issue: Tax

PPI’s Mosaic Economic Project Announces Second Cohort of Policy Experts

Posted on by The Progressive Policy Institute

12 Women Join the Effort to Diversify the Policy Debate

Today, the Mosaic Economic Project, an initiative of the Progressive Policy Institute, announced it’s second cohort of policy experts participating in the ‘Women Changing Policy’ workshop, March 29 – 31, 2021. The women are all experts in the fields of economics, business and technology, who are forging a path forward to bring a diverse perspective to today’s public policy debates.

The project’s goal is to locate, elevate, and advocate for the inclusion and engagement of experts with diverse experiences and an interest in meaningful policy conversations with a focus on Congress and the media.

“We are thrilled to welcome another class of talented, highly skilled, and diverse leaders to Mosaic Economic Project’s second cohort. This event will help this dynamic group of women hone their skills for high-profile engagement in public policy debates, and promote inclusiveness within the economic growth and innovation fields of study,” said Crystal Swann, Mosaic Economic Project team lead.

This diverse and talented group of leaders will hear from experts in public policy and media, including leaders and representatives from the United States Congress, the media, communications consulting firms, and more.

The Mosaic Economic Project Cohort includes:

      • Hilary Abell, co-founder of Project Equity
      • Dr. Lisa Abraham, Associate Economist at the RAND Corporation
      • Joanna Ain, Associate Director of Policy at Prosperity Now
      • Talisha Bekavac, Vice President of Government and External Affairs for the U.S. Black Chambers (USBC)
      • Dr. Carycruz M. Bueno, Postdoctoral Research Associate at the Annenberg Institute and The Policy Lab at Brown University
      • Melissa Gopnik, Senior Vice President at Commonwealth
      • Dr. Tiffany Green, Assistant Professor of Population Health Sciences and Obstetrics and Gynecology at the University of Wisconsin-Madison
      • Dr. Leshell Hatley, Associate Professor of Computer Science at Coppin State University
      • Gabriella Kusz member of the Board Directors and Public Policy and Regulation Committee of the Global Digital Asset and Cryptocurrency Association
      • Aditi Mohapatra, Managing Director at BSR
      • Dr. Sarah Oh, Senior Fellow at the Technology Policy Institute
      • Jessica Schieder, Federal Tax Policy Fellow at the Institute on Taxation and Economic Policy (ITEP)

For more information on how to contact the members of the Mosaic Economic Project please reach out to Crystal Swann at cswann@ppionline.org.

Media Contact: Aaron White – awhite@ppionline.org

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The IRS and the Second Stimulus Payments

Posted on by The Progressive Policy Institute

It’s hard to take your eyes away from the ongoing political drama in Washington, as the presidential transition turns violent and even fatal. Yet at the same time, it’s important to note additional evidence that basic government competency functions have been ignored under the Trump Administration.

As the Washington Post reported earlier this week, the IRS has sent out about 68% of the second stimulus payments. But many Americans will have to file a 2020 tax return to get their money, much to their disappointment.

This problem should not have been a surprise to the IRS. As the  even-keeled “Accounting Today” noted: “The Internal Revenue Service is once again depositing the latest round of Economic Impact Payments in the wrong bank accounts in a replay of problems experienced last year by many taxpayers.”   According to the Post article, the National Consumer Law Center “blamed the IRS for not being ready after it had months to prepare for this second round of aid payments and said as many as 20 million people could be impacted.”

In a narrow sense, the IRS fumbled the ball on an issue that was clearly going to reoccur, perhaps because of all the other demands on the agency. Tax preparation companies sometimes set up temporary bank accounts for taxpayers to receive their refunds. Instead of mistakenly using those temporary accounts, and running the risk of the deposit being rejected, the IRS could have mailed the checks to the current address on the return.

That’s one of those problems which can be a surprise the first time, but should be easily fixable the second time around. Unfortunately, the IRS made it worse.  WHen this problem occurred for the first stimulus check, the IRS tried to issue new payments or allow updated information on the bank accounts. This time the needs of the upcoming tax season means that the IRS doesn’t have the human or computing resources to make fixes. As a result, it’s telling Americans to file their tax return to get their money.

In a broader sense, this points out long-standing issues with government IT spending and execution. In a September 2020 report, PPI showed that the government has fallen short on IT spending by hundreds of billions of dollars relative to the private sector.  An October 2020 PPI report focused directly on the IRS, and the dangers of pushing the IRS beyond its core mission of handling tax returns rather than giving out money for social policy purposes,  which the agency was never set up up to handle.

There’s no free lunch here. If we want the IRS to handle a wider scope of activities, it needs more resources and more attention to consumer service. In the short run, we should focus on making sure the agency does its core mission right.

 

 

 

 

The Low-Income Tax Trap and COVID: The Real Societal Cost of Having the IRS Do Too Much

Posted on by The Progressive Policy Institute

The working poor are burdened with some of the most complex tax returns in the country as they annually claim Earned Income Tax and Child Tax refundable credits.  In the coming months, low- and middle-income Americans who received unemployment insurance payments during the Covid-19 pandemic may also face a “tax trap” that unexpectedly reduces their EITC benefits. At the same time, some have advocated that the IRS core mission be substantially expanded beyond their traditional role in society.  But the emerging environment tells us something important about the complexity of our tax system, and the societal costs of pushing the IRS to do too much. 

October 15th is the final tax deadline for the 2019 Tax Season, but it also the last normal Tax Day that Americans will have for a while.  Someone who filed for an extension to their 2019 taxes will have their return due on that day. But next year’s tax return, for Tax Year 2020 when it comes due in 2021, will reflect the utter chaos of our collective 2020 experience.

Many Americans will be dealing with a much different tax situation than they expected at the beginning of 2020.  If they worked remotely from a different state than their office, it’s entirely possible that many workers may end up paying taxes to two jurisdictions. If they lost their job, their earned income from work might be less, while their unemployment benefits might be higher. For too many unfortunate people the pain of a Covid diagnosis will be accompanied by much higher medical expenses.  All of these factors, and more, will lead to a 2021 Tax Day more painful and burdensome, and carrying greater risk, than usual for millions.

Facing particularly big problems in their Tax Year 2020 returns are the low- and moderate-income Americans who might qualify for the earned income tax credit (EITC). The EITC, along with the Child Tax Credit (CTC) is one of the nation’s most important anti-poverty programs. The EITC refundable credit alone provides as much as $6660, depending on income and number of children.  As of December 2019, the EITC paid out $63 billion to 25 million Americans.  Roughly 85% of that total went to taxpayers with adjusted gross incomes (AGI) of less than $30,000.

The importance of the EITC and the CTC cannot be overstated. In 2018, the EITC alone lifted about 5.6 million people out of poverty, including about 3 million children. But the problem is that the EITC has an extremely complicated set of rules and requirements about who is eligible and how much money they can receive, based on a combination of earned income, adjusted gross income, number of children, familial relationships, who lived with whom for how long, the composition of the family unit, and more. Individuals who violate any of these rules can have the tax credit taken away and may be banned from getting the credit for years.

Beyond this tax complexity that is always faced by working poor and moderate-income taxpayers, the returns due in 2021 are looming on the horizon as a daunting challenge for this population. A September 2020 report from the Tax Policy Center argues that recipients of the EITC will face a potentially large and unexpected Covid-related tax trap when they do their Tax Year 2020 returns. It turns out that the hundreds of billions of special unemployment insurance benefits received during the pandemic––so needed by those affected by pandemic loss of jobs—count towards overall income for tax purposes, but do not count as “earned income” for EITC purposes.  Because of the complex EITC rules, observes the TPC report, “receiving UI benefits can decrease the EITC, but cannot increase it.”

This Covid tax trap may unexpectedly reduce the EITC credit for many low-income families when it comes time to file their next taxes—an unwelcome surprise for people that are already struggling with the financial and health impacts of this pandemic. That’s a special problem, says the TPC report “since research shows low- and moderate-income families plan for that annual tax refund.”

Advocates of a return-free tax system have long contended that the IRS already has all the information it needs to prepare the returns for low- and moderate-income taxpayers. So in this real-world scenario, could the IRS use the information that it already has to help low- and middle-income Americans figure their EITC refund in this very complicated pandemic year, without the taxpayer having to struggle through all the rules and calculations to prepare their own return, or get professional help to qualify for refundable credits and determine the refund due to them?

