the MID almost since its beginnings, saying it merely raises the price of homes. At a cost to the U.S. Treasury of $69.7 billion in 2013, it is one of the federal government’s largest tax preferences, and one that many say actually has no effect on whether average-income earners buy homes. The deduction benefits homeowners with more expensive homes and incomes over $100,000 the most, not only because the interest paid on an expensive home is substantial enough to be worth the deduction, but because the MID is only accessible when deductions are itemized. According to CFED, over 95 percent of tax filers with incomes over $200,000 itemize, but the majority of Americans—and homeowners—claim a standard deduction, and therefore get no benefit from the MID.

To help make the benefits of homeownership more accessible to homeowners at all income levels, CFED has proposed a package of housing tax credit reforms. Among them is the lowering of the MID cap to $500,000, thereby reducing this federal expenditure. CFED suggests that the savings could be applied toward establishing a credit for first-time homebuyers to help them afford closing costs.

Another proposal, presented by the United for Homes campaign of the National Low Income Housing Coalition, also supports lowering the MID cap by half, but would direct those savings to fund the National Housing Trust Fund. Created in 2008 by the federal government—although not funded until this year—the NHTF is designed to increase the affordable housing supply for the lowest-income households in the U.S. However, its inaugural funding of $174 million has been called “woefully inadequate” by NLIHC. In conjunction with the campaign’s MID cap proposal, it would convert the deduction into a nonrefundable credit so that more homeowners (those who do not itemize their taxes) may benefit. Campaign leaders say the proposed changes would provide at least $200 billion in savings in a decade, which would be put into the NHTF.

For people who do not own, but rent their homes, some U.S. states provide renters credits. Yet Will Fischer, senior policy analyst at the Center for Budget and Policy Priorities, says these programs are quite shallow, and not comprehensive enough to enable a family at or near the poverty line to afford rent. To more broadly support low-income renters, CBPP has proposed a federal tax credit that would be administered at the state level.

Designed to complement existing programs like Low Income Housing Tax Credits and Housing Choice vouchers (which, due to funding limitations, currently only reach a fraction of families who qualify for them), the credit would cover the cost of rent that exceeds 30 percent of the renter’s income. Targeted primarily to extremely low-income families, the credit is designed to address a portion of the need that is currently unmet for housing assistance. The non-refundable credit is designed to be filed by the owner or mortgage lender and not the renter because CBPP wanted to ensure the benefit would reach the whole range of low-income earners, and many individuals and families at that level do not file tax returns.

Like Housing Choice vouchers, the credit would enable a landlord to reduce rent to 30 percent of the household’s income. A landlord who charges below-market rent to low-income families would receive a credit based on the difference between that amount and the fair market rent, which would be capped based on HUD’s Small Area Fair Market Rent for the zip code. For landlords who need an incentive beyond a reliable stream of tax credits, the bill also gives the option to set the credit modestly above that difference.

Fischer says there is support for the proposal, and growing bipartisan interest in tax reform, in general. In fact, U.S. Rep. Charles Rangel, D-New York, introduced a renters credit bill (H.R. 4479) based on CBPP’s proposal in 2014, but Fischer noted that it would be more likely to pass as part of a comprehensive housing tax reform package, which wouldn’t happen until a new administration takes office.

“There’s encouraging talk about this kind of thing [reform of housing tax expenditures]; it’s something that’s been increasing in recent years,” says Fischer.

Expanding the Power of the Lump Sum

The Earned Income Tax Credit was a temporary refundable tax credit that was part of the Tax Reduction Act of 1975, but was made permanent in 1978. It has received wide bipartisan support (and was initially proposed by Republican lawmakers) as a welfare alternative because it rewards people who work. The maximum credit—which varies with an individual’s or family’s earnings—has steadily increased during and since the Reagan administration.

CBPP research demonstrates that in 2013 (the last year for which data is available), the EITC moved 6.2 million people out of poverty, more than half of whom were children. As wages stagnate and become more unpredictable, families have particularly come to count on the credit to help manage what Sarah Halpern-Meekin, co-author of the book, Its Not Like I’m Poor, calls the “shocks,” or unpredictable spikes in expenses that can prove to be devastating. “Families can account for wages being low, but the shocks, the expenses you can’t handle: car breaks down, kid gets sick . . . ,” she says. “One problem can act like a wildfire.”

Halpern-Meekin’s book includes the stories of families who must regularly turn to credit cards to pay for necessities throughout the year. The lump sum tax refund enables them to pay the debt back in full, or at least make a payment larger than the minimum they are usually able to afford. She also recalled families who paid a year of car insurance at once in order to have one fewer bill to budget for the coming year.

Through its research, CFED found that many families who utilize the EITC purposely claim fewer exemptions throughout the year in order to receive a larger refund, which in many cases can be up to 20 to 40 percent of their annual income. In collaboration with CFED and several other advocacy organizations, Sens. Cory Booker, D-New Jersey, and Jerry Moran, R-Kansas, proposed the Refund to Rainy Day Savings Act in April of this year. The program would allow filers to build emergency savings by deferring a portion of their refund (20 percent plus interest accrued) for six months.

