Two Democrats challenge the payday-loan industry
Could a small change in a federal tax credit significantly reduce people’s need for predatory payday loans?
That’s the hope of a new tax bill introduced Wednesday by Sen. Sherrod Brown and Rep. Ro Khanna. Their topline idea is to massively expand the Earned Income Tax Credit (EITC), which gives low- and moderate-income Americans a subsidy for working. Most attention will focus on the cost of the legislation, which could run near $1 trillion over 10 years, although an exact estimate isn’t available. But buried within the bill is a small change that could have big ramifications for the payday loan industry, which covers short-term financial needs by charging very high interest rates.
The idea is to let people who qualify for the EITC take up to $500 as an advance on their annual payment. Normally, the EITC is a cash benefit that arrives all at once, after tax time—a kind of windfall that’s nice when it happens, but doesn’t help cash-strapped workers cover costs during the year, when they actually arise. The so-called “Early EITC,” which Brown first proposed in 2015 and built off a proposal from the Center of American Progress in 2014, would fix that by allowing workers to request an advance, an amount that would later be deducted from their lump-sum EITC benefit. In effect, the advance is a no-interest, no-fee federal loan that could help cover short-term expenses or a gap in income.
The EITC is the rare government program with support across the political spectrum: It's a mechanism for providing benefits to low-income Americans while encouraging work, since it increases as a person’s income rises. But the way it's paid out, as a lump sum in the form of a tax refund, has attracted critics. “Why do we have a credit that is geared towards households making between $10,000 and $25,000 a year where they are getting between $2,000 to $6,000 in one payment?” said David Marzahl, president of the Center for Economic Progress, which has proposed reforms to the EITC. “In reality, their needs are spread across the year.”
Would an advance actually work, and help relieve the burden of high-interest payday loans? In theory, the idea makes a lot of sense. Most payday borrowers have jobs and bank accounts, and they make an average of $30,000 a year, making them prime candidates to receive the EITC. (This would be especially true if the entire Brown-Khanna bill was enacted, because nearly every person earning $30,000 a year—even those without kids—would receive more than $500 in EITC benefits each year.) The average payday loan is around $375—within the $500 cap in the Early EITC—and is used to meet an unexpected expense, like a surprise medical bill, or because they worked fewer hours.
But consumer-finance advocates, who have long hoped for ways to reduce people’s reliance on payday loans, are still somewhat skeptical. Though they’re expensive, payday loans have become a big business because they fill a hole in the financial system: They get money to cash-strapped workers quickly, easily and with certainty. If the Early EITC wants to replace payday loans, said Alex Horowitz, an expert on small-dollar loans at the Pew Charitable Trusts, it needs to be just as fast, easy and certain.
“This is a group that borrows primarily when they are distressed, so they aren’t very price-sensitive,” he said. “The fact is that a no-cost advance is not sufficient to make it work. If it’s going to be successful, it’s going to have to compete on speed and certainty.” In addition, he added, borrowers must actually know that the Early EITC exists, which can be an insurmountable challenge for many government programs.
There’s reason to be skeptical that Washington could deliver Early EITC benefits quickly, easily and with certainty. The federal government is not known as the quickest of institutions, and it will have to move especially fast to compete with payday loans. To do so, Brown has designed the bill to work through the employment system; the employer would fund the money up front and later be reimbursed by the federal government. It’s an interesting fix, but workers wouldn't get the additional money until their next paycheck, which still leaves a gap that payday loans are designed to fill. Said Horowitz, “If it takes three days or five days to receive funds, for the most part, people will pass.” In addition, it isn't available to workers who are unemployed or who were hired in the last six months, a problem for workers whose incomes fluctuate due to job loss.
For some advocates, the Early EITC is a step in the right direction, but not the bigger reform the tax credit needs. In 2014, Marzahl’s organization experimented with spreading EITC benefits across the year, giving 229 low-income Chicagoans half their money in quarterly payments. (The other half of benefits was delivered as a normal annual payment.) Participants who received quarterly EITC benefits, the study found, cut their payday loan usage by 45 percent compared with those who continued receiving their EITC benefits annually. Ninety percent said they preferred the periodic payments over the lump-sum approach. Such periodic payments, Marzahl argued, would be a big help for recipients, but they're a long way from anything now being proposed in Congress.
Right now, with Congress fully in GOP hands, the Brown-Khanna bill doesn’t stand a chance of becoming law, but lawmakers on both sides of the aisle, including House Speaker Paul Ryan and Sen. Marco Rubio, have shown interest in reforming and expanding the EITC. At some point in the next few years, Congress could take a real shot a restructuring it—and the Early EITC could serve as model for an improved tax credit.
“At the end of the day what all these reforms are getting at is that at certain times of the year, American households are very hard-pressed financially to meet their day-to-day needs,” said Marzahl. “Payday loans end up becoming a way to stop the gap on a very short-term basis. Ultimately, we need something more than that.”