The short answer is no. The IRS does not have the necessary information in its databases to accurately determine a low-income taxpayer’s eligibility for EITC and/or correctly calculate the amount of credit due to the taxpayer—indeed, far from it. The EITC is based on a stew of residency, family relationship, and income limits, with complex tie breaker rules. And like a giant puzzle, it requires deep knowledge of the personal lives of people living in the same household or family unit, with who else, for how long, and what their relationships and incomes are, just for a start. If a child qualifies to be claimed for EITC purposes by more than one person, there are six tie breaking rules.  Single parent households, and the non-traditional makeup of today’s household relationships, have also evolved in modern society faster than government regulations can keep up.

And especially when there are dramatic shocks to the economy—such as the health crisis of 2020, or a severe natural disaster or climate change event, or a future large-scale economic dislocation—there’s no way to use the previous year’s information as an accurate guide.  Moreover, no information return is automatically generated that says whether a child is living with their grandparents while their parents do essential jobs around the clock. And unique household or family circumstances are equally challenging given the velocity of domestic changes in today’s society, or in coping with crisis as we have in 2020. For example, the IRS does not automatically receive reports of split custody divorces where the children spend more than half of 2020 at the one parent’s house which had better broadband connections for school purposes or had broadband at all.

Suppose the next administration wanted to help out low- and middle-income Americans by estimating their EITC for 2020 and 2021. It would be a massive and costly undertaking for the IRS to go out nationwide to even try to collect and process the necessary extensive personal data on individuals, households and families to even begin to have enough information to even attempt to accurately determine eligibility for EITC and calculate the credit payment. To put this in perspective, the ten-year cost of conducting the 2020 Census is in excess of $15 billion. However, calculating the EITC actually requires collecting annually much more personal information than even the decennial Census. Moreover, part of the reason that the Census is so expensive is to track down precisely the low-income population that is eligible for the EITC.

Why so expensive and mammoth an undertaking? The rules for which taxpayers get to claim a child for EITC purposes depends crucially on who the child lived with during the year, and for how long. In other words, the IRS would need to know for each potential claimant—including grandparents and aunts and uncles in a multigenerational household, and whether and how household or family makeup changed or evolved during the year—and how many months each child lived there and with whom. In addition, the rules require information on adjusted gross income (AGI) per potential claimant.

The IRS already has a Dependent Database which helps it determine if two or more taxpayers have claimed the same child after they have filed, as part of tax administration. But the database does not have the prospective information to determine which person is the right one to make a claim for EITC before filing, much less accurately determine the amount of refund credit that the taxpayer will be due.

The only place this information can come from is the potential EITC recipients themselves. The data would have to be voluntarily submitted by the taxpayers themselves in advance of the government being able to attempt to accurately prepare the tax return for the taxpayer.  That means they would have to fill out new data collection forms in January, either online or on paper, which would compile the necessary information about where the child or children resided, with whom, for how long, the relationships to the children and among household or family members, and the varied incomes of those individuals in the household.  Indeed, expansion of the IRS into the function of annual collection of extensive personal nonfinancial data about individuals, households and families might very well receive bipartisan outcry, for any number of public interest reasons ranging from fiscal cost to the impact on personal privacy. The task each year would be huge.

Oddly enough, low- and moderate-income taxpayer returns that claim the EITC have been repeatedly described as “simple” returns by advocates of having the IRS take over tax preparation. But a study by the Tax Policy Center highlights the sheer complexity of low-income tax returns, noting that

…eligibility for child benefits has increasingly relied on the concept of a tax unit, which has not evolved with families…. The income tax law is based on annual filing and bases the definition of a filing unit primarily on legal relationships, child residency, and support. Consequently, families that change throughout the year may have difficulty correctly determining their filing status and who can properly claim a child for the purpose of receiving child-related benefits.

As the TPC study observed, “[b]ecause of these changes in family structure, tax filing has become more complex for many and will likely continue to grow more complex.”

The reality is that the IRS already collects 3.5 billion information returns each year, but most of them are generated automatically in the course of doing business by companies, such as employers and financial institutions.  Out of the 3.5 billion, for example, 2.3 billion are 1099-B forms for reporting securities transactions, which are tracked by brokerage firms as part of doing business. These forms are then delivered electronically to the IRS ready to be processed.

In contrast to the billions of electronic reported information forms, the IRS only processed 40 million paper information forms in FY 2019 and has been trying to drive down that number even more, as it continues its long-term modernization toward electronic tax operations originally begun back in 1998 as result of the work of President Bill Clinton’s National Commission on IRS Restructure and Reform, and its implementing Act. Shifting resources to a massive new data collection function to obtain the kind of personal data required to establish eligibility for the EITC, would require the IRS to go in the opposite direction and set up an entirely new set of workstream and systems for electronic and paper submission of “pre-return” personal information returns. In the best-case electronic scenario, that would include creating and maintaining a significant new online user interface for entering details of children, residency, relationships, and potential claimants.

Indeed, the United Kingdom offers a real-world case study of exactly this problem, based on their difficult experience with the UK version of the EITC, the Working Tax Credit, introduced in 2003. According to a study by the All-Party Parliamentary Taxation Group, a non-partisan committee of the UK parliament, the government figured out the hard way that it simply did not have enough information to accurately determine family tax credit eligibility, despite the fact that Her Majesty’s Revenue and Customs (HMRC) had long run a classic ‘return-free’ tax system for blue-collar taxpayers.

In response, the HMRC mandated the annual preparation and filing of a multi-page “pre-return” by taxpayers to establish their eligibility for the Working Tax Credit.  This pre-return, resembling an old-fashioned, multi-page American 1040 tax return, provides the government the extensive personal information it needs for the government to prepare the taxes for the taxpayer– so the taxpayer doesn’t have to file a return.  This tortured logic illustrates the problems that low- and middle-income taxpayers in the U.S. would face if the IRS followed the UK example, held up by return-free advocates as the state-of-the-art model to follow to reduce taxpayer burden.

How much would it cost to expand the IRS Dependent Database on short notice, in order to collect the significant additional information necessary, process it, to accurately establish whether EITC claimants are eligible or not, and then correctly calculate the tax benefit?  There’s no way of knowing the total overall cost for this data collection undertaking, but we can analyze the problem.

The IRS processed roughly 250 million personal,business, and related tax returns and 3.5 billion financial information returns in FY 2019, and handled 650 million online visits to IRS.gov. Against that backdrop, 25 million EITC recipients don’t seem like much of an extra burden.

But as noted above, the vast majority of those information returns are electronically generated and low-cost to handle. And the vast majority of the website visits are queries about the status of refunds and tax return transcripts, rather than the sort of interactive data entry that the EITC and CTC would require.

The Taxpayer First Act of 2019 did require the IRS to develop an internet portal by 2023 that allows taxpayers to electronically file 1099 forms for reporting income and other financial data, which are vastly simpler than the personal information collection that would be needed for the EITC. However, that process of development of a 1099 financial reporting portal is just starting, with Deloitte just recently receiving a 3-year contract to set up a project management office.

So we can reasonably expect that the EITC information return would have to be supplied via paper form submissions, at least for the foreseeable future, just as took place in the United Kingdom when the requirement was mandated there. One 2009 estimate by the Treasury Inspector General for Tax Administration put the cost of processing a paper tax return at $2.87 per return.  But greatly complicating this type of undertaking is the fact that the IRS has gradually dismantled its paper return processing capacity over the last 20 years, with a residual capability that is a shadow of the legendary IRS paper processing operation in the first century of the IRS’s existence.

The Broader Context

This analysis, driven by the crisis of 2020 and the tax year to follow, raises the obvious question of why the IRS would set up an expensive new process to collect substantial personal information from EITC recipients, separate from the citizen’s actual tax return, which would have otherwise been submitted by the taxpayer in the normal voluntary compliance process.  More generally, it does provide some insights into the costs of adopting return-free filing in an uncertain world and rapidly changing society.  Return-free filing has often been thought of as a free lunch, where the IRS makes use of information that it already has to make life easier for low- and middle-income taxpayers and to save money. But the reality is starkly different from the rhetoric, and the often-claimed benefits for the working poor could in fact turn into another burden.

