The good and the bad of tax policy, and why it matters for SaverLife members
How can Tax Time transform the financial health goals of people living on low-to-moderate income? Tax season might seem like a boring, bureaucratic process, but tax refunds are actually a lifeline for many SaverLife members. They help members get caught up on bills, reduce debt, save, and maybe buy something extra for their kids.
Take SaverLife member Tiffany. When asked what Tax Time meant to her, she said: “Tax Time is Christmas time. We tell our kids that if they want something, they need to wait until Tax Time, not the holidays."
The U.S. tax system has important functions that help SaverLife members maximize their refunds. But it can also be better — much better. Read on to learn the good and the bad of tax policy in the U.S. and how it impacts people living on low-to-moderate incomes.
The Good: Tax credits support households that benefit the most
SaverLife members know just how powerful refundable credits are. We found that our members who received expanded CTC payments in 2021 were able to improve their financial health by increasing their savings and paying for childcare.
“My husband is a freelancer, but he hasn’t gotten paid yet,” explains SaverLife member Devorah. “Knowing I have the Child Tax Credit makes me a lot more comfortable. It means I can comfortably cover my bills while we wait for his freelancing checks to come in.”
What makes tax policy so beneficial is that refundable tax credits and a progressive marginal tax rate can be used to support people who need it most.
Refunds are made possible by tax credits like the Earned Income Tax Credit and the refundable part of the Child Tax Credit (CTC). To get these credits, all filers need to do is file their federal income tax return once a year and they’ll receive a tax refund that they can put toward their financial health goals. Unlike many public benefit programs, they don’t have to deal with a complicated application, wait in long lines, and miss work.
The many benefits of tax refunds are also made possible by the progressivity of federal income tax rates. Filers pay more taxes when they have higher income and less taxes when they have lower income. The less taxes they pay, the greater the chance they’ll get a refund, especially if they claim refundable tax credits.
The Bad: Poor design leads to upside-down taxes
Did you know that tax filers in the top 20% of income receive 50% of all tax breaks, so higher-income tax filers get more help than lower-income filers? This happens because many tax credits and deductions are poorly designed, creating an “upside-down” tax system. This can affect SaverLife members, and people living on low-to-moderate incomes, in several ways:
Renting — People who own homes and have a mortgage can deduct the interest they pay on their mortgages (on up to $750,000 of debt). However, there’s no comparable tax credit for renters, even though renters have a much harder time paying for housing than homeowners.
Retirement — If a person works for an employer who offers a retirement plan like a 401(k), the money that they take out of their paycheck and contribute to their retirement plan doesn’t count as income, meaning they’ll pay lower taxes. Yet, this current design doesn’t benefit workers who earn a low-to-moderate income. Only 49% of people taking home low-to-moderate pay have access to a workplace retirement plan, compared to 83% of higher-income workers.
The Secure 2.0 Act was passed in December 2022, and will make it easier for workers to save for retirement through an employer match based on their student loan payments. But, for the 51% of gig workers and lower-wage workers whose employer doesn’t offer a retirement plan, they’ll still miss out.
Climate change initiatives — the Inflation Reduction Act (IRA) includes various tax incentives for people to transition to clean energy, such as a tax credit for buying an electric vehicle (EV). But few tax filers living on low-to-moderate incomes can likely afford an EV, even with a tax credit.
SaverLife member José would like to purchase a back-up generator for his home, but says it’s not within his budget right now. “I wish there were more programs that were affordable to people living on lower incomes — even if it’s just a rebate,” he says. “That would be extremely helpful.”
The IRA also offers incentives to buy energy-efficient appliances, heating and cooling systems, and solar panels. However, renters are unlikely to benefit because they must rely on their landlords to access these incentives and they may not live in their housing unit long enough for the purchase to pay for itself through energy savings. (Read our research on the uptake of energy-efficient amenities, especially among renters)
State and local taxes — State and local taxes are also upside down in 44 out of 50 states (see if your state is upside down), because sales, excise, and gas taxes are regressive. In other words,the lower a person’s income, the higher their tax rate. For a SaverLife member living in North Carolina whose monthly income is $2,500 and pays for 50 gallons of gas per month, they would pay 7% of their income on gas, including $20.20 in gas taxes. By comparison, if a person’s income is $5,000 a month, and they pay the same amount for gas, that gas (including the taxes!) would only be 3.5% of their income — half as much as the person with less income.
Gig work: Many SaverLife members use gig work like ride-sharing and other types of self-employment to supplement their incomes. This means that they have to pay self-employment taxes if they make $400 or more from this work. Unlike work through an employer, where an employee pays half (7.65%) of their “FICA” — their Social Security and Medicare taxes — with gig work, the employee is responsible for all 15.30% of their FICA. This is the self-employment tax.
Additionally, if a self-employed person doesn’t pay estimated taxes during the year, they may have to pay a penalty when they file their taxes if they end up owing $1,000 or more. Filing taxes can also be more complicated for gig workers because they must complete Schedules C and SE which limits their options for free filing.
Let’s break this down: people whose wages are too low to pay for their basic expenses like food and housing do gig work so they can make ends meet. In return, they pay more in taxes, risk being penalized, and have to pay for filing their taxes when it would have been free if they didn’t do gig work. But if these challenges were improved, SaverLife members could use Tax Time to increase their yearly income and work toward lasting financial health and well-being.
Seven ways we can improve the tax system for LMI households
There’s a lot we can fix about our tax system to improve the financial health of SaverLife members and families living on low-to-moderate income. Here are just a few ways that policy makers and other decision makers can transform the tax code:
Make the 2021 expanded Child Tax Credit permanent for families living on low-to-moderate income.
Waive the employer portion of self-employment taxes for tax filers with low-to-moderate income.
Guarantee free tax filing for tax filers living on low-to-moderate income who have basic returns, including gig and contract workers with self-employment income.
Give people who qualify for refundable credits the choice of receiving part of their refunds in advance.
Eliminate the mortgage interest tax deduction and replace it with a tax credit for renters.
Make state income taxes more progressive to make up for “upside down” consumption taxes.
Automatically offer public retirement savings programs to employees and gig workers who lack access to a retirement plan through their employers and increase the amount of the Savers Match that will start in 2027 under the Secure 2.0 Act.
As SaverLife members have shared, Tax Time can look very different to everyone. Some members see their tax refund as the chance to make progress toward a financial goal, while others bank on their refund to pay for basic expenses like food and housing and get caught up on bills.
No matter how someone sees Tax Time, SaverLife members deserve access to tax refunds, credits, and resources that accurately reflect their financial priorities. We can achieve this by designing a tax system that supports them to make the most of Tax Time by claiming credits and deductions that maximize their refunds and improve their financial health.
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