Refundable vs. Nonrefundable Saver’s Credit

Yesterday’s post described the Saver’s Credit, a taxpayer-paid matching contribution designed to encourage and assist low income workers to save for their retirement. In a thoughtful comment, David highlighted the purpose of the Saver's Credit, which is to asist low-income workers in saving for their own retirement.

Which leads me to focus on one particular feature of the Saver's Credit: it’s a nonrefundable credit. That’s tax jargon for a credit that is limited to your tax liability. A nonrefundable credit can only operate to reduce your tax liability. If your potential credit is a dollar more than your tax liability, you don’t get that extra dollar.

There’s currently a bill recently introduced into the House of Representatives by Congressman Pomeroy (H.R. 1961) that would turn the Saver’s Credit into a refundable credit. If your potential Saver’s Credit exceeds your tax liability for the year, the taxpayers give you a refund anyway—although “refund” is a poor choice of words, since the dollars would come from other taxpayers.

What is the point of drawing a bright line at your tax liability? Opponents of refundable credits call it welfare, since the refundable part comes from other taxpayers. If you limit the credit to tax liability, it’s easier to characterize it as a tax reduction. (“Welfare,” “tax reduction.” Words are really loaded, aren’t they?) Proponents of refundable credits note the arbitrary nature of the line that’s being drawn at the taxpayer’s tax liability. If she’s engaging in the favored activity that generates the credit, why draw a line at her tax liability? Particularly as the complexity of the Tax Code, with all its other deductions, exemptions and credits, makes that line increasingly arbitrary.

It’s instructive to note what other credits in the Tax Code are refundable. What activities are so favored by Congress that they are willing to have other taxpayers support the activity? The big one is the earned income credit, which constitutes taxpayer help for the working poor. There are also a couple of narrowly targeted credits aimed at farmers with high fuel costs and some unemployed individuals who need help with their health insurance costs. Most other credits—the child tax credit, adoption assistance, dependent care, the list is a long one—are nonrefundable. Congress just hates stepping over that line.

So what do I think? (Actually, nobody really asked me, but I have the floor.) I favor making the Saver’s Credit refundable. In my view, helping low income workers save for their retirement falls into the same category as the earned income credit for the working poor. They’re doing everything society wants and encourages them to do, yet often through no fault of their own they need help making ends meet. They’re exactly the ones the rest of us, through our tax dollars, ought to encourage, assist and support. They're the productive ones, the good guys.

Besides, if you look at the way the Tax Code is structured, you get the definite sense that deductions and credits serve fundamentally different purposes. Deductions are generally aimed at figuring the "right" measure of your ability to pay income tax. Credits, on the other hand, are designed to encourage specific activities; they are not germane to calculating your fair share of the country's overall need for tax revenue.

So what do you think? I’d like to know. Send me an email at TheTwoLeggedStool@gmail.com. Or, better, post a comment.