The IRS estimated that 25.3 percent ($17.4 billion) of the total EITC payments made in FY 2019 were “improper.” However, the IRS also estimated that approximately 21% of eligible taxpayers did not claim the credit that they deserve.   That leads people to jump to the conclusion, as one journalist wrote, that “….Automatic filing would provide EITC payments to many of that 20 percent not getting them, and would spare taxpayers from doing complex calculations that sometimes lead to errors.”

But there are no secret troves of free data that are being hidden that would immediately translate into return-free filing, with fair and equitable treatment for the working poor and disadvantaged. One issue is that the United States has no official resident register that tracks where people are living. By comparison, many of the countries that have “return-free” filing are already tracking where people live through an official resident register. In Germany, often held up as a return-free filing example, the Federal Ministry of the Interior, Building and Community supervises an official resident register:

“Anyone who moves into a residence in Germany must register within two weeks of moving in. To register, you have to go to the registration authority of your municipality and present a valid ID card, passport or passport substitute document and a certificate issued by the person providing the residence.”

The U.S. does not maintain such official government requirements for registration of domicile. Drivers’ licenses, school records, healthcare records, and tax records could be used to assemble a partial picture, but not enough to fulfill the needs of the EITC.

Proponents of return-free filing argue that the IRS can use data already submitted by the taxpayer in the past. For example, Austan Goolsbee in 2006 proposed a Simple Return that “would use the taxpayer’s tax return information from the previous year.”

However, the 2020 example shows it’s just not possible to assess today’s residency from last year’s reports due to rapidly changing household units and relationships, and now especially with remote work and remote learning. The research by the TPC demonstrates that even in ‘normal’ times the increasing velocity of change in the makeup, location and relationships of American households, particularly among the working poor, is significant and government’s regulatory frameworks and definitions cannot keep up.

Moreover, these changes interact with the tricky rules for EITC eligibility.  The Center for Budget and Policy Priorities notes that:

families’ living arrangements can be complicated, with working grandparents or aunts and uncles living with working parents and their children. More than one working adult in such families may potentially qualify to claim a given child for the EITC. Neither they nor, in many cases, their tax preparers may fully understand the complex rules that determine who is entitled to claim the EITC in such circumstances.

In the same vein, a report from the Tax Foundation observes that “improper payments are largely a result of the same child being claimed multiple times due to shared custody agreements or other complex living situations.”

Of course, the deeply layered complexity of the tax system doesn’t help either. The analysts at the Tax Policy Center write “If an income tax system were simple enough, the government could withhold taxes owed and do its own accounting at the end of the year without much help from taxpayers.” But what they mean by simple enough is a massive and comprehensive overhaul of the tax code, including a myriad of such fundamental changes as making the unit of taxation the individual rather than the family, and simplifying eligibility requirements for refundable credits.

The EITC and similar tax benefits such as the Child Tax Credit are hard cases for return-free filing just as a practical matter, because they require so much information which the IRS does not currently have. And prior year tax returns are no cure for ensuring accurate payment of future refundable credits, or avoidance of improper payments (either too little, or too much, or correct determination of eligibility for payment at all).  The essence of accurately establishing annual eligibility is in its recognition of the greatly increased velocity of societal changes in the family unit, household makeup, human relationships, job changes, moving and other changed housing circumstances, and more, But they are also the cases that make a difference, because they directly affect the lives and economic well-being of so many low- and moderate-income Americans, because they are so complicated, and because there are so many mistakes, in both directions.  And getting it right directly affects the economic condition of the people for whom refundable credits are intended as an anti-poverty lifeline.

There are no shortcuts. Precisely the people who need the help are those who would not benefit from return free filing. What 2020 shows us is that rather than giving these Americans extensive new forms to complete and file as a pre-return, or alternatively, to establish an intrusive new government national program of annual personal information collection, it is better to take that money and use it to improve the whole rickety IT infrastructure of the IRS in the performance of its core mission, which has been underfunded and woefully behind the IT and performance curve for decades.

Indeed, in a recently released paper PPI estimated that the federal government has an accumulated software investment deficit in excess of $200 billion. That is the extra amount that the federal government would have needed to invest in software to keep up with the private sector. Under these circumstances it’s difficult to justify diverting the IT funds to set up a “return-free” system that is actually not return-free for the low- and middle-income taxpayers who carry the burden of its complexity.

At its heart, this analysis of the Covid tax trap raises the broader question of the true societal cost for low- and moderate-income Americans in mandating a fundamental change in the nation’s voluntary compliance tax system that is touted as “reform”, “burden reduction,” and “cost reduction.”  As we have shown here, the reality is quite different, and those adversely hit by the “return-free” proposal––making the government tax collector also the nation’s tax preparer––are the working poor and other low- and moderate-income Americans. These are the people with the least means, voice or resources to advocate for themselves, turning tax fairness and societal equity on its head.

Interactive Calculator: How Much Federal Support Do State and Local Governments Need?

Posted on by The Progressive Policy Institute

Social distancing is essential to limit the spread of the novel coronavirus, but it also reduces opportunities for millions of Americans to earn a wage or buy goods and services from others. As a result, state and local income and sales taxes that fund education, public safety, and other essential services are drying up. Meanwhile, the rising unemployment rate is causing states to spend more on safety-net programs, such as unemployment insurance and Medicaid. Because most state and local governments are required to balance their budget, this fiscal squeeze is compelling them to cut their budgets right when people and businesses need government support the most.

PPI’s Center for Funding America’s Future has developed a tool to help estimate the additional aid state and local governments will need from the federal government over the next two years to compensate for lost economic activity. Users can input an unemployment rate in each quarter through 2021 (the default values for which are based on the Federal Reserve’s September 17th projections) and set the percent of emergency reserves they are comfortable asking states to draw down.

The results show how much money, beyond what Congress has already appropriated, states will need to fund their aid spending and make up for lost revenues without cutting their budgets or raising taxes. The figures only show the change in revenues or spending from what they were before the crisis, without accounting for the lost economic growth that was previously projected to occur in the coming years before the pandemic hit.

PPI currently estimates that state and local governments will need at least $250 billion in additional federal support between now and the end of 2021. 

This estimate is based on the latest labor market data and experiences during past recessions, but it is important to note that the unique nature of the current crisis, as well as changes to state fiscal policy or the economy at-large since those recessions, has already meaningfully altered the expected impact on state and local government finances. In fact, our current baseline estimate is significantly smaller than the $500+ billion estimate produced by our calculator when it was first published in May. The biggest reason for the change is that better-than-expected economic news: the current unemployment rate, as well as the projected unemployment rates for future quarters, are below what they were projected to be four months ago. 

Given the demonstrated unpredictability of the current economic crisis, PPI’s estimates should be considered a guideline rather than a concrete policy prescription. We strongly encourage congressional lawmakers to design programs that provide aid to state and local governments based on real economic indicators, rather than appropriating a precise amount of money that could easily be significantly larger or significantly smaller than what is needed. 

We have also made some important methodological changes to our calculator. We no longer give users the option of including shortfalls in state unemployment insurance systems that are currently set to be recouped under current law from higher taxes that automatically apply to employers who lay off workers, as the unprecedented nature of this crisis has made it difficult to produce credible predictions based on the experiences of past recessions. Additionally, the calculator now includes the cost of supporting K-12 schools, which joins several other new spending needs beyond covering existing shortfalls, such as election security and creating a national state-led testing program (but still does not account for other costs directly related to addressing the pandemic, such as increased spending through public health insurance programs). 

Click here to download the tool. (Updated September 22, 2020)

Create a “Fiscal Switch” to Make Our Economy More Resilient Against Recessions

Posted on by The Progressive Policy Institute

The federal government is on track to run a record-shattering $4 trillion budget deficit in 2020, in large part due to its aggressive fiscal response to the pandemic-induced recession. Some on the right have raised alarm about this borrowing, despite their support for budget-busting tax cut and border-control policies over the last three years. The hypocritical chorus will likely only grow louder if Democrat Joe Biden is elected president in November.

But temporary deficits are an invaluable tool for mitigating the damage caused by economic downturns, as government spending replaces a drop in demand from the private sector. The long-term fiscal costs of failing to support an economy with a double-digit unemployment rate would far exceed those of even the most overzealous stimulus measures. Necessary fiscal support should therefore continue as long as the economy remains hobbled by the coronavirus, no matter the cost.

