By former United States Senator Bob Kerrey
In the series of movies called “Nightmare on Elm Street” the warning that Freddy Krueger was not dead after all was two chilling words: He’s back! The tax reform equivalent to Freddy Krueger is the so-called “return-free tax system” that would make the IRS the nation’s tax preparer and just tell each of us how much taxes we owe each year. As this year’s April 15th Tax Day approached, Freddy ‘Return-Free’ was once again slashing his way back onto the airwaves and into our political and public policy discourse.
When this concept is described by academics, electoral candidates or political advocacy journalists, it all sounds too good to be true. And that common sense cautionary instinct is correct. The experience of California and Great Britain were anything but a success.
In California, where millions of taxpayers were sent pre-populated tax returns each year, an average of only about 2-3% of the state’s taxpayers ever elected to accept the government- prepared return. Eventually, the experiment fell of its own weight, and California abandoned it, quietly announcing its demise with a press release on a Christmas Eve when nobody was paying attention.
Some proponents have also claimed the idea originated with the 1998 IRS Restructuring and Reform Commission, which I co-chaired, and to the subsequent statute enacted that year that implemented the commission reforms. This is simply not true. The 1998 act did instruct the Treasury Department to study the proposal. Their conclusion was that Congress would have to enact radical changes in our tax laws before it could conceivably be feasible. Question asked and answered. The truth is that radical change in our tax law is unfortunately about as close as the Ultimate Thule, the piece of rock NASA recently photographed. Located in the Kuiper Belt – the ring of material that circles our solar system – the Ultimate Thule is 4 billion miles away.
Whatever the name, and however it is described, the idea of curtailing or eliminating the participation of the taxpayer in their own taxation would fundamentally change the voluntary compliance system that’s been at the core of the American income tax for a century. For a variety of reasons – whether from a desire for more expedient tax administration, or as a strategy to increase revenue collections to pay for public spending – it is a public policy theory that hasn’t gone away and needs to be addressed directly.
The fact is that the American system of income taxation has become, over many decades, a central instrument of national economic policy. A significant proportion of the complexity we all rail about in our income tax system emanates from the public policy objectives we have asked the tax system to carry, and the complexity with which we’ve enacted them, compounded by additional complexity layered-in through regulatory implementation.
Welfare-to-Work proposals turned into the Earned Income Tax Credit (EITC). Energy independence objectives turned into tax credits for home renovations and retrofits for energy conservation. The need to encourage personal retirement savings turned into Individual Retirement Accounts (IRAs). And the list of bi-partisan economic policy initiatives goes on. Despite of all the speeches given by Members of Congress, and political candidates, about the need for tax simplification, this list of complicating provisions is long and growing longer. And the implementing regulations have unfortunately turned complexity into an art and science.
An oft-repeated claim made by those advocating that IRS should just take over tax compliance for the country is the idea that the Federal Government supposedly already has all the information needed to prepare your tax return, and should therefore relieve the citizen of the need to do so. This is fantasy.
How has this so-called ‘simpler’ system worked in Great Britain, the example of perfection that return-free advocates say we should emulate? The Progressive Policy Institute has unearthed a recent study by the British Parliament about the efforts by that Government to implement an EITC-type tax credit, which were initially a disaster. The government simply did not have the kind of information needed to accurately qualify eligible taxpayers, and so their much-vaunted no-return tax system had to go to Plan B.
Unlike in the United States where taxpayers file their own returns at tax time, and claim their own tax credits, the UK has minimized the involvement of the taxpayer in their tax system, and eliminated it entirely under their return-free system – called Pay As You Earn (PAYE) — for blue-collar workers. The Government therefore relied on their PAYE tax withholding assumptions, that were deeply flawed, and produced the overpayment of billions of Pounds in tax benefits to ineligible taxpayers.
And their Plan B solution? British workers are now required to prepare a pre-return tax submission, reporting extensive personal and family information to the Government, in order to claim eligibility for their tax credits. This lengthy pre-return tax filing then enables the Government to determine the citizen’s tax liability, so the taxpayer doesn’t have to prepare and file a tax return. Rather than getting a free lunch, the taxpayer ends up paying twice: once for preparing and filing their own pre-return, and then again when the Government and their employer do their taxes for them so they don’t have to prepare and file a return. The circular logic of this process is what passes for a “return-free” tax system in practice in the real world.
The Parliament’s post-mortem analysis summed up the myth-buster reality of it:
“The Right Honourable Alan Milburn, a former Labour Chief Secretary to the Treasury during Prime Minister Blair’s Premiership, described the reason for the inaccurate and significant overpayments as a result of the state not having enough information about people’s lives to accurately determine tax credit eligibility….”
This is the return-free tax system that is most frequently held up by advocates as the one we should adopt to replace American voluntary compliance. And yet the conclusion of the UK study states the obvious:
“The only party that has all the relevant information about an individual’s economic and family circumstances pertinent to his taxation is the individual himself, not the government and not the individual’s employer….”
