After the debt deal: A tax reform idea

The debt deal punts on tax reform. That's unfortunate. But when lawmakers finally get to it, this idea can garner bipartisan support and save the government serious money: Have the IRS fill out tax returns for millions of taxpayers. It's a proven concept in Scandinavia -- and California.

The great debt debacle in Washington is over – for now. One idea that was punted for later consideration is tax reform. This is stupefying because the elimination of all corporate and individual “loopholes” from the tax code would free up about $1 trillion each year to either reduce tax rates or debt – or both.

The issue was too politically hot to handle, yet talk of tax reform doesn’t always have to spark a beltway bonfire. Here is an idea that should find common ground and one that immediately yields to common sense: Simplify the process of preparing tax returns by shifting the burden from the individual taxpayer to the government itself.

Why and How?

Often the Internal Revenue Service has all the information it needs to do the same thing that taxpayers toil over every April, except it can complete the task much more efficiently and accurately. Wages and salaries (the W-2) and interest and dividend income (the 1099) are tabulated on forms that employers and financial institutions feed directly into IRS computers.

Why require taxpayers to reinvent the 1040 wheel by spending time gathering documents and struggling to master the tax man’s gobbledygook in the tax forms and instructions? Particularly when, as is often the case, taxpayers incorrectly fill out their returns and are contacted by the IRS telling them how they erred and how much more (or less) they owe.

Or why force 60 percent of taxpayers to hire professional tax-return preparers, many of whom have their clerks take the taxpayer’s information, feed it into software that spits out the tax return, and then send a bill for anywhere from $100 to $1,000?

This idea for the tax agency to do the heavy-lifting computations is not new. California launched such a program, called “Ready Return,” as a pilot plan in 2004 and 2005 and made it permanent in 2007.

European countries, Scandinavian in particular, use what is known as a Tax Agency Reconciliation (TAR) system. In Denmark and Sweden, the vast majority of taxpayers use the program.

This is more than a theoretical idea. The multi-page, multi-form 1040 tax icon carries with it an instruction booklet of 179 pages of gibberish. The IRS estimates that US taxpayers toil 3.8 billion hours each year gathering information and preparing the 1040 alone, at an imputed cost of $120 billion, or a full 10 percent of the tax revenues collected by the agency.

Yet tax return simplification is not just about easing the burden for 150 million individuals come April 15. It’s also about converting confused, agitated, and tempted noncompliers into silent, mollified, and compliant taxpayers.

The country’s tax compliance rate is 86 percent and the “tax gap” – the amount of taxes that are owed annually but not paid – exceeds $300 billion a year. Each 1 percent improvement in compliance will produce an added $20 billion in revenues. That’s serious money in today’s era of unsustainable trillion-dollar deficits.

Here are some of the details of what I call the “EZTax.” About two-thirds of all taxpayers don’t itemize but claim a standard deduction. Many of these taxpayers have compensation income from one employer and perhaps interest income from one financial institution. These are the ideal candidates for EZTax returns, estimated to be up to 50 percent of all filers. If Congress were to undertake “real” tax reform and eliminate the many loopholes that fill the 30 lines on Schedule A (itemized deductions), then the number of added eligible candidates would surge dramatically.

The IRS would determine eligibility for EZTax returns based on the prior year’s return and would prepare a “draft” 1040. It would notify the taxpayer of his or her eligibility and establish a secure online mechanism for the taxpayer to review it or, alternatively, an appropriate mailing address for the return to be sent.The taxpayer would then review the return and either agree to the content and file it; make appropriate changes and file; or toss it in the trash can and start from scratch.

Participation would be voluntary

The EZTax process would be entirely voluntary. Those skeptics who don’t trust the IRS will simply decline to participate. They may even test the agency to “get it wrong” with an error favoring the taxpayer.

But many view California’s tax administration system as in the forefront, and the state has had good results with its Ready Return program. More than 97 percent of those who use the system report a “satisfied” or “very satisfied” experience, and say they will continue to use it. California also reports the cost of processing paper-filed returns is close to 10 times that of a Ready Return ($2.59 vs. $.34).

The high usage of the TAR system in the Scandinavian countries is a direct result of tax systems considerably simpler than America’s, and taxpayer compliance costs are estimated at 1 percent of revenues collected compared to 10 percent in the United States. Again, real tax reform in the form of simplification of the code by Congress would likely yield greatly reduced compliance costs.

Common ground and common sense

The Obama administration has not been silent on this idea. Back in September 2007 while on the campaign stump, then Sen. Obama advocated a “Tax Fairness” plan that included a “five minute return” – virtually the same as that described here.

Additionally, the president’s outgoing main economic adviser, Austan Goolsbee, is a passionate supporter of the concept. Mr. Goolsbee reckons that an EZTax type of return system would save taxpayers $2 billion a year in preparation fees, not to mention millions of hours of time.

Clearly here is one of those campaign promises that deserves some presidential heft, for it should be one on which Mr. Obama can garner bipartisan support. This is because the EZTax concept is likely to be one of those rare ideas where mainstream Republicans and even tea party hardliners would not mind seeing a little more proactive government – especially where that added bureaucracy reduces overall costs.

John Klotsche is a retired partner and former chairman of the executive committee of the international law firm Baker & McKenzie. He served as senior advisor to the IRS Commissioner from 2003-2008. He lives in Santa Barbara Calif., and writes fiction and nonfiction short stories.

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