However, Washington also faces structural deficits that will persist long after the pandemic has been contained. Thanks to the Trump administration’s reckless borrowing binge at a time when the unemployment rate was below 5 percent, the federal government was already projected to spend over $1 trillion more than it raised in revenue even before the pandemic hit. This structural deficit will only grow worse in the coming years because our nation’s aging population is causing federal spending on health-care and retirement programs to grow significantly faster than the revenues needed to finance them. The Trump administration did not create these problems, but it did make them significantly worse with its pre-pandemic fiscal policy and its disastrous handling of the public health crisis.

In the two years following the 2008 financial crisis, the national debt grew from less than 40 percent of gross domestic product to more than 60 percent of GDP. In 2020 alone, the debt will likely surpass the all-time high it reached following the end of World War 2 (106 percent of GDP). The rising cost of servicing this growing debt threatens to crowd out critical public investments that lay the foundation for long-term growth after the recession ends.

The federal government spent more money servicing the national debt last year than it spent on critical public investments in education, infrastructure, and scientific research combined. Although interest rates are low now, they eventually will rise as the economy recovers. Allowing interest payments on our debt to further crowd out these investments – which have already fallen by nearly 40 percent in real terms since the 1980s – would have disastrous consequences, including lower incomes, fewer high-quality jobs, and reduced economic mobility.

It is therefore essential to pay down the debt during expansions to create fiscal space for the necessary surge in short-term borrowing during recessions. Unfortunately, Washington has often waited too long to enact sufficient stimulus in response to recessions, and then failed to summon the will to narrow the structural gap between taxes and spending when the economy rebounds.

To make our economy more resilient against downturns, PPI proposes the federal government adopt a “fiscal switch” that automatically balances out the business cycle by increasing spending during recessions and recouping the cost during subsequent periods of economic growth. This switch would trigger based on economic variables such as the unemployment rate and operate through three mechanisms: a rebalanced relationship between federal and state governments, a more dynamic and progressive tax code, and phased-in reforms to mandatory spending programs driving our structural deficits. Implementing these automatic mechanisms, as recommended here and in PPI’s Emergency Economics report earlier this year, takes politics out of these decisions and ensures stimulus or deficit reduction will be implemented as warranted by economic conditions.

The first step is to better leverage the federal government’s unique borrowing capacity, which is unavailable to the vast majority of state and local governments required by law to balance their budget each year. Many government programs, including Medicaid, infrastructure, and education spending, are partnerships in which the federal government provides matching grants for state and local spending.

Some of these partnerships could be improved by allowing matching rates to adjust up or down automatically based on a state’s unemployment rate. This would prevent state and local governments from having to cut essential services during a downturn while asking them to shoulder a greater share of program costs when their budgets are healthy.

Other programs that currently function as a federal-state partnership but whose costs fluctuate significantly with the business cycle would benefit from becoming more nationalized. For example, when Congress tried to ensure that unemployment insurance replaced a minimum percentage of lost wages for everyone who was laid off in the early days of the coronavirus recession, lawmakers found they were unable to do so because of outdated operational infrastructure in a messy patchwork of 50 different state programs. As a result, policymakers were forced to settle for a controversial across-the-board benefit increase of $600 per week that gave some laid-off workers even more income from unemployment benefits than they lost in missed wages, while failing to make others whole. Even worse, Congressional squabbling over how long to maintain this benefit increase allowed them to lapse temporarily in the midst of an economic crisis.

Moving the operations of unemployment insurance and similarly-situated safety-net programs off state balance sheets and onto the federal government’s, in addition to automatically making benefits more generous during downturns and phasing them out in recoveries, would leverage Washington’s fiscal firepower in recessions when it’s needed most.

The second step is to make the income tax code more progressive, which serves as a strong automatic fiscal stabilizer by boosting average tax rates when incomes rise in expansions and lowering them when incomes fall in recessions. This objective could be accomplished by closing tax preferences for the wealthy, such as lower tax rates on inherited income and income from capital gains, while expanding the Earned Income Tax Credit and other pro-worker tax incentives. PPI also favors replacing the antiquated payroll tax with a dynamic value-added tax – which has a rate that automatically falls during recessions and rises during expansions – to encourage hiring and consumption when the economy needs it most and reclaim substantial revenues during economic expansions.

Finally, lawmakers must take additional measures to rein in the drivers of underlying structural deficits automatically when the fiscal switch calls for a pivot away from stimulus. Social Security and Medicare – the two largest programs in the federal budget – both face the prospect of becoming insolvent within the next decade, potentially leading to sudden and across-the-board benefit cuts for millions of seniors if lawmakers take no action to close the growing gap between dedicated revenue and scheduled benefits. Significant deficit reduction that takes effect in the middle of a recession could be catastrophic, but lawmakers should put in place a process now to develop and phase in a balanced package of revenue increases and benefit changes as the economy recovers. PPI’s Progressive Budget for Equitable Growth offers policymakers a model for how they can modernize these programs to strengthen work incentives, retirement security and financial sustainability in a way that is fair to both younger workers and older beneficiaries.

The right fiscal policy in a recession is not the right fiscal policy for an expansion, and vice versa. Washington politicians are often too slow or ideologically beholden to react sufficiently swiftly to changing economic circumstances. Taking these steps and creating a two-sided fiscal switch will give our government the tools it needs to manage the economy through both the ups and the downs of the business cycle.

Regulatory Improvement for Independent Workers: A New Vision

Posted on by The Progressive Policy Institute

One of the biggest productivity advances in recent years has been the use of platforms to connect buyers and sellers at lower cost. Platforms offer less rigid contractual arrangements, expanded earnings opportunities for workers and access to essential goods and services for underserved communities. Overall, platforms generate win-win economic activity which benefits everyone. 

The flexibility of platforms will play a critical role in helping the U.S. labor market recover more quickly from the Covid recession. In most economic recoveries, companies have been apprehensive about making the commitment to hire given lingering economic uncertainty. That has typically made employment a lagging indicator in recoveries. By contrast, platforms will make it easier for workers to scale up hours worked gradually as the economy expands, which will boost consumer spending and demand, which will in turn boost employment. 

The big question, though, is how to regulate platforms in a way that preserves the flexible nature of the work and the benefits to our economy at large, while continuing to protect both workers and consumers. The Progressive Policy Institute believes strongly in the importance of regulation for a well-functioning market economy. Yet we have long advocated for “regulatory improvement” as essential for accelerating growth and job creation.

Regulatory improvement is very different from deregulation. Too many sectors of the economy have overlapping and contradictory layers of regulation that get in the way of productivity gains and rising incomes. At the same time, there may be parts of the economy where new rules are necessary. In this case, platform businesses need to step up and provide a baseline level of benefits to their workers.

The labor market, in particular, is struggling with a 20th century regulatory framework imposed on a 21st century economic structure. The first 1099 was issued in 1918 and the first W-2 in 1944. To this day the labor market is artificially divided into “employees” and “independent workers”, including freelancers, sole proprietors and other self-employed workers. The dividing line is quite complicated and, in some cases, almost impossible to understand, with different federal and state agencies following different rules for establishing the dividing line. This patchwork of conflicting regulations creates enormous business uncertainty, reducing the incentive to create new work opportunities.

In the current regulatory framework, workers classified as “employees” are subject to a completely different regulatory regime than independent workers, including rules for scheduling and hours worked, working conditions, minimum wages and who pays Social Security and Medicare taxes. Employees are subject to employers’ control in every aspect of how they do the job, which for many low-income workers means shift work tied to a single company, which sets the exact hours. Employees typically get certain benefits, such as workers compensation and unemployment insurance, which are generally paid for by payroll taxes, and possibly access to other benefits, such as group life insurance, defined contribution retirement plans, and employer-sponsored health insurance or health savings accounts (HSAs).

Independent workers have a unique flexibility that employees do not enjoy at all. In the same survey, 51% of respondents said there is no amount of money where they would definitely take a traditional job. Part of the explanation may be that independent contractors simply aren’t able to work under the terms of normal employment; in fact, 46% say they could not have a traditional job due to personal circumstances (e.g., health or caregiving duties).

But in exchange, independent workers, almost by definition, are not allowed to get benefits from the companies that they do business with. As an IRS publication states:

Businesses providing employee-type benefits, such as insurance, a pension plan, vacation pay or sick pay have employees. Businesses generally do not grant these benefits to independent contractors.

