Refund Anticipation Loans Are Killing Us

It's tax season in the U.S. again and I'm glad to be involved with a group offering VITA (Volunteer Income Tax Assistance) for low and moderate income households as a part of my internship with the International Rescue Committee. The VITA program is vital to the most successful poverty alleviation program the Fed has found so far: the Earned Income Tax Credit. When I was working with ACCIÓN USA I had the good fortune to be present at the first convening of the Atlanta Prosperity Campaign's Earned Income Tax Credit (EITC) task force and I'm glad to see that the campaign is in full swing a few years later.

You might recall that we've discussed the EITC a few times here on the blog.

It's been credited as very successful in assisting those of low and moderate incomes to develop assets, that is, wealth building.  

Started in 1975, the Earned Income Tax Credit is a refundable federal tax credit designed to reduce the tax burden on low- and moderate-income workers and encourage participation in the labor force. In 2006, EITC benefited 22.4 million people with an average credit of $1,951. Research has shown that the EITC is often used to pay off debt, but it can also present an opportunity for wealth building.

I copy + pasted the last three sentences from a study recently released from the Woodstock Institute, a Chicago-based research and policy organization. They go on to point out that the "primary consumers of Refund Anticipation Loans (RALs) are recipients of the Earned Income Tax Credit. According to the National Consumer Law Center, 63 percent of the 8.67 million people who received a refund anticipation loan in 2007 also received the EITC."

RALs are those loans that tax prep sites (like H&R Block, Liberty Tax, Jackson Hewitt, etc.) offer to folks that want their tax return refunds ASAP. As they state:

While RALs give borrowers rapid access to their tax return, they do so at a significant cost to borrowers. According to a February 2009 report on the RAL industry produced by the National Consumer Law Center and the Consumer Federation of America, fees for a RAL in 2007 ranged from $104 to $111 per loan, with an average fee of $107.50. Lenders charged additional fees to borrowers who wanted their loans processed in one day. These costs are substantial when considering the size of the loan. For a refund anticipation loan of $3,000, annual percentage rates (APRs) ranged from 77 to 140 percent. On top of these RAL fees, an estimated 20 percent of RALs included additional application fees which can add another $40 to the cost of the loan. In addition, borrowers pay tax preparation fees that average as much as $183 at one nationwide vendor.

They then quote the National Consumer Law Center study that states that, "EITC recipients generated $525 million in fees for refund anticipation loans in 2002." Then citing a Brookings Institute study stating, "the complexities of the EITC qualification and application process appear to drive low-income taxpayers to use paid tax preparers. The means by which tax preparers are compensated for generating RALs rewards steering. A tax preparer is compensated for each loan they generate, and in some cases receive additional bonuses for meeting the quotas of the lender."

The Woodstock researchers point out that there is evidence for a motivation toward tax fraud present in these Refund Anticipation Loans, "In 1994, the IRS estimated that 92 percent of fraudulent returns filed electronically involved refund anticipation loans. In an effort to reduce fraud, the IRS stopped providing tax preparers with information on outstanding tax debt, a function called the Debt Indicator. Both RAL volume and RAL fraud dramatically declined after the elimination of the Debt Indicator. However, the IRS reinstated the Debt Indicator in 1999, after which RAL fraud rates increased."

So who are the folks making these RALs possible? According to the National Consumer Law Center it's: JP Morgan Chase (with 13,000 independent tax preparers), HSBC (H&R Block's RAL provider), and Pacific Capital Bancorp - the parent company of Santa Barbara Bank & Trust. According to the NCLC's recent press release, "RALs drained the refunds of about 8.4 million American taxpayers in 2008, costing them in the neighborhood of $738 million in loan fees, plus over $68 million in other fees." It's obviously popular to complain about the Wall Street Bailouts, but here is an annual bilking of Main Street.


Weirdly, the IRS doesn't require any kind of regulation of tax preparers, until this year, as the NCLC reports this year, "On January 4, 2010, the Internal Revenue Service (IRS) announced its plans to finally regulate the tax preparation industry. Currently, most tax preparers are not subject to any sort of licensing, competency or minimum educational requirements, a fact long criticized by consumer advocates and others, such as the National Taxpayer Advocate."

While it would be great if the EITC was used to build assets among those that qualify, the reality is that the recipients are often on the business end of a host of predatory lending practices (such as RALs, Title Loans, Pay Day Loans, Check Cashing services, Rent-to-Own schemes, etc.) and so the monies that are allocated with EITC are usually spent servicing debts. As the National Consumer Law Center points out, if you're considering a debt repayment program, caveat emptor (buyer beware):

[D]ebt settlement companies usually take out all of their fees, ranging from 14 to 20 percent of the total debt, within the first half of the contract. For debts totaling $20,000, a consumer could pay fees of $2,800 to $4,000.

"Debt settlement companies usually collect most or all of their fees from consumers long before they have eliminated any of their debts, and consumers pay these high fees regardless of whether their debts are settled or not," said Susan Grant, Consumer Federation of America’s Director of Consumer Protection.

