A Backdoor Tax on the Poor

A Backdoor Tax on the Poor

November 08, 2011
Originally published in The Hill

The IRS wants poor people to pay higher taxes. And it has figured out a way to do so without a rate increase. It is called a return-free system. Instead of completing your 1040 form yourself, the IRS would fill it out for you. All you have to do is cut a check. Congress is currently considering a bill to create such a system: H.R. 1069, sponsored by Rep. Jim Cooper (D-Tenn.).

Return-free taxes sound quite convenient. After all, the average American spends 26 hours filling out tax forms every year—over half a workweek. But there is a catch — a lot of them, actually. One is that the IRS would have to collect a lot more information about you than it already does. This requirement would exasperate already overburdened human resources departments across the country, which will need to collect, organize and report much more information than they already do.

Joseph Cordes of George Washington University and Arlene Holen of the Technology Policy Institute estimate that the increased paperwork burden of a return-free system would cost businesses at least $500 million, and possibly as much as $5 billion.

Another issue is that the IRS will miss out on a lot of possible deductions. Most people in the return-free program — as many as 40 million taxpayers, if the program is fully implemented — will pay more taxes. People marry, divorce, have kids, pay tuition, buy homes and sell them — the list goes on. The IRS couldn’t possibly keep up with 40 million life stories, no matter how hard it tries. In fact, it has an incentive to minimize individual deductions. That way it gets more revenue.

The result is that most people participating in a return-free program will pay more in taxes. That is exactly the case in the U.K., which uses a return-free system. The government has a 15 percent error rate, overwhelmingly in the government’s favor. In 2009, British taxpayers were overcharged the equivalent of $370 million. Those lucky enough to underpay still didn’t get a good deal. They are held liable for the government’s mistakes. Today, 1.4 million people are on the hook for an average of $2,200 each — a month’s pay for many people.

There is another issue that should especially concern progressives: The poor would pay more. Return-free is only feasible for people with simple tax situations, such as one source of income and few or no investments. That means that the people who would find themselves paying more would be the ones least able to afford it. Return-free is a backdoor, regressive tax increase.

When a proposal has three strikes against it, it should be out. But the IRS is pushing hard for this system. Every agency wants to increase its size, scope and budget. The IRS is no exception. The proposal is already prompting rent seeking. Government contractors that would make millions by designing the system are pushing for a return-free income tax. They could easily milk the system by intentionally designing sub-par software. That would ensure regular service calls to fix bugs and reduce error rates.

So that makes four strikes.

In fact, make it five. Privacy advocates should be up in arms about return-free proposals. The IRS already has 106,000 employees. Many of them earn their bread by investigating taxpayers’ personal lives. There is no need for them to deputize human resources departments across America. Seen in that light, return-free is inherently creepy.

The bill from Rep. Cooper should be withdrawn as quickly as possible. Better yet would be passage of Rep. Sam Johnson’s (R-Texas) H.R. 2528, which would nip return-free in the bud. Congress should learn from the lackluster international results with return-free. Closer to home,

California’s return-free experiment has been a complete failure, one that over 90 percent of Golden State taxpayers refuse to use.

A return-free tax system has something for everyone to hate. Progressives should be up in arms over its disproportionately hurting the poor. So should privacy advocates; the IRS does quite enough snooping as it is. And conservatives should oppose return-free because, even though tax rates would remain unchanged, it is still a tax increase.

There are much better ways to reduce the 26-hour burden Americans face every year. The obvious solution is to simplify the 70,000-page tax code.

NOTE: In an earlier version of this piece, H.R. 2569, a bill co-sponsored by Reps. Peter Roskam (R-Ill.) and Ron Kind (D-Wis.), is mentioned as also backing a return-free tax system. That is incorrect. H.R. 2569 would make the popular Free File program permanent and would block the IRS from duplicating or replicating private tax-prep services.