Archive for April, 2011

Best Practices in Tax Administration: Comments to Senate Finance Committee

Thursday, April 28th, 2011

The issue of government-prepared tax returns was discussed during the April 12, 2011 hearing of the Senate Finance Committee, Best Practices in Tax Administration: A Look Across the Globe.  Joseph Cordes of the George Washington University and I submitted comments to the Committee, based on our paper Should the Government Prepare Individual Income Tax Returns. The comments and the paper will be published in the hearing record.

TPI’s paper examines evidence about the costs and benefits of government-prepared or pre-populated tax returns and concludes that adopting such a tax system is not advisable for the U.S.  Other countries use such systems, including the United Kingdom, as does the state of California.

Cost savings for individual filers would likely be modest at best because checking a return for completeness and accuracy requires much of the same compliance work as preparing a return.  Only 3 percent of eligible filers in California have chosen to use the pre-populated returns provided.  This suggests that most people do not believe it is to their advantage to use the system. In addition, IRS costs could increase since the agency currently lacks the essential electronic processing capabilities and the staffing to implement a return-free system.  Third-party costs—those   of employers, financial institutions and other payers of income to individuals—could rise substantially because reporting deadlines would have to be advanced in order to provide timely tax refunds.

We also advise in the comments that, beyond questions of costs, government preparation of returns raises challenges and difficult issues at the policy and operational levels.  These include:

• Taxpayers would become less cognizant of the incentives embodied in the tax code and their personal and family finances.

• Risks of error would result from stretched IRS capacities, particularly as the agency’s mission has been significantly expanded under healthcare reform.  The UK’s system has encountered major accuracy problems.

• Taxpayers who are unwilling to challenge an official IRS document would nevertheless retain sole responsibility and liability for errors in government-prepared returns.

• IRS preparation of individual returns could compromise taxpayers’ privacy and data security. The government mailing pre-completed tax returns could result in privacy breaches with returns sent to incorrect addresses when people move. Similarly, the IRS posting returns on the Internet, seeking electronic signature, presents risks of breach and cyber-crime.  This risk may be greater than in the private sector because firms face stronger financial incentives to invest in sound security practices in an environment of rapidly advancing technology and changing threats.

• Return-free systems cannot be readily adapted to the U.S. system, which uses tax incentives as a means of implementing social policies. Other countries that have adopted pre-populated returns have far simpler tax codes than the United States.

Our comments and the complete paper are posted on the TPI website.

Privacy Bill of Rights Act – Not Terrifying but Still Cause for Concern

Wednesday, April 13th, 2011

Senators Kerry and McCain released their long-awaited privacy bill yesterday afternoon – the Commercial Privacy Bill of Rights Act of 2011. After scanning through the bill summary and text, I thought I would add my initial thoughts to the mountain of reaction the bill is sure to produce.

First of all, it is clear that the Senators made an attempt at addressing calls for privacy regulation while acknowledging the importance of the free-flow of information in the marketplace.  Specifically, the Senators cite the importance of online advertising in funding the “free” online content and services we all enjoy.  Also encouraging is the bill’s call for opt-out consent requirement for behavior advertising or marketing, which would have much less impact on commerce than mandatory opt-in consent.

Still, the bill does raise some concerns, which I touch upon below.

The bill requires that firms provide individuals access to information collected and mechanisms to correct the information.  This has the potential to create a host of issues.  First of all, anytime an individual accesses such information, it is an opportunity for a security breach or even fraud, which runs counter to the bill’s intention to improve information security.  Second, it is unclear if an individual is allowed to change any and all information a firm may have collected.  What about in instances where an individual may want to remove something they deem as negative, but still accurate?  Because of the vagueness of the language, these concerns are not addressed in the bill but they should be considered.  CORRECTION: It was just pointed out to me that the bill does allow a firm to deny access and correction, as long as they allow an individual to request that the firm stop using or distributing that information. 

Also of concern is the bill’s requirement to only collect information that is needed to deliver a specific service, but allow the use of this information to research and development for a “reasonable amount of time.”  There are real trade-offs when the flow of information is restricted.  In this case, restriction of information, including the length of time information can be held, will result in hindering innovation, especially in online services.  It is unclear if consumers value this restriction of information more than innovation in services, but their actual behavior in the marketplace suggests a willingness to give up information in return for services and content. 

Finally, the bill raises an overarching concern that has been reiterated many times by TPI’s esteemed leader, Tom Lenard: “Where’s the data?”  Indeed, the influx of privacy bills and reports of late seem to be based much on feeling and opinions – with not a real analysis of costs and benefits among them.  Without a cost-benefit analysis of these proposed regulations and identification of the actual harms the regulation is trying to address, it’s impossible to tell if any of these proposals will actually make consumers better off.   Since the commercial use of information has been a vital component of the wide array of services offered on the internet, it is imperative that any policy regulating the use of this information is supported by real data and analysis going forward.