"There is no guarantee that your debts will be settled," said Gail Hillebrand, Financial Services Campaign Manager at Consumers Union. "The industry’s own statistics show that debt settlement doesn’t eliminate all of the debt for most consumers. The full fee can be deducted from your savings even if you are still stuck with your debts."

The drop-out rate for debt settlement services is very high; a study of one company’s customers revealed that 60 percent had cancelled within 5 to 6 months after starting debt settlement. Claims for success rates can be very misleading because they often don’t take into consideration the cost of the fees consumer pay or the size of those debts that are never settled.

The NCLC is an excellent source for those of us that don't have much money and don't know how the credit and financial systems are set-up (and how they're predisposed to bleed us).

One Last Taxes Blog

Okay, well, maybe I'm doing you a favor as you go into tax season by talking about taxes in an election year.

Fact is, you're not going to get much more than rhetoric from the candidates (ever) and I feel that if you're going to have an opinion it should be based on reflection and deliberation with the facts as they lay.

Today I point you to Paul Krugman and AngryBear as they dove tail nicely around the question of how government intervention affects (I don't mean "effects") the economy.

Right now there is talk about the Federal Reserve cutting the lending rate, again, this time an anticipated .5%; but what does that mean? From Krugman's Post :

Monetary policy mainly exerts its influence through housing: high interest rates squeeze home construction, low rates encourage it. Interest rates have much less direct effect on business investment. The reason? Housing lasts much longer.

Suppose you take out a loan to buy a machine whose economic life is only 5 years — which is highly likely, given both physical wear and tear and technological obsolescence. How much difference does it make whether the interest rate on the loan is 4 percent or 6 percent? Not much: the monthly payment on a 5-year loan at 4% is less than 5% lower than the monthly payment on a loan at 6%. So interest rates don't have much effect on business investment.

On the other hand, suppose you buy a house with a 30-year mortgage. The monthly payment on a 4% mortgage is more than 20 percent lower than on a 6% mortgage. So interest rates make a lot of difference to housing.

So here's what normally happens in a recession: the Fed cuts rates, housing demand picks up, and the economy recovers.

Krugman goes on to point out that the problem with this strategy, this time, is that the source of recessionary pressure lies largely with the housing market, itself. This happened because accounting for banks changed (the following from Calculated Risk):

The accounting rule in question, Financial Accounting Standard 114, was adopted in 1993. Lynn E. Turner, a former chief accountant of the Securities and Exchange Commission, recalls that it was enacted because of abuses by financial institutions during the savings and loan debacle. Under the old rule, banks could avoid reporting losses so long as they expected to get the principal back eventually, even if the borrower did not have to pay interest on the restructured loan. The rule put an end to that.

Or at least it put an end to it for most types of loans. These banks live with F.A.S. 114 for their commercial mortgages and corporate loans, but according to Ms. Utermohlen, they don't have systems in place to do the calculations for large numbers of restructured residential mortgage loans.

The calculations, it turns out, are not that complicated. You could do them with a decent financial calculator, or an Excel spreadsheet. But the banks argue that would take too much effort, given the volume of loans likely to be restructured. "This would be extremely time-consuming and would likely involve additional staff dedicated to this purpose," Ms. Utermohlen said in a letter to the Financial Accounting Standards Board this week.

(emphasis added)
That's right, the banks are arguing that they're not responsible for the recession because EXCEL IS TOO HARD TO USE.

Well, it wouldn't be a big deal, I suppose, except for the fact that since this Bush came to office we've been fighting a recession by stimulating the generation of long term loans we call mortgages. Why do this instead of promote long term growth through paying down debt or promoting government spending on education and grants to scientists? I don't know why not. That's not what this administration and those within our government wanted to support.

Probably because those supporters of less government intervention (let the markets fix themselves, that's fair) believe that tax cuts (reducing the amounts of taxes individuals pay) have a stimulating effect on the ecnomy.

They say that instead of paying the government, those individuals will invest in the market (remember the dot-com crash?), or save (Americans now carry thousands more in debt than in savings), or create jobs (unemployment is expected to return to 6% because housing construction has ceased). Here are some graphs from AngryBear's blog:

Below is a graph showing the annual growth in real GDP per capita, by president starting with Ike, sorted from fastest growth to slowest growth. Data comes from the BEA's NIPA table 7.1. For each president, its calculated from the last year before the President took office to the last full year the President served. (Since JFK was killed and Nixon quit more than half-way through the year, I assumed JFK's "last full year" was 1963 and Nixon's was 1974.)


Now, another graph... This one shows the annual change in taxes as a percent of personal income. With the same color scheme. (I hope you've figured it out!!) This includes taxes on labor and capital gains. The data comes from the IRS.

That's right: the less you tax individuals (now remember, a corporation is by law an individual and given the same or more rights and protections as a human being), the less the economy has benefited.

