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Return-Free Filing Would Revolutionize Americans’ Taxes

Felipe Castro in Miami, Fla., holds a sign advertising a tax preparation office for people that still need help completing their taxes before the Internal Revenue Service deadline.

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Joe Raedle/Getty Images

About the author: Thomas J. Healey is a senior fellow at Harvard Kennedy School and former assistant secretary of the Treasury.

Of the many government bureaucracies Americans must confront regularly, none is more reviled than the Internal Revenue Service. It has earned this distinction in a variety of ways, as evidenced by the approximately 35 million unprocessed tax returns that had piled up in its offices by the end of last year, dashing hopes of speedy refunds by countless individuals. And by the 73 million phone calls from taxpayers seeking help or guidance during the 2022 filing season, of which a dismal 10% actually reached an IRS agent.

It can safely be said this nation’s tax agency is not about to win the Malcolm Baldrige Award for customer service. Making matters worse is the fact that only $3 billion of the $80 billion infusion to the IRS as part of the Inflation Reduction Act signed into law in August is actually earmarked for improving taxpayer service. Nearly half of the outlay will instead be channeled into beefing up enforcement, and a portion of the remainder for upgrading antiquated technology.

President Joe Biden nominated the new head of the IRS last month—Danny Werfel. Werfel should focus on a tiny $15 million component of the new funding package which could well hold the key to the future of the sprawling, 75,000-employee agency. That money will underwrite a study on a program which, if implemented, could be transformative in how Americans pay their taxes, and how the IRS functions. The program is known as “return-free filing,” and what it essentially means is that a significant proportion of the population would no longer fill out a federal tax return. Instead, the government would do all the paperwork based on information it already retains on each taxpayer, and the taxes it has withheld throughout the year from their paychecks. A model could well be the exact withholding systems used in other countries where authorities try to minimize withholdings and thereby eliminate the need for a costly and time-consuming refund process.

An estimated 36 countries—including the United Kingdom, Germany, Japan, Spain, Denmark, and Sweden—have implemented return-free filing for their taxpayers. The U.K.’s Pay as You Earn system, in operation since the 1940s, taxes around two-thirds of its taxpayers at the same basic marginal rate. That system was revised in 2013 to require employers to report salary payments in real time, with the goal of decreasing costly withholding errors. The change also linked revenue collection and benefit payments to the same database, increasing the system’s efficiency.

In the U.S., former President Ronald Reagan mapped out for the first time in 1985 a return-free system which would relieve about half the population of having to fill out a tax return. Under that blueprint, taxpayers with simple returns would receive at the conclusion of each tax season either a refund or a notice detailing taxes owed. Those with more complex returns could continue to use the system in place. In 2006, the Obama administration picked up the idea, suggesting a simplified process where taxpayers would receive each year from the government an already completed tax return for their review or correction. It was estimated that this overhaul of the business-as-usual system could have saved taxpayers more than $2 billion annually in tax preparation fees. That’s the primary reason why a return-free filing system—for all its promise and across-the-board benefits—was never able to get off the ground in this country: stout resistance and unrelenting lobbying from the tax preparation industry.

The U.S. has actually offered some form of free basic tax return preparation for over 50 years to low-income individuals, the elderly, and people with disabilities. In a report by the Government Accountability Office in April, however, the watchdog reported that while 70% of taxpayers were eligible for free-filing programs, only 3% actually took advantage. Those programs consist of a public-private partnership of tax software companies that offer free-of-charge tax preparation services outside the IRS website.

Given the unfairness baked into the American tax system, and the legions of wealthier taxpayers who have no guilt exploiting it, revolutionary change in the form of return-free filing is an idea whose time has definitely come—again! Countries around the world have demonstrated conclusively that it works. Ideally, such a venture in this country would be coupled with a sweeping overhaul (that is, simplification) of the tax law, which is famously riddled with loopholes and inequities. But even in the absence of such an overhaul, we can no longer afford to surrender to the tax preparation lobby and forgo an elegantly simple and uncluttered system of tax reform that promises historic benefits for taxpayers and the IRS alike.

Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to ideas@barrons.com.

Credit: marketwatch.com

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