When U.S. states tried — and failed — to simplify tax filing

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With the launch of the Internal Revenue Service’s new Direct File website — which will compete with paid tax prep software by offering a new free filing platform for some taxpayers — some advocates are touting the experiment as an overdue step toward a broader reform to simplify taxes.

They point out that filing taxes is both free and much easier in many countries. For example, at least 47 nations offer an option unavailable in the United States: The government fills in some information on a citizen’s tax return, known as “pre-population,” saving residents some of the trouble of doing taxes themselves.

Direct File, as a pilot project limited to certain states, won’t go that far. But IRS officials haven’t ruled out adding such a feature to future versions of the site, and its debut has renewed long-standing discussions about why the United States lags in this respect. According to one 2022 study that included authors from the Federal Reserve and the Treasury Department, the IRS could correctly calculate about 45 percent of households’ taxes without collecting any additional information from the taxpayers.

Are you one of the first to test the new Direct File site? The Post wants to hear from you.

Skeptics, however, point to the complexity of the U.S. tax code and the strength of the commercial tax prep industry’s lobby as entrenched obstacles. And past experiments show why several U.S. states’ attempts to simplify tax returns have failed — while other countries’ programs have met with more success.

Struggles at the state level

In 1996, Michigan launched a program to allow some taxpayers to skip filing a tax return at all. But in the first year, just 94 people chose to participate, according to a Treasury report.

Douglas Roberts, who launched the program as Michigan state treasurer, now says: “It was not one of my better ideas.”

The program required taxpayers to tell their employer at the beginning of the year if they wanted to participate. Their employer would then collect a precisely-calculated dollar amount as their state tax withholding over the course of the year. The catch: Participants couldn’t claim certain state tax credits, which Roberts says were only worth $5 to $25 for most taxpayers. “As soon as they hear [they] don’t have to file an income tax return, I thought people would jump at it,” he said. “But clearly … they didn’t jump very far.”

Roberts blamed the program’s failure on taxpayers’ concern about not getting credits. The Treasury report cited additional reasons, including a lack of publicity to taxpayers that they could sign up through their employers.

Other people who have tested return-free filing programs believe the idea remains a good one despite past disappointments. In 2005, Stanford law professor Joseph Bankman (recently better known as the father of indicted cryptocurrency mogul Sam Bankman-Fried) helmed an initiative in California that sent pre-filled returns to some taxpayers. Only 1 in 5 chose to use the pre-filled form.

Bankman now thinks that the pre-filled state forms didn’t save that much time because most of the filing effort goes into the federal return. “Even though people [who used it] loved it, people do their federal taxes first anyway,” he said. “Being able to get that same data for your state didn’t help people all that much.” A federal initiative, as he sees it, would be more effective and more popular.

Another challenge: Intuit and other companies that sell tax software lobbied fiercely against the continuation of the California “Ready Return” program.

“The tax prep industry is terrified of pre-population,” said University of California at Davis law professor Dennis Ventry, who also worked on the California program.

In other states, the problems were technological. Ventry recalls meeting with officials in the Maryland governor’s office to speak about setting up a similar program. State leaders were interested, but their process of collecting and sorting information from state residents’ W-2s was much slower than California’s, making them unable to process the information in time to pre-fill returns, Ventry said.

Colorado ran into a similar problem when it tested a program, File4Me, in the 1990s. Information from W-2 data and from the federal government, which had to tell the state what the taxpayers reported on their federal returns, came in too slowly to make the program workable, recalls John Vecchiarelli, the state’s director of taxation for 31 years.

“We could do it,” he said. “But it required the return to be filed so late that it was almost past the due date.”

With current information technology, Vecchiarelli believes File4Me would be possible today. “It’s an idea whose time has come,” he said. “We have enough information. We can file on behalf of a lot of people.”

In many countries, pre-filled tax returns are the norm. A report by the Organization for Economic Cooperation and Development (OECD) on tax filing practices in 57 countries found that 47 offered some level of pre-population on their tax returns in 2020. In 44 of those countries, national tax agencies pre-filled residents’ wages; Czech Republic, Israel and Switzerland filled in only personal information about the taxpayer, not their income.

Some countries went further than wage data, filling in income from pensions in 37 countries, from interest in 26 countries and from capital gains in 15 countries. In Australia, 88 percent of all income reported by individual taxpayers is pre-filled. Taxpayers then get the chance to make corrections to that information, typically adjusting about one out of 10 entries.

Many of the countries also collect and pre-fill information about residents’ tax-deductible expenses. The OECD found that 18 countries pre-fill residents’ donations during the year; 10 countries pre-fill the amount people paid for child care; and 13 countries pre-fill medical expenses. Italy, Portugal and South Korea go furthest, filling in residents’ education expenses, insurance payments, retirement savings and mortgage-interest payments, too.

Recent technological innovations have improved tax filing in several of these countries, the report points out. Singapore, for instance, extended its “No-Filing Service” in 2021 beyond wage earners to some self-employed people, starting with thousands of taxi drivers who have their income reported by companies. The tax agency tells self-employed filers what percent of their income they can deduct for expenses and then withdraws the tax payment due from their bank account.

U.S. politicians, meanwhile, have talked of pre-filling returns at the federal level for decades. U.S. presidents from Ronald Reagan to Barack Obama have vowed to get it done. In 1998, Congress passed a law that required the IRS to start pre-filling tax returns for “appropriate” taxpayers within a decade. But the IRS never did.

The Treasury Department published a report in 2003 on what it would take to follow that law. It noted that the United States has more complicated deductions and credits than most countries, and that Americans wouldn’t want pre-filled returns if it meant getting their refunds later in the year.

Janet Holtzblatt, who is now a fellow at the Tax Policy Center, remembers working on that report. In the years since, she has noted how many more countries have started pre-filling returns.

“The European countries have simpler tax returns,” she said. “There were times when they made changes to their tax systems … [and] simplified their rules for computing income before adopting the pre-populated tax system.” As she sees it, if you want to simplify tax filing, you might need to simplify the tax code first.

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