Stimulus Spawning More IT-Enabled Fraud for States – and Potentially Feds

The COVID-19 pandemic has spawned historic levels of fraud in state government unemployment insurance (UI) programs – enabled through combined failures of policy, procedure, management, leadership, and technology.

The pandemic fraud-wave has resulted in perhaps the greatest financial debacle in state governance history – wasting as much as $30 billion in California alone. Nationwide on a state-level basis, that total may reach as high as $200 billion.

And with the Biden Administration’s new stimulus package just taking off, those totals may be just the beginning.

The $1.9 trillion American Rescue Plan (ARP) – one of the largest Federal aid packages since the Great Depression – will extend regular UI benefits for another 29 weeks, and boost benefits by $300 weekly until September. The continuation of benefits through later this year means the chapter on potential fraud is far from closed.

The Numbers Game

Temptation toward fraud isn’t a new story in the human tale. Neither is fraud executed with the assistance of IT systems that have not been sufficiently designed and/or managed to prevent large-scale theft.

What is new over this most difficult of pandemic periods, however, is the sheer increase in volume and value of benefits being provided by Federal and state governments through IT systems that often are old, overburdened, and not up to the task of effective fraud prevention.

By our rough count, the Feds have authorized over $6 trillion in pandemic-related benefits over the past 12 months, while a number of individual states have tailored their own stimulus packages adding billions more . With the pot thus sweetened, it’s not surprising that criminals are trying their best to take advantage. After all – as in the case of banks and those who choose to rob them – that’s where the money is.

Already we’ve heard a few ominous signs on that front – with one industry source reporting that fraudulent UI claims have increased 10-fold over the last several weeks alone in anticipation of the extension of benefits. Elsewhere, one state in the central U.S. actually recorded 3.6 million new claims last week – hundreds of thousands more than its entire state population.

Here are some programs to watch that historically have been big losers on the fraud front.

Possible Federal Exposure

The new stimulus plan includes boosts to many benefit-related programs, and this time the target of fraud will include the Federal government – although states will not be immune.

The plan increases the IRS child-related tax credit from the current $2,000 per child, to a total of $3,600 for each child under six, and $3,000 for each child under age 18. The single-year enhancement is projected to cost $110 billion for 2021.

However, in the “projected” part of that equation lies the rub.

Five years ago, the Treasury Inspector General estimated that the IRS paid out improper child tax credits payments in 25 to 30 percent of total payments. These new benefit boosts may be an attractive target for further mischief.

I recall in 1989 when the IRS began to require social security numbers for dependent children on tax forms. When the new rule took effect the number of taxpayers claiming the credit dropped by 30 percent! It will be interesting to see if these new enhancements will trigger a new round of fraudsters to test the child-related tax credits program again, perhaps claiming new “pandemic babies” on their 1040s.

EITC Worries

Then there’s the earned income tax credit (EITC). The program is a well-intentioned plan designed to incentivize low-income individuals to work by giving them a tax refund (technically a refundable tax credit) on money that they’ve earned.

But similar to rates seen with the child tax credit, the Treasury IG estimates improper payments in EITC at 22 to 26 percent each year. The new stimulus plan will nearly triple the EITC credit, to over $1,500. In the past, a taxpayer had to actually have income to receive the benefit. But the ARP has removed that stipulation, and even with no earnings at all, individuals will receive a check for the credit. Such an enhancement will hardly go unnoticed by those with fraud on their minds.

State EITC Exposure

In 2008, Washington became the first state to pass legislation for an EITC. Since then, 28 other states and the District of Columbia have enacted an EITC program. For the most part, these state plans calculate the tax credit as a percentage of the IRS deduction.

In addition, California Governor Gavin Newsom last month announced the Golden State Stimulus program which will refund $600 to all 2019 taxpayers who received a California EITC in 2020. The California program – unlike the Federal one – allows undocumented persons to receive the EITC stimulus funds. Last year, nearly 3.9 million California EITC tax returns were filed. I believe it’s safe to say that that number will increase this year – a pattern expected to be followed across the country.

For the most part, states will use a percentage formula to calculate the credit. Consequently, if states wish a validation of their taxpayers EITC claims, they will have to rely on the IRS to do so. Given the improper payment history described by the Treasury IG in the past, that reliance may be foolhardy, especially given the benefit enhancements and thus the greater temptation to fraud created by the new tax credit.