Return-Free Tax Systems and Taxpayer Compliance Costs.ppt

Return-Free Tax Systems and Taxpayer Compliance Costs Presentation to the President’s Advisory Panel on Federal Tax Reform by Eric J. Toder Urban Institute and Tax Policy Center May 17, 2005 Issues in Return-Free Systems What are Return-Free Systems? What is the Problem They Seek to Correct? What is the Private-Sector Response? Who Can Benefit from Return-Free Systems? What Tax System Changes are Needed to Make Them Work? Are They a Substitute for Tax Simplification? Types of Return-Free Systems Exact Withholding Many taxpayers do not have to file returns; correct tax liability is pre-paid by withholding Examples: United Kingdom, Germany, Japan Tax Agency Reconciliation Tax agency computes final tax liability based on 3rd party data (e.g., W-2s, Form 1099s) Examples in U.S. – Michigan, California test The Problem: Compliance Costs IRS Estimates 26 hours and $157 per return in 2002 But costs are disproportionately borne by those with more complex returns Self-employed taxpayers Form 1040 filers Chart 1 Chart 2 The Response: Computerization Tax Preparation Methods Changing More paid preparer use Dramatic growth in software Over 85% of returns prepared on computers Growth in electronic filing New methods reduce only some costs Taxpayers still incur large costs of record-keeping, gathering materials and tax planning Chart 3 Chart 4 Potential Users of Return-Free Systems: Exact Withholding In lowest tax bracket, wage income only, no itemized deductions, no credits except child credit 17% of taxpayers in 1999 (U.S. Treasury) Extra 10% bracket added in 2001 Administrative changes could raise use to 38% Withholding on other income sources (interest, dividends, pensions and IRAs, unemployment benefits, capital gains distributions by mutual funds) Separate determination of EITC eligibility for non-filers Features of UK Law that Facilitate Exact Withholding Individual filing Only 3 rates; 80% pay basic tax rate Withholding on interest and dividends Exemption of first