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.