Unfortunately, the current tax system systematically penalizes independent workers who try to provide their own benefits and companies that want to help these workers maintain flexibility while accruing appropriate benefits or protections. For example, as we explain below, most independent workers have to pay FICA taxes on the money they contribute to their tax-deferred Individual Retirement Accounts (IRA), Simplified Employee Pensions (SEP) or solo 401k accounts. By comparison, the contribution of employers to employee retirement accounts is exempt from both employer and employee FICA taxes. This saving can be worth thousands of dollars. The same or similar problems show up with other benefits as well. 

This puts independent workers into a catch-22 situation. The companies that they do business with can’t provide benefits because that would turn them into employees, an outcome that the overwhelming majority of these workers do not want. But independent workers providing benefits for themselves incur a much bigger tax burden than they would face as an employee. 

There are two solutions to this problem for independent workers. One is to double down on the historical dichotomy between employees and independent workers and make the distinction even more rigid. This “Procrustean Bed” solution is best exemplified by which imposes rigid tests on who can be classified as an independent contractor. Basically, it forces companies to turn many of their independent contractors into employees, which would lead to the loss of these workers’ flexibility and control over their hours and who they can work for. In the gig economy space, this would almost certainly mean set schedules and the inability to work on more than one platform. Minimum wage rules and other employment regulations would lead to reduced service at certain times of day or in certain geographical areas.

The other alternative is to improve the position of independent workers by creating a new regulatory regime that extends them important new benefits, while still allowing the flexibility that self-employed workers choose. 

This new regulatory regime would have several important features. 

  • It would straighten out the tax treatment of benefits so that independent workers are on a level playing field with employees.
  • It would require a baseline level of benefits and protections for independent workers, including a cafeteria style plan with a menu of options for workers to choose what makes the most sense for them.
  • It would have a uniform national standard for determining who is an independent worker. One possibility is that companies would have no control over hours of work, and no non-compete agreements. 

A separate and important question is whether the new regulatory regime would be opt-in or mandatory. We lean towards opt-in, as discussed below.

The Structure of Benefits 

What benefits are U.S. employers actually paying to their employees? Table 1 below summarizes the distribution of benefits for full-time and part-time workers for the 2018-2019 period, based on BLS data. Note that part-time workers get a significantly small share of their compensation in benefits compared to full-time workers. Moreover, almost half of the benefit “package” for part-time employees comes through the legally mandated “benefits” such as employer tax payments for Social Security and Medicare, much of which independent workers already pay on their own. 

In general there are two problems with independent workers providing their own benefits. First, as we will see, the tax laws are written in such a way as to be biased against independent workers compared to employees, especially when the independent workers file on Schedule C. Second, if the businesses hiring the independent workers try to provide benefits, that’s taken as prima facie evidence that the independent workers are really employees, which the overwhelming majority of self-employed workers typically do not desire to be. 

Example 1: Retirement Savings

We already mentioned that the current tax system systematically penalizes independent workers who try to provide their own benefits. Let’s begin with retirement. Suppose that an employer wants to contribute $1000 to an employee retirement plan such as a 401k. That employer contribution is deductible from the employer’s business income and does not incur Social Security or Medicare Taxes for either the employer or the employee, as long as certain rules are met. 

Now suppose a company gives that $1000 to an independent worker who is filing as a Schedule C sole proprietor or single-person LLC. They deposit the $1000 in their IRA, SEP, or solo 401k account as a tax-deferred retirement contribution. The independent worker gets to deduct this contribution from their federal income tax (line 15 or line 19 on schedule 1). 

However, the independent worker has to pay both the employee and employer FICA tax, minus the net impact of the deductibility of the employer share (Schedule SE and line 14 on schedule

1). So, for example, if the independent worker’s marginal federal income tax rate is 22%, they end up paying a bit under 13% on the $1000, rather than 0%.

In other words, the independent worker is penalized on the retirement savings side. And the company can’t offer to bring the independent worker into the company’s plan without classifying the worker as an employee. 

Example 2: Healthcare Benefits

 A similar disparity holds in the case of healthcare benefits. If an employer contributes $1000 to a health insurance plan for their employee, that contribution is deductible from the employer’s business income and exempt from both employer and employee FICA taxes (within limits). And the contribution does not count towards the employee’s taxable income. 

That same $1000, paid directly to the independent worker, can also be used to finance health insurance. In many circumstances, that spending on self-employed health insurance can be deducted from taxable income (Line 16 on schedule 1). However, the independent worker still must pay employer and employee FICA taxes on that $1000, minus the deductibility of the employer share. As before, if the independent worker’s marginal federal income tax rate is 22%, they end up paying just under 13% on the $1000, rather than 0%. 

Example 3: Workers’ Compensation

Workers compensation is basically an insurance policy that covers employees for on-the-job accidents or injuries. Workers comp benefits are typically not taxable, and workers comp premiums are deductible from business income. Depending on the particular state, independent workers with no employees are usually not required to purchase workers’ comp for themselves. Such individual policies can be quite expensive, so many independent workers go without. But going without workers comp or occupational accident insurance, runs the risk of being exposed to large medical bills and a significant loss of income if workers are injured on the job. On the other hand, if the company provides worker compensation to an independent worker, that runs the risk of having them reclassified as an employee, which is not the outcome self-employed workers want. 

Example 4: Unemployment Insurance 

Under ordinary circumstances, the U.S. unemployment insurance system is a fairly small part of benefits. Depending on the year, average state and federal premiums for unemployment in the private sector amounts to between 0.5% and 0.9% of compensation. In 2018—a low-unemployment year–that came to only about $40 billion, on an annual basis. By contrast, unemployment benefits received in 2018 came to only $27 billion. Unemployment insurance premiums are deductible from business income, while unemployment benefits are subject to income taxes but not to FICA taxes. 

On the other hand, during recessions, unemployment insurance benefits received swell far out of proportion to taxes paid in, as the federal government typically appropriates more money to beef up unemployment insurance. In 2009 and 2010, for example, unemployment benefits rose to over $130 billion annually. Because of these special payments, unemployment benefits paid out over this last business cycle (2008-2019) exceeded unemployment insurance taxes paid in by more than $100 billion, none of which went to independent workers. 

However, the discussion around unemployment insurance for independent workers is different now than it would have been even six months ago. The Pandemic Unemployment Assistance (PUA) covered self-employed workers and small businesses, and showed that it was possible to provide “income insurance” for independent workers in hard times outside of the conventional unemployment insurance structure. 

So let’s focus for now on how to provide “income insurance” for independent workers in normal, non-recession circumstances. The key is that independent workers need a cushion not just against economic shocks, but personal shocks such as illness or family needs. One solution is for employers to contribute to a pot of money for the independent worker that could be used for a variety of different purposes. Like unemployment insurance premiums, the contributions to the fund should be tax-deductible.

One variant of income insurance that could apply to independent workers is income averaging for tax purposes. Because of the progressivity of the income tax code, allowing independent workers and employees to average between good years and bad years could significantly reduce the average tax bill, and cushion the effects of fluctuations. Income averaging was available to taxpayers whose income spiked up until 1986, when it was eliminated by that year’s tax reform (it is still available to farmers and fishermen). 

The Wrong Approach

The key goal is to make independent workers better off. One potential solution, as noted in the introduction, is to double down on the historical dichotomy between independent workers and employees. California, which went into effect on January 1, 2020, is the exemplar of this approach. This codifies and expands the “ABC test” which says that a worker is an employee unless they meet all of the following conditions: (A) “the individual is free from direction and control,” applicable both “under his contract for the performance of service and in fact,” (B) “the service is performed outside the usual course of business of the employer,” and (C) the “individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed.”

Under this extremely stringent test, some independent workers would need to be reclassified as employees. This reclassification is incompatible with business models predicated on independent workers, and as a result, many businesses have cut ties with California-based workers or shut down operations in California entirely. Under the new classification, it’s not illegal per se to allow an employee to completely decide which work opportunities to accept and to set his or her own days and hours (without any intervention from the business), but it’s certainly doesn’t fit the way employers typically operate.