This should be a no-brainer becuase if you ask someone who actually makes a lot of money they will tell you that paying more in taxes shows that you've made more money.

Why did Carnegie give away all that money? He knew, and stated that he knew, that he made his fortune by exploiting the conditions of his society. He felt he had to give back the largest portion of it so that society would benefit somewhat from his exploitation in the end.

Further, your taxes are there to support you, citizen. You like that road? Your taxes built it. You like that park? Your taxes paid for it. You like that there is less crime? Your taxes are used to alleviate the pressures that lead to crime.

And now, a final note about why you want to better understand taxes and what is unfair about the tax code today. I want to talk about the Earned Income Tax Credit (EITC). The following is from the Atlanta Prosperity Campaign:

The EITC is a tax benefit for low- to moderate-income working families. U.S. Census Data show that in 2003, the EITC lifted 4.4 million people out of poverty, including 2.4 million children – more than any other single program or category of programs. Without the EITC, the poverty rate among children would have been nearly one-fourth higher. For tax year 2005, 79,338 households in the city of Atlanta received $170,351,176 in Earned Income Tax Credits, resulting in an average EITC credit per household of $2,147. However, the Internal Revenue Service estimates the EITC participation rate for eligible individuals ranges from 75% to 80% Thus, increasing the EITC participation rate for Atlanta families by a mere 10% (7,934) could result in over $15 million in additional benefits.

If an individual qualifies for the EITC, he or she might also qualify for the Advance EITC, which allows workers to receive part of their refund in their paychecks during the year. It provides an opportunity for employers to effectively give their employees a raise without having to increase their salary. To increase enrollment in the Advance EITC, employers need only to be equipped with the knowledge and the tools to help their employees apply for the program.

(The emphases, obviously, are mine.)

What's unfair is that there are numerous opportunities for large corporations to avoid paying taxes and they have the financial resources to pay for accountants to find those opportunities. Those accountants, then, turn around (once the egg is on their faces) and make some hare-brained response like the one we have above.

Poverty in the Suburbs, Earned Income Tax Credit

According to the Institute for Financial Literacy, the average person filing for bankruptcy in 2006 was:
white, male, between the ages of 35 and 44, making less than $30,000 a year.

The official beginning of the recession was recorded in December, 2007 (although the feeling of being in recession was felt in 2006 by many); the Institute for Financial Literacy's follow-up on who filed bankruptcy in 2008 found the same group from 2006 was filing for bankruptcy - but that there has been a sharp shift into the middle class. Among the groups they found with the greatest rates of increase were the college educated, self-employed, making more than $40,000 a year.

Let's combine this with the Brookings Institute's study on the surge of poverty in the suburbs:

• 7.2 million jobs have been shed from the economy since December, 2007
• the majority of these job losses were in "decentralized" (not concentrated in industrial or city centers) i.e. real estate, construction, retail; and are part of a greater trend since the 1990s of the suburbanization of the poor
• low-density "exurbs" have been particularly hard hit because these communities don't have the same infrastructural safety nets that have become structural in the city. This can be seen in the use of food stamps: although there are more poor people living in the suburbs, only 32% of suburban families received food stamps vs. 39% in the primary cities they surround.

And, finally, lets briefly jextapose these micro-level economic indicators with what the ruling class had to say in Davos, Switzerland:

• Government debt has reached historical levels for peace time in a number of advanced economies.
• With a few exceptions, the larger advanced economies have been the most affected by fiscal crises. According to the IMF, by 2014, the average debt-to-GDP ratio of advanced economies that are members of the G20 is expected to climb from the 2007 pre-crisis level of 78% to 118%.
• According to the same IMF analysis, between 2007 and 2014 the average debt-to-GDP ratio of emerging countries that are members of the G20 will never exceed 40%.
• The U.S. will continue to experience plant foreclosures and the the bankruptcy of small and medium size enterprises, one legacy of this may be a legacy of underemployment in the U.S. as there are 9 million part-time workers today seeking full-time employment (myself included, y'all).

Since it is tax time again, I think it's appropriate to remind the readership that there is no reason to pay someone to help you prepare your taxes. This is particularly a problem for the most vulnerable section of the economy: the working poor. The Nation has a fine article discussing the problem of tax refund advance loans here.

If you are concerned that you won't be able to file your own taxes or are having a difficulty with your tax preparation, please consider using a VITA site, the Atlanta Prosperity Campaign helps working families find many sources of support.

I've discussed the Atlanta Prosperity Campaign before. A primary tool in their belt is the Earned Income Tax Credit (EITC), a refundable federal income tax credit for low to moderate income working individuals and families. The EITC is an effective tool for asset-building among the working poor:

[T]he Internal Revenue Service estimates the EITC participation rate for eligible individuals ranges from 75% to 80% Thus, increasing the EITC participation rate for Atlanta families by a mere 10% (7,934) could result in over $15 million in additional benefits.

Good luck.