Sunday, January 24, 2010

Why Is Filing Taxes Still So Hard in the Internet Age?

The New York Times has an interesting column arguing that because the federal government already has a lot of information about your earnings (through W-2's and the like filed by employers), why can't it fill in some of (or all) the blanks on your online tax return? The columnist argues:
Requiring taxpayers to file returns without being told what the government already knows makes as much sense “as if Visa sent customers a blank piece of paper, requiring that they assemble their receipts, list their purchases — and pay a fine if they forget one,” said Joseph Bankman, a professor at the Stanford Law School.
Indeed, such a system would save substantial headache for millions of taxpayers every year. Why doesn't it already exist? Maybe it is the result of a lack of innovation on the government's part. Or maybe the tax preparation industry has sufficient lobbying clout to discourage such efforts; after all, the harder and more inconvenient it is to file taxes, the more profit these firms can expect to earn, as taxpayers turn to them for help.

However, I can think of two legitimate reasons this is not done:

(1) For the conscientious taxpayer, a form that is already filled out may lead to oversights. Because I have to start from scratch every year, I make myself a list of the jobs I've had in the past year, the interest income I've earned, my charitable giving, etc. If the norm were for taxpayers to glance over a prefilled form every year, many of these things may be overlooked.

(2) More importantly, many people are tempted to evade taxes. Taxable income falls into two categories: things the IRS knows about, and things that it doesn't. Under the current system, the taxpayer isn't sure what the government knows, so he should err on the side of reporting everything. If he omits some income that he doesn't think the government knows about, and he's wrong, he could be subject to hefty fines if this is discovered in an audit. This threat of being caught is enough to keep many people honest, even if the odds of punishment are low. However, if the government prefills a tax return, it is showing its hand. If the taxpayer notices that certain income has been omitted, what incentive does he have to report it? The government has admitted that it does not know about this income, and it likely never will. Therefore, the government collects more money under the current system than it would if tax returns were prefilled. However, the magnitude of the collection is important: if the current system collects only an additional $1 million in tax a year, the cost to taxpayers is not justified. H&R Block has an annual income of around $4 billion a year; this number is just for one firm, and all of that money wouldn't be saved under the proposed system, but it helps us understand how many resources are required to sustain the current tax filing system. Clearly, the increase in tax receipts as compared to the proposed system would have to be substantial to justify the additional expenses on tax preparation services. It is unclear how the IRS's budget would be affected under either scenario.


Kathy Gregory said...

I’m with you on your first reason. Filing taxes is all about the fine print that many want to avoid. However, I find it hard to think that this is a problem considering the technology we have today. Almost every government service is transitioning into online service, and it’s only a matter of time until the tax filing system forms an online standard that has no loopholes.

Winston Sutton said...

Excellent write-up! Filing your own tax will surely open your eyes. Although, it can be both enjoyable and frustrating. Turbotax software is quite handy, but I do prefer handling my own tax by myself.