As a response to this new law, California independent workers have been laid off en masse. In its news coverage of the passage of AB-5, Vox published an article with the headline “Gig workers’ win in California is a victory for workers everywhere.” Its reaction as a business, however, was quite different. A couple months later, the parent company Vox Media laid off 200 freelance writers right before the holidays (and right before the law went into effect on January 1). Deliv, a Menlo Park-based crowdsourced, crowd-shipping, same-day delivery startup, severed its relationship with 591 drivers a few months after it went into effect. 7-Eleven halted new California franchises. One estimate from the Berkeley Research Group concluded that switching the status of app-based drivers to full-time employees would reduce the number of drivers by 80 to 90 percent in California.

A Better Way

An alternative is to construct a new regulatory framework that explicitly recognizes a middle ground of independent workers who can receive benefits from the (multiple) companies they contract with. 

As we noted above, would have to address three main issues. 

  • It would straighten out the tax treatment of benefits so that independent workers are on a level playing field with employees.
  • It would require a baseline level of benefits and protections for independent workers, including a cafeteria style plan.
  • It would have a uniform national standard for determining who is an independent worker. One possibility is that companies would have no control over hours of work, and no non-compete agreements. 

A separate and important question is whether the new regulatory regime would be opt-in or mandatory. We lean towards opt-in given the wide variety of independent contractor arrangements that exist (e.g., doctors, realtors, etc.). If companies do not opt in, they would remain subject to existing legal tests for determining worker classification. 

Note that our proposal is very different from the “marketplace contractor” laws passed in states such as Florida. Such laws merely specify that certain on-demand workers are to be treated as independent contractors. However, they do not fix the federal tax laws that unfairly penalize benefits for independent workers. They also do not specify baseline levels of benefits and protections. 

Straightening out the tax code

As documented in this paper, the current tax treatment of benefits systematically favors employees over independent workers. Sole proprietors and single-member LLCs that file via Schedule C pay a substantial tax penalty for attempting to access the same benefits employees get. That needs to be fixed. For example, when a self-employed worker contributes to an SEP, that contribution should be exempt from payroll taxes. The tax fix here would be a simple one, allowing independent workers to deduct healthcare and retirement contributions from the earnings calculation for the self-employment tax. 

The companies need to step up here, too. A company should be able to contribute to an independent worker’s retirement or health accounts without triggering additional tax consequences, just as would happen for an employee. This would require a modification to current law governing benefits.

Simplifying the dividing line

The dividing line between independent workers and employees should include whether the company contributes to benefits for the independent worker. To the contrary, in this new category, once a worker reached a certain number of hours contracting with a particular company or platform, the worker would be entitled to a required set of tax-advantaged benefits —for example, portable benefits including paid leave, retirement savings accounts and contributions towards an individual’s health insurance premiums. All workers should be covered by occupational accident insurance for on-the-job injuries. On the other hand, companies would be forced to allow workers in this third category the freedom to choose their hours as well as work for other companies in the same industry. In other words, control over hours or non-compete agreements. 

Baseline level of benefits

The exact level of benefits required in the new category would have to be considered carefully. The optimal mix of benefits will create an option that is preferable to current rules for many companies and workers, creating a win-win proposition. The flexibility, in particular, will be attractive to many workers.

We note that it’s especially important to design the benefits package to help low wage workers. For example, one could imagine zero-cost banking as part of the package in order to link the unbanked to the financial system. These zero-cost bank accounts would be designed to be portable and would be subsidized by the companies with which the worker contracts. 

Companies would be required to choose, on a year by year basis, whether they treat their independent contractors under this new category. This choice would allow companies to offer benefits to independent contractors without worrying that they would be reclassified as employees at either the state or federal level, while preserving the flexibility and independence that are synonymous with independent contractor status. And independent contractors would be on a level playing field with the tax-advantaged employee benefits.

How the cafeteria style plan would work

The cafeteria plan would allow independent workers to choose from a variety of pre-tax benefits, including health insurance, paid time off, and retirement savings. These benefits would be tied to the individual, not the job, making them truly portable. Plans would be managed by a qualified benefits provider. If an independent contractor ceases work for one company, they do not lose any accrued benefits from that relationship. Companies pay the equivalent of a certain share of the worker’s earnings into a dedicated account for pre-tax benefits. There is no required match from the beneficiary – the cost is fully borne by the business and nothing comes out of workers’ pockets. The independent contractor accrues benefits in proportion to the amount of money earned on the platform.

Independent workers can choose to use these funds towards individual health insurance premiums. They can also choose to add the money toward paid leave or retirement. Individuals access the paid leave benefits by self-certifying that they have experienced a qualifying event, such as falling sick, needing to take care of a family member, or living under a state of emergency. Since there is no separation event for an independent contractor similar to an employee being laid off an employer, there needs to be a cutoff when this short-term insurance plan converts into a cash benefit. For example, at the end of the year, the unused benefit funds could be rolled into a retirement savings account.

In order to prevent a patchwork of state and local laws from developing, the new federal law needs to include preemption. This new regulatory model — in particular the social insurance component — is critical to solving market failures. To take one illustrative example, consider the negative externalities created during a pandemic. In the case of a contagious disease, one individual’s actions (such as wearing a mask) directly affect the likelihood of others getting infected. Similarly, there is a public interest in ensuring independent contractors aren’t financially pressured to work when they’re feeling sick. The government needs to create a new regulatory framework that incentivizes private sector companies to fund benefits programs such as sick leave or paid leave to reduce the recurrent negative spillovers in labor markets.

Cost

Obviously this new regulatory regime extends certain tax breaks now enjoyed by employees to independent workers as well, which incurs some hit to tax revenues. But note that the alternative solution to the independent contractor problem—redefining the dividing line so that more independent workers are reclassified as employees—also incurs a hit to tax revenues. Reclassification of independent workers as employees costs the federal government FICA tax revenues on employer contributions to healthcare and retirement plans. In addition, reclassification significantly reduces the amount of work (and therefore the amount of taxable worker pay) overall. 

Consider, for example, business payments for health insurance. As we saw earlier, for independent contractors who file a Schedule C, those health insurance payments can be typically deducted from taxable income, but not from the payroll tax base. By contrast, business payments for health insurance for employees are not subject to the payroll tax. So, legislation that forces independent workers into employee status ends up reducing payroll tax revenues, all other things being equal. This would reduce the public funds available for vital social insurance programs. 

This is not a final answer on the cost question, of course. But it does mean to get a good cost estimate, it’s necessary to compare apples to apples. Critically, businesses should incur the full cost of participating in the new framework we are proposing.

Conclusion

Independent workers face a dilemma where they cannot currently receive benefit payments from companies without risking their independent status. Meanwhile, they cannot provide benefits for themselves without being unfairly penalized by the tax code relative to employees.

Previous attempts at the state level to define a new category of “marketplace contractors” has not fixed this dilemma, because they did not address disparities in the tax treatment of benefits. Nor did they create a baseline benefit package that companies must provide. 

We suggest that it is possible to design a new regulatory regime that is a win-win proposition. It makes independent workers better off by making it easier for them to either get benefits from a company or provide the benefits for themselves, while still retaining the flexibility that is an essential attraction of independent work for most. At the same time, by allowing companies to opt into this new regulatory regime, it ensures that companies have an alternative to a patchwork of state regulations if they are willing to offer a baseline package of benefits. 

Return Free Filing Won’t Fix What’s Wrong With America’s Tax System

Posted on by The Progressive Policy Institute

Because of COVID-19 Tax Day moved this year from April to July. That means the debate over the supposed panacea to the convoluted process of filing taxes – a return-free filing system (RFF) – is now making its annual appearance, albeit four months late.

The return-free filing idea has been around for a longtime and is currently in practice in Denmark, Sweden, Spain, and the United Kingdom (among other countries), places with limited or no tradition of voluntary compliance. If the U.S. government adopted RFF, the Internal Revenue Service (IRS) would estimate your taxes by using information from a mix of sources (depending upon the system) including employers, financial institutions, other third parties, and in some cases the individual taxpayer themselves. Proponents say (in effect) let the government do your taxes and spare you the burden of hiring a tax preparer, purchasing commercial tax software, or trying to do it yourself.

That sounds alluring, but it’s important to underscore the limits of what an RFF system could achieve and what it would not. For example, an RFF would not eliminate the $1.6 trillion in tax incentives that benefit primarily wealthier taxpayers. Nor would it raise revenue to build new roads, rail, or schools; support scientific research; pay down public debts; make the tax code fairer and more progressive; or, help us close our $458 billion annual tax gap (the difference between what is owed in taxes versus what is paid).

