Financial Empowerment Helps Low-Income Families Keep More of What They Earn
With the tax filing season in full swing, millions of Americans are assembling the necessary paperwork to file their income tax before the April 15 deadline. For low-income workers, filing their income tax this year could provide a significant boost to their income if they take advantage of the earned income tax credit, or EITC. The EITC is a refundable federal income tax credit for low-income working individuals and families. It allows workers who qualify to increase their income by an average of $2,240. Congress originally implemented the credit in 1975 in part to offset the burden of social security taxes and to provide an incentive to work. Over the years, the EITC has received wide support across the political spectrum and in recent years was expanded to provide additional benefits to larger size families and married couples, boosting its poverty reducing benefits.
While millions of low-income families look forward to this time of year and the income boost the EITC provides, many are not getting the full benefits of the credit because they turn to expensive tax preparation vendors to file their taxes. During tax filing season these vendors bombard low-income communities with a host of advertisements. They market their services as effective tools to help low-income consumers get their refund faster to make purchases, pay off bills, and avoid the traps of credit cards. Of course what’s missing from this marketing are the hidden fees and high interest families pay to get their tax refund a few days early.
High-cost tax preparation strips millions of dollars from families and communities each year. It is estimated that consumers in 2009 paid $606 million in refund anticipation loan, or RAL fees—essentially a high-interest loan against an individual’s tax refund. In addition to RAL fees, consumers paid another $58 million in filing charges and other processing fees to tax preparers. IRS data reveal that 87 percent of taxpayers who applied for a RAL in 2009 were low-income. Not surprisingly these loans offered by many tax preparation vendors are uniquely designed to target low-income workers. An Urban Institute report found that the median adjusted gross income of RAL borrowers is under $20,000, and that 1 in 4 taxpayers earning $10,000 to $25,000 use a RAL. These individuals typically live in low-income communities with limited access to mainstream financial services and institutions.
The targeting of low-income communities with expensive financial products isn’t just a problem at tax time, it continues throughout the year. A number of consumer instruments similar to RALs are marketed as reasonable, short-term options for individuals facing financial emergencies, those wanting to avoid late fees, or other less desirable short-term credit options. They include payday loans, high-interest loans that are geared toward low-income individuals who need immediate access to cash prior to receiving their next paycheck; auto title loans, small short-term loans secured by a borrower’s vehicle; and, rent-to-own programs. Due to the upfront charges and short repayment periods many of these programs carry fees equivalent to high annualized interest rates that can approach 400 percent. These type of loan instruments strip enormous amounts of capital from low-income communities. The Center for Responsible Lending estimates that services like payday loans trap over 12 million Americans in a vicious debt cycle while providing nearly $5 billion profits annually to the payday loan industry.
These predatory lending practices target communities, remove limited capital, and restrict the ability of many low-income families to become financially stable by building assets over time. The 2012 Corporation for Enterprise Development, or CFED, Assets & Opportunity Scorecard shows the impact of these products. In 2011 more than 1 in 4 households, 27 percent, qualified as asset poor, not having sufficient resources to survive for a short period and 43 percent of households counted as liquid asset poor, a measurement that does not include assets like a home that can’t be easily converted to cash.
Why antipoverty advocates should embrace financial empowerment
Policy changes made by the IRS in 2010 will reduce the ability of banks to offer RALs, limiting this specific form of asset stripping from low-income communities. But there are other types of high-cost financial instruments emerging to replace RALs.
Since the EITC is one of the largest single cash payments most low-income workers will receive in a given year, it presents the best opportunity for antipoverty advocates to engage families in financial empowerment planning. Across the country, communities are experimenting with different strategies and system reforms to empower low-income families so they can keep more of the income they earn. The first and perhaps easiest strategy being utilized is to encourage more families to use the free Volunteer Income Tax Assistance, or VITA, centers now available in many communities across the country. These facilities, certified by the IRS and operated by local social service providers and governments help families keep the full amount of their tax credit.
Utilizing EITC more fully
Moving beyond the free preparation, the tax filling season provides an opportunity for antipoverty advocates to implement creative programs and partnerships to help families prepare for the additional income they will receive, to think strategically about ways to avoid predatory financial practices, and to start saving for the future. If more low-income families are able to save they can better prepare for emergencies and earning fluctuations that frequently push people into poverty. Additionally, savings help keep families from falling into debt or turning to high-cost financial services during emergencies.
