A Completely Screwed Up System

The following chart from the Congressional Budget Office (CBO) shows who pays federal income taxes in America.

It should come as no surprise that individuals with the highest incomes pay the most in taxes. The top 20% pay 94% of all income taxes according to the CBO. It should also be no surprise that the bottom two rungs (40%) of the income groups pay very little taxes. But it was surprising to me that the bottom 40% actually pay a negative income tax.

How does one pay negative taxes? Tax transfers to low income groups exceed their tax liabilities. Two examples of these transfers are the EITC (Earned Income Tax Credit) and ACTC (Additional Child Tax Credit).  The following chart from the Congressional Research Service (CRS) describes the effective negative tax rate phenomenon.

For those earning up to $26,000, there are no income taxes levied, but those individuals pay FICA (Social Security taxes). The value of the tax credits available to those individuals is greater than their SS taxes. Therefore, the group, ends up with a negative tax rate.

I favor this type of income redistribution. I think high-income groups should end up supporting lower income groups. I have no problem with negative effective tax rates for individuals and households that are at, or below, the poverty line.

But….

The CRS reported:

individuals who were not authorized to work in the United Statesreceived $4.2 billion by claiming the refundable portion of the child tax credit—the additional child tax credit (ACTC).

“How is this possible?” How could illegal workers end up receiving federal tax credits? The IRS is encouraging the process. 

The IRS issues two kinds of tax identification numbers. A traditional SS# is available for all legal residents. Illegal residents can obtain an ITIN (Individual Tax Identification Number). The use of ITIN has exploded 10-fold over the past decade. In 2010 3.2m people used these numbers to file tax returns and obtain refunds.

The use of ITINs is just one component of the problem. The Social Security Actuary estimated that 75% of illegal workers are using a fraudulently obtained SS# to get work. The IRS/SS knowingly collects this tainted money.

Combining the ITIN data with the 75% estimate by SSA leads to an estimate of 12m taxpayers contributing (and getting refunds) who shouldn’t be in the system at all.  (Note: the Census Bureau put the number of unauthorized aliens at 11.2m in 2010.)

What happens when a cash incentive to have children is made available to people who live in the country? They have babies, of course.  From the CRS:

Do existing laws permit illegal workers to get tax rebates and benefits?

For refundable tax credits like the EITC and ACTA, the answer is a very clear “No!” But that hasn’t stopped the IRS from allowing this to happen.

However, it is completely legal for an illegal worker to obtain Social Security benefits. Illegal workers who have contributed to SS (FICA taxes) for a minimum of 10 years are illegible to receive retirement benefits on the same schedule and terms as an individual who works legally. (Note: I was shocked when I first learned this, but it is true {Link}).

How many undocumented workers are there that might be eligible to get Social Security benefits? Pew answers that:

35% of unauthorized adults have resided in the United States for 15 years or more and that 28% have resided for 10 to 14 years. The report also found that the proportion of unauthorized aliens who have been in the country at least 15 years has more than doubled since 2000.

Based on the Pew numbers, 62% of the 12m unauthorized aliens will be eligible to receive benefits in their lifetimes. These workers have contributed to SS, so the law says they can get monthly checks. But the reality is that a significant percentage in this group is paying negative effective tax rates after taking into consideration the refundable tax credits described above. In the end, the lower 30% of income groups (including undocumented workers) end up “paying” for SS out of one pocket, while getting a similar sized refund check in the other pocket.

What are my points/objectives in writing about this?

–       Our immigration laws (and how they are applied) are completely idiotic.

–       The IRS is facilitating the problem by allowing refunds to be paid to those filing with illegal SS#s (or legally obtained, but fraudulently used ITINs).

–       Stirring the pot on the issue of illegal workers and their rights to receive Social Security benefits. It is now more than two years since the Chief Actuary of the SSN, Stephen Goss, spoke about this matter (Link). This is a political issue. The country deserves an update on how big this problem is before November. The candidates should be asked what they plan to do about it. Illegal workers have contributed as much as $240Bn to SS (10% of all assets).

–       Stimulate a discussion on a very complex and emotive topic.

Notes:

I have a soft spot for illegal immigrants. My father came from Europe in 1939.

I know many illegal families. I like them. They are good parents. They are hard workers. They would be happy to pay taxes as regular citizens do. They want to own property, cars and have their children get an education.

But the numbers are too large, and the consequences too significant. In the end, this about the law.

So I don’t know what to do.