Rather, pursuing return-free filing is a way to avoid the hard choices needed to revamp our tax code to promote economic fairness and growth. It would put the burden of contesting initial tax determinations on the filers rather than on the IRS, fundamentally reversing the presumption of the tax system today. And, if truly voluntary, it is unlikely to have a significant impact on the way most Americans complete their taxes. In California, which proponents often cite as a good example of how an effective return-free filing can be implemented only about 90,000 people used “Ready Return” in any given year of that experiment (despite the some two million Californians that were annually offered the government-prepared tax returns) — putting into serious doubt the idea that a federal return-free filing system could be voluntary and actually achieve the purported national benefits it proponents claim will occur.

In fact, moving away from a voluntary tax filing system would actually worsen many of the problems that an RFF system is supposedly designed to fix — accuracy, tax evasion, and simplicity. Furthermore, were the U.S. to implement an RFF system, it would eliminate the moment of financial planning and review that is tied to the self-return process, and as the only time each year many households take stock of their finances, has an intrinsic value for American families.

Accuracy

As tax codes around the world have become more complex, many countries that are currently using RFF systems are increasingly finding it necessary to re-engage taxpayers in order to ensure accuracy. In the introduction to a 2017 report by the UK’s All-Party Parliamentary Taxation Group on Pay-As-You-Earn (PAYE), the RFF system utilized by the United Kingdom. Ian Liddell-Grainger, the Chair of this non-partisan policy committee and a Conservative Member of Parliament, noted that:

(Given) the changing nature of the workforce, a growing self-employed community and the complexity of our current system leading to significant overpayments…It is my firm belief that we need to involve the taxpayer in this process. It is them who can improve the accurate flow of information throughout the fiscal year.

The Parliamentary report found that as a result of a number of economic changes since the creation of PAYE, approximately one-third of British taxpayers were effectively filing their own taxes via a process known as Self-Assessment — negating much of the “will save the taxpayer time” rationale for a RFF system. The report cited a number of reasons for the increase in Self-Assessments, including a rising number of self-employed workers; a more mobile workforce; and an increase in tax code complexity driven in part by the growth in tax incentives.

Unfortunately for the PAYE system, these trends are likely to worsen over time given the growth in globalization and the growing mobility of the workforce.

The PAYE report also noted that error rates had been rising significantly in the United Kingdom, costing the government and taxpayers billions over the years. This counters another rationale for RFF — that no-file systems reduce the error rate and the thus help close the size of the tax gap. The parliamentary analysis points to exactly the opposite outcome in the real-world experience of their RFF in practice.

Tax Evasion

While unintended error is one major source of the tax gap, another is the intentional underreporting of income subject to tax — or tax evasion.

Some have argued that RFF systems could help reduce the tax gap because it would reduce underreporting. In a 2006 paper on return-free filing, Austan Goolsbee, former Chairman of the White House Council of Economic Advisers under President Obama, cites a 1996 General Accounting Office (GAO) report that concluded that a no-file system could help the Internal Revenue Service significantly reduce its number of “underreported” cases.

In a 2010 paper, economists Jeffrey Eisenach, Robert Litan, and Kevin Caves took a contrary view. They argued that the adoption of an RFF tax system would not have any impact on the U.S. tax gap, adding that it would

“do virtually nothing to reduce under- reporting on individual tax returns, because almost all under-reporting is associated with types of income that would make filers ineligible to use RFF in the first place.”

In fact, the authors contend that RFF might actually make the tax gap larger, since taxpayers who receive completed tax returns that understate their actual tax liabilities are not likely to challenge the IRS’s errors in their favor. Even Joseph Bankman, a longtime advocate of RFF, has explicitly acknowledged it could lead to greater opportunities for taxpayers to underpay what they owe.

In a 2017 article in Propublica, Bankman noted there were multiple ways taxpayers could benefit from an RFF system and stated that “If there’s a mistake that goes in your (the taxpayer’s) favor, maybe you don’t call attention to it.”

Supporting this argument is data on tax evasion in countries with return-free systems compared with the U.S, which relies on voluntary citizen compliance.

According to the Tax Policy Center (TPC), 36 countries permit return-free filings for some taxpayers. This is typically accomplished in one of two ways. In the pay-as-you-earn systems used in Japan, Germany, and the United Kingdom, the government calculates tax withholding to match the amount of annual taxes due. Most citizens, particularly those whose income is derived from a single employer, never even see a tax return.

Other nations like Belgium, Spain, and Denmark, use what’s called a pre-populated return. Employers report individuals’ income directly to the government, which then sends the taxpayer a pre-filled return he or she just has to verify.

In Table 1 we compare tax evasion rates in 13 countries — six that use pay-as-you-earn systems in which the government calculates withholding, six that pre-populate returns with information provided by employers, and one, the United States, where citizens file their own tax returns. (Tax evasion data was not available for all 36 countries using RFF)

The average rate of tax evasion as a percentage of GDP for the 12 countries on this list was 1.45. For those countries that have pay-as-you-earn systems, the average was 1.35. For those with a pre-populated return system, the average level was 1.71. In contrast, the level of tax evasion for the United States as a percentage of GDP was only 0.1.

While many other factors need to be taken into account when looking at what is responsible for the different levels of tax evasion by country, including trust in government, complexity of the tax code, type of taxation (income tax, sales tax, etc.), and effective rate of taxation, it is nevertheless of interest that the U.S. had a significantly lower level of tax evasion as measured by GDP than those countries that utilized either system of return free filing.

Simplicity

Proponents of return-free filing say it would greatly simplify the process of filing taxes. Goolsbee argued in 2006 that moving to a return free filing system would save taxpayers 225 million hours of tax compliance time.

However, it’s doubtful that such savings would materialize in the United States. We have a very complicated tax system. Governments at the federal, state and municipal levels all have taxing authority.

The federal tax code, moreover, is encumbered with $1.6 trillion worth of tax incentives for a vast array of activities. And because we have a large number of self- employed workers and two-income families, moving to an RFF system would still necessitate a great deal of taxpayer involvement to ensure accuracy, completeness, and fairness.

Adopting an RFF would not address the growing complexity of the U.S. tax code. In fact, if an RFF system works as its proponents argue, it would leave the status quo in effect – an inefficient tax code riddled with tax breaks that disproportionately benefit wealthy taxpayers at the expense of working class families.

As PPI has long contended, what America really needs is a comprehensive overhaul of
the tax code, not an army of government tax collectors doing your taxes for you. In addition to big changes in what we tax and restoring progressivity, radically streamlining the tax code is the right way to make our government more user-friendly and to reduce the time and money citizens spend on filing their taxes.

Financial Planning

One often overlooked benefit of America’s tradition of voluntary tax compliance is that it educates citizens about their financial condition.

Ironically, filing one’s taxes provides a window of opportunity during which Americans can review their financial history from the prior year and reassess their needs for the future — such as how much to save for retirement.

But shifting to an RFF system would eliminate or reduce that educational moment. As former Senator (and co-chairman of the National Commission on Restructuring the IRS) Bob Kerrey noted in an article for Time Magazine entitled “Beware of Simple Solutions to the Tax Code:”

“Perhaps the worst aspect of the simple return is that it reduces or eliminates
one of the most important activities that occur during the tax-filing season: individual financial review and planning. Calculating how much we owe in taxes is an unpleasant activity, but it is also central to understanding our personal financial situation and planning our financial futures — and often the only time all year that the average family looks at its finances.”

As exasperating as it can be, doing your own taxes, and understanding you family’s financial relationship with government, is more worthy of a free and self-reliant citizenry than delegating that responsibility to government tax collectors. We shouldn’t reduce taxpayer engagement in their own financial affairs simply to avoid the hard work of passing and implementing real tax reform. The impact of greater taxpayer disengagement from their own personal finances is not an inconsequential consideration as a matter of national economic policy. To the contrary, numerous analyses of the national savings rate and financial literacy underscore the need for more personal engagement in one’s financial affairs—not less.

