A Right to Free Tax Preparation?
The founders knew we all had the rights to life, liberty, and the pursuit of happiness, but they apparently did not know that we also have the right to free online tax-preparation tools. It took Sen. Elizabeth Warren to discover this new inalienable right late in the 2015 filing season.
The founders might be excused for their failure of recognize this right, because in their day, the U.S. had no income taxation. The personal income tax would not become a permanent feature of the American economy until 1913. At that time, there was still no software and no internet, but there was also no need for technological assistance in complying with the tax.
As you can see from reviewing the original IRS Form 1040, tax returns were relatively easy to compute back then. All forms and instructions totaled a mere four pages. Most taxpayers simply reported their total income, subtracted some basic deductions, and then multiplied the balance (if any) by 1 percent. Only taxpayers reporting income over $20,000 paid graduated marginal tax rates ranging from 2 to 7 percent. This complexity affected a relatively small number of taxpayers, since $20,000 in 1913 was equivalent to over $450,000 in today's money.
Over the years, tax forms became more and more complex. The instruction booklet for today's Form 1040 extends to over 100 pages. While Form 1040 itself is only two pages, entries on the 1040 must be substantiated by a variety of supporting forms and schedules. In all, Form 1040 references 11 supporting schedules and 25 supporting forms. Not only is computing taxable income complex; calculating one's tax liability based on this income can also be very involved due to the Alternative Minimum Tax and phase-outs of various deductions. The complexity of income-tax compliance is especially objectionable because every other payment we have to make each year is either calculated for us or simple to compute.
Innovative firms such as Intuit and H&R Block have responded to this mind-numbing complexity by developing desktop software and, more recently, internet-based tools to perform many of the lookups and calculations for us. The cost of using such tools is typically below $100, well worth the money for the time and aggravation they save.
The two tax firms have even gone further by offering free access to their online tools for taxpayers who are eligible to file simplified forms 1040A or 1040EZ. These taxpayers have less than $100,000 in income, don't itemize, and don't have self-employment income. One incentive for the tax-preparation companies to offer these free services is clear. Taxpayers with simple filing requirements are often at the beginning of their careers. If they become Intuit or H&R Block users in 2016, they are likely to become paying customers in future years as their tax-filing needs become more complex.
But this isn't good enough for Senator Warren. On April 13, her office released a report criticizing the IRS' reliance on for-profit tax-preparation firms and proposed legislation directing the IRS to develop its own free online tax-preparation and filing service accessible to more taxpayers.
In fairness to Warren and her colleagues, a law enacted by a Republican Congress in 1998 did call for return-free filing, and it is true that the tax preparation industry has lobbied against the implementation of this provision. Further, the tax-preparation companies have inserted language into their free-file service agreements with the IRS that preclude the agency from developing its own return-free solution.
But asking the IRS to create its own tax-preparation software would threaten a repeat of the HealthCare.gov fiasco: an expensive development process that results in seriously flawed technology. The IRS' record is not promising in this regard. In the 1990s, the agency spent $4 billion on a failed system modernization. After that effort was canceled, more modest upgrade initiatives suffered from cost overruns, delays, and less-than-expected functionality, as shown in a 2003 IRS Oversight Board Analysis and a 2014 GAO Report.
Warren's report alleges that the tax-preparation industry and anti-tax groups have teamed up to prevent the IRS from simplifying the tax filing process. Her approach, endorsed by Bernie Sanders, Al Franken, and other left-leaning senators, is to have the IRS complete our tax forms for us by harvesting data from all the W-2's, 1099s, and other third-party forms it receives on our behalf. Ultimately, they imagine that the IRS could implement a return-free tax system like those in Denmark and Sweden.
Taxpayer advocates are rightly concerned that return-free filing could be a gateway to greater government control over our financial affairs. Besides, private tax-preparation services already interface with many third parties that provide tax data, so it is hard to see how the technology-challenged IRS can provide substantial benefits in this regard.
Rather than socialize the tax-preparation industry, perhaps Warren and her colleagues should embrace the idea of shrinking the industry through tax simplification. Despite differing views about tax rates, there should be broad agreement across the political spectrum about increasing the efficiency of our tax system. Reducing the number and complexities of tax brackets, deductions, and phase-outs will both ease compliance and reduce the distorting impact of tax rules on economic behavior.
Marc D. Joffe is an independent public policy researcher. He also heads the not-for-profit Center for Municipal Finance.