Traditional strategies to help the poor have rightly focused on increasing family income through employment and maintaining a strong, functioning safety net. After all, boosting incomes is the fastest way to reduce hardship and lift a family out of poverty. At the same time, higher costs for basic services reduce income and create barriers to saving and upward mobility. That’s why a comprehensive model to help low-income individuals reduce their costs, better utilize mainstream financial systems, and build assets is needed. Here are four strategies that must be incorporated into that model:
- Expand access to low-cost, mainstream financial services. Efforts must be made to encourage more financial institutions to expand services that are cost-effective, convenient to families, and profitable to an institution’s bottom line. Without available services in their communities, individuals will turn to high-cost services that are convenient.
- Establish financial education programs. These programs inform low-income families about available options and provide them with the skills to avoid predatory financial traps.
- Restrict predatory financial practices. Policymakers must implement guidelines to limit predatory marketing and financial practices that strip assets from low-income families and communities. This is simply another approach to boost the income among low-wage workers, reduce the reliance on government income transfers, and create additional incentives for work.
- Provide incentives to save. Policymakers should experiment with more programs that provide incentives to increase the savings rate among low-income communities.
A major obstacle to low-income families gaining more stable financial footing is that many of these families don’t have checking or saving accounts leaving them prey to predatory lenders.
In 2009, almost 8 percent of Americans were without a checking or saving account—what is termed “unbanked.” The unbanked level jumps to 22 percent for African Americans and 19 percent for Hispanics. Many of these families have lower incomes, yet pay higher fees to cash checks and pay for typical bills. One survey of low-income families in Kentucky found that 35 percent of regular customers of high-cost check-cashing establishments earn less than $20,000 annually, and about 62 percent earn less than $40,000.
Working toward solutions
Currently there are a number of initiatives up and running across the country that are working to financially educate families, reduce high-cost financial products, increase access to mainstream banking, and help put more families on the path to financial stability.
SaveUSAis a four-city initiative started in New York City (SaveNYC) that provides free financial counseling and money management tips to low-income families. SaveUSA also provides participants with a 50 percent match if they deposit at least $200 of their tax refund into a SaveUSA account and maintain the deposit for one year. In its first year, participating residents in the four cities opened more than 1,600 SaveUSA accounts with almost $1 million in savings. In New York City, residents with an average income of $16,000 were able to build a combined $250,000 in savings. Along with New York City, the program is now running in Newark, San Antonio, and Tulsa, Oklahoma. The matching funds are provided through a federal Social Innovation Fund grant.
Low-cost financial services
It is estimated that low-income workers pay up to $1,000 in annual fees for check-cashing services alone. Two examples of programs that are successfully working to reduce these fees and improve access to low-cost financial services operate in San Francisco.
Bank On started in San Francisco and expanded to over 100 cities across the nation. The program works with low-income families to help them develop relationships with mainstream banks. Bank On programs build local partnerships across governments, financial institutions, and nonprofits. They connect unbanked individuals to low-fee bank accounts, raise public awareness about predatory financial practices, and improve access to financial education for low-income consumers.
Payday Plus SF provides an alternative to the traditional payday loan. The program helps low-income people build credit and avoid debt when they need small loans between paychecks. Too often, low-income people use predatory payday loans to bridge the gap between paychecks, which put them at risk of developing bad credit and massive debt. Payday Plus SF loans offer reasonable interest rates and realistic repayment terms. Customers can borrow up to $500 and repay it over 6 to 12 months at a maximum APR of 18 percent, even if they have low or no credit scores.
Oregon Neighborhood Partnerships IDA allows individuals who contribute to the individual development account, or IDA, program to have 75 percent of their contribution count as a tax credit on their Oregon state income tax return. The program uses the donated funds to provide financial education and specific asset training for low-income families and help them establish savings goals by setting up a plan for monthly deposits. The program provides a 3-to-1 match for every dollar participants save toward their goal, up to a maximum $3,000 per year.
To help more working families keep what they earn, antipoverty activists are embracing financial empowerment efforts and pushing for new policies to restrict asset-stripping practices. CAP’s Half in Ten campaign outlined a set of policies in its recent report, “Restoring Shared Prosperity,”to help cut poverty and expand economic growth. Reducing the number of unbanked households is one of the key indicators that the campaign will track over the next 10 years. Half in Ten recognizes that often all it takes is one financial emergency to push a family into poverty. To that end, the campaign will work to maintain a strong social safety net, but will also explore other strategies to help families become and remain economically stable. Across the country, antipoverty advocates have fully embraced the income stabilizing powers of the earned income tax credit and are actively working during the current tax filing season to help families file for and take full advantage of the EITC. As we work to achieve income security for American families we must help more individuals and families become financially empowered so they can avoid high-cost financial products in addition to expanding asset building incentives for low-income families.
Desmond Brown is a consultant to the Center for American Progress Action Fund’s Half in Ten antipoverty project.
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