Binyamin Applebaum of The New York Times recently authored an op-ed advocating for the adoption of return-free filing in the United States. This innovative concept suggests that many taxpayers could receive a pre-completed tax return from the IRS, allowing them to amend it if necessary. While this idea is intriguing, its success hinges on the simplification of the U.S. tax code.

The advantages of implementing a return-free filing system are well-documented. A 2006 study by then-future Council of Economic Advisers chairman Austan Goolsbee projected that if the United States adopted this system, taxpayers would save up to $2 billion annually in tax preparation fees. Additionally, the time saved would amount to around 225 million hours each year. When considering opportunity costs, he estimated that overall compliance costs could be reduced by $44 billion over a ten-year period. Adjusting for current population growth and rising tax preparation costs since 2005, these figures could be significantly higher today.

More than thirty-six countries have successfully implemented some form of return-free filing system, utilizing either exact withholding or tax agency reconciliation methods. In the exact withholding approach, employers aim to withhold taxes as closely to the taxpayer’s actual liability as possible. Conversely, in tax agency reconciliation systems, tax authorities send out a tentative return to the taxpayer based on third-party information—such as income reported by employers—allowing the taxpayer to verify and amend as needed.

The Context of Return-Free Filing in the U.S. Tax System

However, the efficacy of a return-free filing system is contingent upon the nature of the tax code governing it. As highlighted in a 2003 report by the Treasury Department, without significant reforms to simplify the tax code, return-free filing would merely transfer the compliance burden from individuals to employers and financial institutions. While the U.S. tax code has undergone some changes aimed at simplification, particularly following the Tax Cuts and Jobs Act of 2017, it remains a complex framework laden with public policy goals unrelated to revenue generation.

Several inherent challenges complicate the transition to return-free filing in the United States:

1. Administering Social Programs Through the Tax Code: In the U.S., programs like the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC) play significant roles in supporting low-income families. The intricacies surrounding eligibility criteria make it challenging for employers to provide accurate withholding when these credits are involved.
2. Household Filing Issues: Unlike many nations that have adopted return-free filing systems, the U.S. taxes households as collective units. This requirement complicates adherence to a straightforward tax system because an employer must take into account spousal income alongside their employee’s wages.
3. Non-Wage Income Considerations: Most return-free systems focus primarily on wage income. In the U.S., however, various forms of capital income such as interest and dividends are categorized differently and are subject to their own tax strategies. This classification can complicate compliance, especially since certain types of income are not subject to withholding.

Return-Free Filing and the Tax Gap

Many experts have posited that adopting a return-free filing system could significantly reduce the tax gap—the discrepancy between taxes owed and taxes actually collected. A Government Accountability Office (GAO) report from 1996 indicated that return-free filing could save the IRS approximately $36 million by minimizing errors in tax returns. Adjusted for economic growth and inflation, this figure could be considerably larger today.

Currently, the tax gap in the United States is estimated at about $630 billion. While it’s conceivable that the savings from a return-free filing system could equate to twice the previously mentioned GAO estimate, that amount would only scratch the surface of the overall tax gap. The reason for this modest impact lies in the fact that income typically subjected to exact withholding reflects low rates of underreporting, while more complex income streams with higher noncompliance rates—like partnership income—remain unaffected by such systems.

Addressing Additional Concerns

While the potential benefits of return-free filing are compelling, there are legitimate reservations regarding its implementation. One concern is that empowering the IRS to act as both the tax collector and the tax preparer could generate disincentives and potentially lead to overpayments. Conversely, some advocates of return-free filing, like Stanford Law Professor Joseph Bankman, warn that it might result in underpayments; taxpayers may challenge inflated IRS estimates of their tax liability without compensating for potential underestimations.

Moreover, the act of filing taxes traditionally holds societal value, serving as an educational opportunity to familiarize taxpayers with their financial circumstances. Streamlining the process through return-free filing could diminish the transparency and engagement that currently exists.

Ultimately, while a return-free filing system bears the potential to ease compliance burdens for taxpayers, its efficacy is inextricably linked to the structural reforms needed within the current tax code. Without addressing the multifaceted and often convoluted policies embedded in the tax system, the implementation of return-free filing may fail to deliver meaningful reform.

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