Simplifying the complex U.S. tax code is the most direct way to reduce both the public and private costs of complying with the federal income tax, but tax reform is extraordinarily difficult to achieve. Some analysts have argued that return-free filing systems, such as those used in other countries and in the state of California, could substantially reduce the costs for many individual taxpayers with relatively simple returns at little or no net administrative cost to the government.
There is substantial uncertainty as to how a federal return-free system would affect the costs of government and individual tax filers. California‟s program appears to have reduced the state‟s administrative costs, but the net savings are largely attributable to e-filing rather than to the return-free system itself. The vast majority of California‟s eligible filers have declined to use it (only 3.2 percent do), suggesting that most people believe the savings they would realize in time and out-of-pocket spending would be outweighed by the costs, including risks to privacy and security.
A return-free tax system would increase third-party tax compliance costs—those of employers, financial institutions and other payers of income to individuals—largely because reporting deadlines would have to be advanced in order to provide timely returns and tax refunds. Calculations of such costs range from $500 million to as much as $5 billion, offsetting or exceeding any potential savings for taxpayers or for government. Added costs would fall disproportionally on small businesses.
Any cost savings for the IRS and individuals would likely be modest and additional costs to employers and other payers of income could be significant. Further, return-free filing would introduce a host of issues at the policy, economic, and operational levels. These include:
– The Internal Revenue Service (IRS) would face a conflict of interest in functioning as both tax preparer and enforcer.
– Risks of error would result from stretched IRS capacities. The IRS lacks the essential electronic processing capabilities and would face challenges in carrying out new responsibilities, particularly while its mission is expanding under health reform. Compressed income reporting schedules would also increase risks of error.
– Taxpayers who are unwilling to challenge an official IRS document—even when it may be erroneous—would nevertheless retain responsibility and liability for errors in government-prepared returns, a problem particularly for lower-income filers and those with English as a second language.
– Taxpayers would become less cognizant of the incentives in the tax code and their personal finances.
– IRS preparation of individual returns could compromise taxpayers‟ privacy.
– IRS tax preparation may pose greater security risks because private providers face stronger financial incentives to strengthen security practices in an environment of rapidly advancing technology and changing threats.
– The government would enter into competition with the private sector, reducing incentives for investment in innovation and electronic tax preparation systems.
Adopting a return-free tax system is not an advisable policy for the federal government.