Each year the Internal Revenue Service receives tax returns that show more income than was actually earned, in some cases twice the actual earnings.
That seems bizarre at first blush. After all, why would anyone tell the tax man they made more than they did?
The answer is that Congress has created an incentive for the poorest of the working poor to report more than their actual incomes. Doing so can be worth more than $3,000 to impoverished working parents under a form of negative income tax known as the Earned Income Tax Credit that sends government money to the working poor.
But it is not the working poor themselves who make up phony numbers. The problem is with unscrupulous income tax preparers, the IRS Taxpayer Advocate, Nina E. Olson, and others who work with the poor tell me.
Ginning up nonexistent income lets dishonest tax preparers charge larger fees and helps attract new clients as word spreads of their success at getting big refunds.
Just last month the Justice Department sued to shut down what it characterized in court papers as a nationwide chain of tax fraud mills that reported inflated incomes and often did not tell people it was filing tax returns for them.
Asked about the allegations, Instant Tax Service general counsel Todd Bryant said they were baseless, with a handful of problem cases mischaracterized as the norm.
The IRS and the Justice Department identified a problem with tax preparers inflating incomes years ago.
Abusive tax preparers have been found at big firms as well as underground operations. Failing to get tough on the abusers makes it hard for the vast majority of honest preparers to prosper, as clients who know nothing about the complexities of tax naturally gravitate toward whoever has a reputation for getting the biggest refunds.