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Are Pre-Filled Forms the Solution to Tax Compliance Costs?

4 min readBy: Jared Walczak

The TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Foundation’s Jared Walczak appeared on the April 8th episode of CBS Sunday Morning to discuss the potential issues with having the IRS issue pre-filled tax returns. You can view it here.

“April is the cruellest month” according to T.S. Eliot, and he didn’t even have to worry about the U.S. income tax filing deadline. With Tax Day fast approaching, Americans are sitting down to that most distasteful of civic rituals, tax preparation. It’s little wonder, then, that around this time every year, there’s always a renewed interest in “return-free filing” (or pre-filled tax forms), designed to take some of the effort out of paying taxes.

There are, after all, real costs to tax preparation. According to somewhat dated IRS statistics, filing taxes takes an average of eight hours and costs $120 for each nonbusiness return. Anything that could potentially save American households more than two billion hours is worth considering. But as it turns out, while there are certainly costs to the current system, a return-free filing system has significant costs of its own.

  1. It’s more likely to result in overpayments. For most taxpayers in the United States, wage income forms the backbone of their return, but there are a wide range of adjustments: state and local taxes, mortgage interest, medical expense, capital gains and losses, miscellaneous income, and more. The federal government possesses some of this information, but not all. A taxpayer with capital gains realization is likely to know that they need to amend their pre-filled return, but many taxpayers could lose out on adjustments in their favor that the IRS didn’t know to claim for them. Some taxpayers may also balk at conflating the roles of tax preparer and tax collector, as their interests and motivations are not necessarily aligned.
  2. It separates taxpayers from their liability. Under the current system of withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. , most taxpayers already have only a vague sense of what they owe in federal income taxes, but at least they have to calculate the number every year. (Note that if they’re also property owners, odds are good that they know what their property taxes came to, because they got an assessment for that amount and had to write a check.) Return-free filing further detracts from tax transparency, both in knowing how much one has paid and how that figure is arrived at. Transparency is important in service to an informed public. If we want people to have a voice in deciding the optimal level of taxes and spending, then systems which make it ever less likely that they’ll even know what they paid in income taxes are not ideal.
  3. It means surrendering a great deal of privacy. Most countries with return-free filing use an approach called “exact withholding,” which requires sharing additional personal information not only with the government, but also with one’s employer. Under this system, employers would need to know about your home mortgage, your medical expenses, and your charitable contributions, to name just a few pieces of information most employees aren’t accustomed to sharing with their employer.
  4. It requires a simpler tax code. The alternative return-free filing approach is called “tax agency reconciliation,” a pre-filled form approach that relies heavily on a simple tax code where everyone files separate returns, capital gains are taxed at the source or not at all, and there are relatively few tax preferences, things like the earned income tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. , the child tax credit, the mortgage interest deductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act (TCJA) reduced the amount of principal and limited the types of loans that qualify for the deduction. , or the state and local tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. . Without first radically simplifying federal income taxes, tax agency reconciliation would allow return-free filing for very few taxpayers—fewer than 5 percent, according to a 2003 study from the U.S. Department of the Treasury.
  5. American taxpayers haven’t embraced the idea. While polls show that most U.S. taxpayers like the idea of return-free filing, when states have experimented with it, few have embraced the option. A California pilot program in the mid-2000s which, in its second incarnation, was to be rolled out to a million taxpayers, only saw 80,000 takers. In Michigan in the mid-‘90s, after two years of offering a no-form filing option, only 128 taxpayers were using the system. A similar program in Colorado also had negligible utilization. There’s no doubt that taxpayers would like to reduce their tax compliance, but at what cost?

The problem return-free filing seeks to address is real. Americans spend far too much on income tax compliance. The best solution, however, is not to eliminate filing but to eliminate complexity. The new federal tax law simplifies filing for many taxpayers, as more than 90 percent of all households can now be expected to take the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. rather than itemizing. However, the tax code still remains far too complex to make return-free filing a viable option, and simplification is important enough to be a goal unto itself.

Louis XIV’s finance minister famously declared that “[t]he art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the least possible amount of hissing.” Return-free filing cuts down on the hissing, quite possibly at the expense of the feathers.