Conclusion

Nobody enjoys paying taxes, and the U.S. tax system leaves a lot to be desired. It is overly complex, wasteful, does not raise enough revenue to cover the needs of its citizens, and tilts toward the interests of the wealthy. Moving to a return free filing tax system would not address any of those problems. If policymakers want to reduce the amount of time taxpayers spend on filing taxes, they should be not be distracted by magical panaceas, but rather aim their sights on creating a simpler, more efficient and fairer tax system that promotes economic growth and equity.

PODCAST: Should we abolish tax returns? A conversation with Sen. Bob Kerrey

Posted on by The Progressive Policy Institute

As millions of Americans rush to file their tax returns, former Senator Bob Kerrey joined the Center for New Liberalism and the Progressive Policy Institute’s Paul Weinstein and Alec Stapp to discuss whether or not the US government should adopt return-free filing for individual taxes. The participants discussed the costs and benefits of return-free filing relative to our current voluntary tax filing system, the main problems with our current tax system, and whether or not return-free filing would reduce tax evasion.

FICO rolls out new credit scoring model

Posted on by The Progressive Policy Institute

Consumers are getting turned down for all sorts of financial products, from personal and auto loans to credit cards. The Wall Street Journal, using Equifax data, reports that credit card approvals totaled 483,000 in the week ending May 10, down from 856,000 in the week ending March 22. To compare to the year prior, weekly card approvals in 2019 “rarely fell below 1.2 million,” according to The Wall Street Journal.

But as banks are tightening their lending requirements, a new tool is trying to prevent lenders from cutting off consumers’ access to credit.

Fair Isaac Corp., the data analytics company behind the FICO credit score, has just launched the FICO Resilience Index, a new scoring model designed to help lenders better assess consumers’ sensitivity to financial stress by looking at their capacity to survive financially though a downturn.

“The FICO Resilience Index, used in conjunction with a FICO Score, allows card issuers to limit access less than they otherwise would have because they can now identify borrowers who are more resilient to the economic downturn,” Sally Taylor, VP of FICO Scores, tells CNBC Select.

FICO defines resilient borrowers as “consumers that are more likely to pay as agreed in the event of a recession.”

The new scoring model ranks consumers’ resiliency on a scale of 1 to 99. The higher your score, the higher the risk you will default on your payments; the lower your score, the more likely you are to make on-time payments even when the economy experiences a downturn.

Read the full piece here.

This piece was originally published on CNBC by Elizabeth Gravier on June 29, 2020.

Economic Impacts of a Moratorium on Consumer Credit Reporting

Posted on by The Progressive Policy Institute

Two bills introduced in Congress, H.R. 6370 and S. 3508, ‘‘Disaster Protection for Workers’ Credit Act of 2020’’ would impose a moratorium on credit reporting of “adverse information” for the duration of the coronavirus crisis. Credit scores are an integral part of the consumer credit underwriting process as their power to predict the likelihood of borrower default is well-established empirically. Consequently, lenders have come to heavily rely on the integrity and information content of credit scores as a critical measure of a borrower’s creditworthiness.

Economic theory suggests that in the absence of viable mechanisms to effectively distinguish between high and low risk borrowers, lenders will ration credit. Under a credit reporting moratorium, the reliability of credit scores to distinguish between borrower risks would come into question. Lenders would respond to the proposed credit reporting moratorium by raising minimum credit score requirements and/or raising borrowing rates as a credit uncertainty premium to offset the risk they face from the moratorium. During the 2008 financial crisis, lenders raised credit score minimums on FHA loans, for example, beyond those set by the agency as a response to uncertainty over indemnification provisions that posed significant costs to lenders. And today, during the coronavirus, a number of Ginnie Mae originators have raised credit scores to blunt some of the risk they face due to requirements to pass-through mortgage payments to investors, including those in default or subject to forbearance.

Read the full piece here.

This piece was originally published on Chesapeake Risk Advisors, LLC by Clifford Rossi on June 17, 2020.

How a Startup Tax Credit Can Spur Re-Employment

Posted on by The Progressive Policy Institute

As federal and state governments outline plans for reopening the economy, lawmakers will have to grapple with the challenge of getting tens of millions of Americans back to work as quickly as possible.

More than 47 million Americans have filed for unemployment since the pandemic began, with the unemployment rate at 13.3 percent in May.

The economic damage has been inflicted on both the employer and worker sides of the labor market. A mass of businesses have filed for bankruptcy as a result of the lockdown, with the American Bankruptcy Institute finding a 48 percent increase in commercial Chapter 11 filings in May compared to last year.

And many laid off workers will not be able to return to their former jobs. As many as 25 percent of jobs may never come back, Joseph Brusuelas, chief economist at consulting firm RSM, recently told Politico.

Part of the problem is that even businesses that survive the downturn are going to be wary about expanding to fill the market gaps left by their defunct peers. Small businesses, which are naturally less risk-tolerant than their large counterparts and have access to fewer resources, will be especially cautious about growth.

That’s why simply “reopening the economy” won’t put everyone back to work. We also need a strategy for incentivizing existing small businesses to swiftly scale up and make room for rehiring the unemployed.

U.S. policymakers need new tools for revitalizing entrepreneurship and leveraging its potent job-creating abilities. To that end, the Progressive Policy Institute (PPI) has proposed a new Startup Tax Credit that incentivizes entrepreneurs to quickly increase employment at their small companies, giving even existing companies a startup-like boost.

Modeled on the Earned Income Tax Credit, the Startup Tax Credit would be a refundable tax credit tied to the number of employees and payroll at a small business.

Read more here.

Discussing the Budget with Students at the New England College Convention

Posted on by The Progressive Policy Institute

Ben Ritz, the Director of PPI’s Center for Funding America’s Future, presented to students during two breakout sessions at the New England College Convention in Manchester, New Hampshire this week. The first session was a joint presentation about the national debt as an intergenerational issue with Bob Bixby from The Concord Coalition and Brian Riedl from the Manhattan Institute. The panelists spoke with local radio host Chase Hagaman about their presentation on his show, Facing the Future, which airs on New Hampshire’s WKXL station and can be found at the link below. Hagaman also moderated a second session in which Ben discussed with students the public investment proposals presented so far in the presidential campaign, how candidates would fund their agendas, and the impact these plans would have on young Americans.

Listen to the interview here.

Ritz for Forbes: “The Trillion-Dollar Question Missing From The Presidential Debate”

Posted on by The Progressive Policy Institute
Congress voted this week for a $1.9 trillion tax and spending deal, over a quarter of which was added to our $23 trillion national debt. Thanks to this and other fiscally irresponsible legislation signed into law by President Donald Trump, the federal government will run an annual budget deficit of over $1 trillion this year and every year that comes after it. Yet of over 500 questions asked throughout six presidential debates, not a single one has raised the issue.

 

Read the full piece on Forbes.

Ritz for Forbes: “Naughty Or Nice? Breaking Down Congress’s $1.9 Trillion Budget Deal”

Posted on by The Progressive Policy Institute
The House of Representatives earlier this afternoon passed two bills to provide $1.4 trillion in funding for defense and non-defense spending programs that must be appropriated on an annual basis. As is often the case with must-pass legislation at the end of the year, these bills have become “Christmas trees” decorated with various policy riders and pet projects for members of both parties in Congress. What are the major provisions attached to this legislation that help add $500 billion to its price tag, and should they put Congress on the naughty or the nice list?

Read the full piece on Forbes.

Ritz for Forbes: “Three Tax Cuts a Santa Claus Congress Could Deliver in 2019”

Posted on by The Progressive Policy Institute

Congress must pass a comprehensive funding bill by the end of next week to avoid a repeat of last year’s government shutdown. Such a must-pass bill at the end of the year often becomes a “Christmas tree” decorated with various policy riders and pet projects for members of both parties in Congress. But under this year’s tree, a fiscally irresponsible Santa Claus Congress might leave wealthy Americans three gifts that together could cost up to $1 trillion over the next ten years – all put on the nation’s credit card for young Americans to pay off for generations to come.

Read the full piece here.

PPI’s Ben Ritz Talks Social Security with Ric Edelman

Posted on by The Progressive Policy Institute

The Director of PPI’s Center for Funding America’s Future, Ben Ritz, joined personal-finance advisor Ric Edelman on his nationally syndicated radio show to discuss the challenges facing Social Security, their role in the 2020 election, and PPI’s proposal to strengthen the program for future generations. Listen to the interview below and read our full plan here.