“The financial lives of these earners are very unstable,” says Levin. “Without emergency savings, sudden ups and downs have a deleterious effect, and they must borrow from family, friends, or payday lenders.” The legislation also includes reform to an existing matched savings program called Assets for Independence. The new AFI program, built on feedback from local practitioners, will evaluate a variety of savings programs and includes the creation of a three-year pilot that would test savings matches of up to 50 percent for Rainy Day program participants.

A population that is largely left out of the EITC’s benefits is low-income earners who cannot claim dependents (non-custodial parents and single or married people without children). Filers in that category receive a maximum credit of $500 and must be age 25 or older. Described as “taxed into poverty,” these low-income workers begin to owe federal income tax after earning approximately $12,000 annually (for a single person), and additional state income tax and payroll taxes push them deeper below the poverty line.

As part of a 40-plus-member coalition of D.C.-based advocacy organizations called the Tax Alliance for Economic Mobility, CFED is embarking on a campaign to expand the EITC so that those who cannot claim dependents are included in reforms.

This past February, the Obama administration’s final budget proposal included expansion of the EITC, raising the maximum credit to $1,000 for workers without custodial children, and lowering the minimum age to 21. The plan is very much in line with the proposal presented by the Speaker of the House, Rep. Paul Ryan, R-Wisconsin, though his proposal has a different funding mechanism than the president’s. The expansion would affect over 13 million low-income workers.


While commencement speeches stress the importance of higher education to high school graduates, and 2015 data from the U.S. Bureau of Labor Statistics show that earnings increase along with educational attainment, the sobering reality is that a growing number of U.S. families are either unable to save for college or cannot afford its upfront costs. According to The College Board, average tuition and fees at public and private institutions increased by 13 and 11 percent, respectively, between 2010 and 2011. And despite increases in grant aid under the Obama administration, college enrollment rates for low-income students have dropped by 10 percent since 2008, according to the U.S. Census Bureau. Though the reasons for this drop may be manifold, a lack of household savings and high upfront costs are undoubtedly part of the cause.

Currently, the largest tax credit for higher education is the American Opportunity Tax Credit, which was created in 2009 and offers an annual, partially refundable credit of $2,500 per student for college expenses incurred in the previous year. The problem with the program, says Levin, is “if you’re a low-income student, you weren’t looking 18 months ahead to your future tax refund when you decided whether or not [you could afford] to enroll.”

The 529 plan is the government’s largest college savings plan. Money invested in a state 529 plan can grow free of federal tax (a growing number of states also offer a tax credit and/or full or partial tax deductions on 529 contributions), and the funds are not taxed at withdrawal when used to pay for college expenses. Though the plan helps to offset the rising cost of higher education, large numbers of people cannot afford to take advantage of it—in fact, according to CFED, 98 percent of 529 accounts are owned by upper-income families. Like the Mortgage Interest Deduction, the tax benefits of 529s come in the form of deductions and exclusions rather than credits, which are more advantageous for households with greater tax liability. In addition, standard features of most state’s 529 plans include minimum deposits and account fees, which can be barriers for lower-income households with little to no discretionary income to put into savings.

“Disproportionately, this tax expenditure is going to upper-income families, and it could be made more useful to low-income families,” says Levin.

CFED worked closely on a bill called the Save for Success Act, which was introduced in the House this March by U.S. Rep. Ben Ray Lujan, D-New Mexico. The goal of the bill is to simplify these tax programs and make them more equitable by combining the power of the AOTC and 529 plans.

In a new AOTC savings provision, families that contribute to a 529 plan would be able to claim up to $250 of contributions every year. This expansion to the 529 plan would create what CFED considers a children’s savings account for college so that more lower-income families can participate. “If you are a lower-income family and save into a 529 account, you can access your credit early,” says Levin, referring to the contributions made to the account that can be claimed on yearly tax filings. When the student enrolls in college, they will still be able to claim the savings in the 529 plan, up to the AOTC’s lifetime cap of $10,000.

Another element of the act is a pilot program that would test “real-time” payment of the AOTC so that students grappling with college affordability would receive the benefit of the credit immediately, which CFED believes would affect enrollment.

The Other Side of the Argument

Through coalitions like the Tax Alliance for Economic Mobility, which has over a dozen member groups including AARP, the Center for Community Change, and the Urban Institute, the movement to make elements of our tax code more equitable is an energized and organized one. It is sobering to note, however, that there are groups on the other side of the argument that are equally passionate. Composed of politicians, lobbyists, anti-tax and trickle-down proponents, most have a message of extreme federal debt reduction, tax breaks for the wealthy, and spending austerity. And when it comes to the tax code, they characterize tax programs like the EITC as handouts to the least deserving among us. In 2013, a business reporter on FOX News said that EITC recipients were a “group of people who have never paid a dime in their lives but they get a check from the government.”

In the face of those messages, advocates of equitable tax code reform believe that the success of their proposals will depend on the intensity of the voices that support them. “The only way we’re going to have success,” says Levin, “is if we communicate these issues effectively.” By collaborating with grassroots organizations that work directly with people to buy homes, save for higher education, and retire more securely, they are able to hone their message and make it as clear as possible.

“What we’re talking about is a large amount of government spending on programs to help build wealth, and the question is, ‘Are these programs going to be fair or unfair?’” says Levin. “Currently they’re very unfair . . . if we’re going to get folks on our side to reform these programs, we’ve got to get people as angry about the inequities as we are when we dive into it.”