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Article Excerpt
INTRODUCTION
The individual tax filing system imposes substantial costs upon taxpayers. Estimating those costs is an imprecise art, which requires a combination of definitional assumptions (e.g., what counts as a cost of filing as opposed to tax planning) and methodological approaches (e.g., how best to extract information from taxpayers on time spent filing). Guyton, O'Hara, Stavrianos, and Toder (2003) have estimated these compliance costs at somewhere between $67 and $100 billion a year, or about ten percent of the tax raised. (1) Approximately 60 percent of those costs are estimated to come from taxpayers with self-employment income (e.g., sole proprietorships). This leaves aggregate costs of approximately $40 billion borne by individuals with wage and investment income, for whom the proposals discussed herein are primarily designed. (2) In one very important sense, all of these figures understate the real costs, since they do not (and cannot) directly incorporate the frustration and anxiety with which Americans view the filing requirement. (3) These costs also fail to capture how anger about the burdens of filing affects attitudes toward the tax system and government--a subject touched upon later in this paper.
In recent years, efforts to reduce filing costs through technology have gotten increasing attention from tax policymakers. This is due in part to the changes technology has wrought in other facets of daily life, and in part to the realization that our filing requirements are far more onerous than those of virtually any other nation. We are one of the few nations, for example, to impose a filing burden on the ordinary worker. The California ReadyReturn project, which used technology to make pro-forma returns available to a sampling of four million Californians with simple returns, garnered attention even in the popular media (see, e.g., Halper, 2006) and a program of federal pro-forma returns was put forward by two candidates in the 2008 pesidential race (Edwards, 2008; Obama, 2008). Technology has the potential of reducing filing burdens on the upper end of the income spectrum even more, to the extent that we weight taxpayer time by an implicit wage rate and measure simplification in dollars. However, the government's ability to reducing filing burdens for the poor or the wealthy depends on its ability to make timely use of third-party reported data.
The first part of this paper discusses the role that technology might play in simplifying filing for those with complicated returns. The second part discusses ReadyReturn and the promise of proforma returns.
DATA RETRIEVAL: SIMPLIFYING FILING FOR THOSE WITH COMPLEX RETURNS
Illustrative Case
As noted above, the promise of technology to simplify filing is most often thought of in connection with taxpayers with low income or simple returns. In fact, technology might significantly reduce costs borne by non-self-employed taxpayers with high incomes and complicated returns. It will be useful here to discuss this promise in the context of a hypothetical taxpayer with a taxable income of $750,000, and who is loosely modeled to resemble the mean taxpayer in this group, as reflected by IRS data (U.S. Treasury, 2008a, 2008b).4 For convenience, I will call this hypothetical taxpayer Leslie.
Leslie has salary income, and income from the exercise of nonqualified stock options. She has interest income from at least one bank account. She has brokerage accounts, which provide her with additional taxable and non-taxable interest income, qualifying and non-qualifying dividends, and short- and long-term capital gains and losses from the sale of publicly traded securities. She has a state income tax refund, royalty income, and is a member of a partnership that provides her with ordinary and capital gains and losses. She is married and has two kids. She itemizes and deducts home mortgage interest, state and local income and property taxes and charitable contributions.
Leslie falls in the category of those with complicated tax returns. We would expect her to spend well over $1,000 preparing her return. (5) Suppose, however, that tax software allowed Leslie to import all the data reported in her name by third parties onto the correct line item on a return, automatically made simple arithmetical computations (e.g., adding up interest income), and carried over her personal data (filing status and dependents and address, etc.) from the previous year. This would be similar to what is now possible, for a price, for some limited number of items of income and deduction, through programs such as Intuit's Turbo Tax. The only thing Leslie would have to add is her charitable contributions. The tax software could prompt her to add that and to add the few other items of income or loss that even a small percentage of persons with Leslie's characteristics might have. Once her contributions were entered, Leslie could hit "calculate" and be done with filing.
Leslie would avoid the burden of saving the dozen or so slips of paper that showed her wages, interest income, income from the sale of securities, taxes paid and home mortgage interest. She would also avoid the time required to determine on which line item each of the figures on each of those slips should be entered, to compute and transcribe totals for each line item, and (depending on her present method of tax filing) to compute subtotals to put on various lines on her return. She would also save the aggravation and anxiety that comes with these tasks. Leslie would also avoid the added costs and anxiety that come from having lost a 1099 or other information return, thereby triggering a notice of redetermination from the government.
Leslie might, of course, continue to incur costs associated with tax planning. She might consult with an advisor as to when she might exercise options, establish, contribute to or withdraw from a retirement account, and so on. But filing would require virtually no time and no decision-making. It seems plausible to imagine that Leslie might replace her accountant with a $60 software program, and plausible to imagine that this same data retrieval program, if made available through a paid preparer, would reduce the costs of preparation for those who continued to use preparers.
The idea of using data retrieval to simplify filing is not new. It is a primary recommendation of the Electronic Tax Administration Advisory Committee's 2007 Annual Report to Congress (2007). However, there has been little public or published discussion of how such a system might work and what the obstacles are to such a system. The remaining sections of this part discuss some of those obstacles, including, most notably, the possibility that the Leslies of this world have other sources of income or deduction for which third-party reporting is not available, and the problem of (and possible solutions to) obtaining timely data.
Is Most of the Data Taxpayers Need Subject to Third-Party Reporting?
Each item of income of our hypothetical taxpayer, Leslie, was subject to third-party reporting (6) and Leslie has been given every significant item of income listed in the IRS summary statistics for her income cohort, save six: pensions and annuities, social security benefits, IRA distributions, income from estates and trusts, business income, rents, and sales of non-capital property. The first three items--retirement distributions and social security--were excluded as inconsistent with the assumption that Leslie is actively employed. As these items are all subject to third-party reporting as well, including these items would not change the picture thus far drawn--that Leslie's return is almost exclusively a function of figures already reported to the government.
Estate and trust income was excluded because of its relative rarity. Even in Leslie's income bracket, only about one in 30 taxpayers showed income from this source. However, this income, too, is subject to third-party reporting.
Income from self employment (e.g., Schedule C income from a sole proprietorship) almost always requires computations based on numerous transactions (such as purchase and sale of goods) that are themselves not subject to third-party reporting. This form of income imposes extremely high filing costs and (due to lack of third-party reporting) cannot be drawn into the data retrieval system outlined here. Roughly one-fifth of all taxpayers in Leslie's income bracket have business income. (7) The exclusion of this form of income is consistent with the focus of this paper, which is on the filing costs of taxpayers with wage and investment income only. To the extent Leslie has business income, and is included in a data retrieval program, one very significant source of filing-related complexity would remain.
Rent is also a significant source of complexity for taxpayers in Leslie's cohort. The income will generally not be subject to third-party reporting; and the net income must be determined after taking into account depreciation and other deductions. Roughly one-sixth of all taxpayers in Leslie's cohort will show rental income. Sales of non-capital property are the final source of complexity, since such sales may not be subject to reporting with respect to either sale price or basis.
What about deductions? The deductions listed in IRS statistics for...
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