As victims of several natural disasters are facing homelessness and economic ruin, many are searching for an economic lifeline. The tax code will provide some assistance, but the benefit is haphazard, somewhat random, and mostly helps wealthy individuals. The provision is so complicated that receiving assistance under it is like winning the tax assistance lottery.
With recent disasters from forest fires, two hurricanes and several tornadoes, Americans are grappling with life-changing devastation. They are facing both the trauma of the disaster coupled with stress of learning much of the losses from these events will not be covered by insurance. These events have the potential to bankrupt citizens and create severe economic hardships.
The tax code provides some relief for a small number who suffered economic loss from natural disasters, but most of that relief will go to the wealthiest taxpayers, those who need the least help. And even for those taxpayers who receive a tax benefit, the fact that they qualify for the tax deduction depends on a multitude of factors that leaves assistance mostly up to chance.
The provision has complicated loss thresholds, income limitations and exclusions. By the time a taxpayer climbs over all these hurdles, there is often nothing left to deduct as a loss. The ones who make it past these hurdles are usually the wealthiest taxpayers with large losses. These are the victims who likely need the least assistance. If we are interested in helping people who have suffered financial calamity due to natural disasters, there needs to be a better way.
The current provision is a result of Congress’s interest in helping disaster victims. Most personal losses are not deductible at all, but Congress created a specific category for personal casualty losses and provided that those losses are deductible in certain situations. Congress was clearly trying to provide relief to individuals who suffered economic harm from natural disasters.
As Congress considers tax reform, it should examine changing the casualty loss deduction to a refundable casualty credit designed to provide basic assistance to victims. When Congress provides a loss deduction, as in the case of casualty losses, individuals with higher tax rates receive higher benefits. This is because the value of the deduction is based on the tax an individual would have paid absent the deduction. Unlike deductions, tax credits provide a credit against the tax owed and are not based on a person’s tax rates. Credits are sometimes phased out as income rises, but the benefit people receive is not usually based on their income but instead on the amount of the loss.
Congress already has a wealth of examples of tax credits that are phased out as income rises. For example, the Child Tax Credit decreases for married couples as income increases over $400,000. But these tax credits provide direct assistance to individuals. They are independent of the taxpayer’s tax rate.
If Congress provides a refundable tax credit to disaster victims, all victims will get the same amount. This would deliver tax credits directly to taxpayers and would provide benefits to those who need it the most.
Many Americans, who are living paycheck-to-paycheck, cannot handle the devastating economic consequences from the disasters. Assistance needs to come in various ways, but a tax system that rewards the few who meet the complicated criteria and generally have the wealth to weather the storm is a misuse of the limited funds available to help victims.
A disaster tax credit would also more align with the goals Congress is trying to achieve by assisting people in need. Almost all victims of natural disasters will have some unreimbursed costs. Some may be struggling to find shelter; others may be struggling for food and clothing. For some, insurance may limit the economic impact of the tragedy, but for almost all victims of natural disasters, the disaster is a physical, emotional and economic tragedy.
Large losses from natural disasters seem to be happening more often and the tax code is a poor mechanism for assisting victims. Policymakers should consider other avenues to deal with future calamities. To the extent Congress wants to use the tax system to assist victims, the worst option is to continue a tax break that compensates wealthy victims at a higher rate than average income earners.
A reformed casualty tax credit aimed at people with incomes under $400,000 aligns better with Congress’s goal of helping victims of natural disasters and will provide some relief to average Americans who are suffering because of these catastrophes.
Donald Tobin, JD, is a tax law professor at the University of Maryland Francis King Carey School of Law. His research concentrates on tax policy and the way the tax code is often used to drive other policy outcomes. Tobin served as dean of Maryland Carey Law from 2014-2022.