The alternative to taxpayers preparing and filing pre-returns over here, as they have to now in Britain, would of course be for the Government to just independently collect extensive additional personal information about the private, personal lives of our taxpayers and their families, in order to make the false assertion true that the Government has all the information it needs to prepare people’s tax returns for them. However, in American culture, such an extraordinary expansion of the role of Government in our society would trigger a host of civil liberty and individual privacy questions, which have yet to even be publicly acknowledged, much less
explored, in the ‘return-free’ advocacy debate. In any serious assessment of this proposal, it would be important to understand the comfort level of the American people for the tax collector to gather the personal and family information necessary to enable Government to develop the detailed profiles of taxpayers needed to permit knowledgeable and accurate preparation of their tax returns with minimal if any involvement of the taxpayer, as the return-free advocates promise. Some might describe this as a chilling prospect.
One more problem with Freddy Krueger’s return-free system: the implications for national security. I have not heard a single expert in cyber security say that we should not worry about the risk of replacing a highly decentralized, diversified tax system with one characterized instead by over-concentration and centralization of systems and data, and the associated risks of attack by cyber criminals and determined nation-state adversaries. We should shiver when Freddy tells us there’s nothing to worry about.
And although it may seem old-fashioned, there would seem to be one final consideration that should somehow figure into this debate as a democratic society. What do the people want? The suggestion that the American public is clamoring for Congress to enlarge the role the tax collector plays in their personal lives is nonsensical. Whether it’s demonstrated in consistent polling data over many years, or simply the plain public sentiment expressed over the backyard fence or around the kitchen table in any city, town or home in America, the idea that the American public would welcome the tax collector as their new best friend is seriously disconnected from reality. And that is compounded by the reality that the IRS is already understaffed and under-funded for its core mission.
If more budget dollars are made available to IRS they need to come in the form of investment in tax administration, technology infrastructure and basic taxpayer service, as well as the agency’s tax collection responsibilities including audits, investigations, and enforcement, both domestically and abroad. Giving the IRS responsibility to also become the preparer of the nation’s tax returns – the accuracy and completeness of which would still be the sole responsibility of the individual taxpayer, whether they understood that fact or not — would further strain the Service’s relationship with the American taxpaying public. It would also create unnecessary political problems for the agency with Congress as predictable problems would emerge from attempting to execute its new role, leading to constituent complaints, Congressional hearings, and lurid headlines. The IRS Restructuring and Reform Commission of the late 1990’s emerged from just such an era of intense controversy, but even then without the added burden of agency trying to double as the nation’s tax preparer.
It is time for a reality check. True tax reform and simplification is very much needed, and Congress has long needed to make it a top priority. The extreme complexity in our tax code is burdensome not only to individual taxpayers and their families, but to small businesses as well, and the emerging self-employed ‘gig’ economy workforce. If policymakers are serious about reducing the need for tax preparation services, a better and more economically sound alternative is to drive complexity out of the tax system, including dramatically simplifying and reducing the number of tax provisions in the code.
And make no mistake, tax code simplification will be hard work. But it cannot be bypassed by instead just getting the taxpayer out of the room where their tax liability is being determined. Disempowering the taxpayer is not reform, and it is not a substitute for doing the hard work of tax simplification. In fact, the direct involvement of our citizens in their own tax system is much
too valuable to lose as a matter of prudent economic policy. That is one of the painful but valuable lessons of the British experience.
Rather than curtailing the role of the taxpayer, we should instead leverage the annual engagement of the taxpayer by helping them develop basic financial literacy, including learning how to save, and the importance of doing so for their own financial well-being. The “tax time moment”, as many economists call it, is an invaluable national economic policy asset, as our myriad of behavior- incentivizing tax credits already recognizes as an essential operating mechanism of economic policy.
As a nation we face an enormous and growing unfunded retirement liability for our society, as the traditional work-based retirement systems of the past fade away, replaced by 401-K’s and IRA’s. Not to mention that Social Security and Medicare have serious solvency challenges coming at us just over the horizon. And the Federal Reserve’s research tells us the average family cannot put their hands on even $400 in rainy day savings if they had an emergency. Improving the nation’s financial capability, and financial security, is a serious economic policy challenge for our shared future as a nation, and having the Government substitute itself for the taxpayer in the taxation process would unwisely compound the problem.
The fact is that for many working-poor and middle-class families, their annual tax refund is the largest paycheck they see all year. Using the tax time moment to help families, self- employed workers, and small businesses, learn to take stock of their financial situation, and save even a small portion of their tax refund, would make a difference not only in their individual and family financial health over time, but in the economic health and savings rate of the nation. The engagement of the taxpayer in determining their own taxes, and taking stock of their finances each year, is much too valuable to the country, and to the average household, to kick it to the curb. It would be the antithesis of reform.
And so, my sincere advice for what to do as the Freddy Krueger return-free advocates try to slash their way back into our lives this Spring like clockwork: Just wake yourself up, look at the real world, and apply common sense. There is no good reason for this nightmare to ever become a reality.