The IRS’s Trojan horse

Ryan Young & David Deerson The Competitive Enterprise Institute
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It may be another 10 months before Tax Day rears its ugly head again, but that doesn’t mean that the American people should take their eyes off the IRS and the 70,000-page tax code. IRS Commissioner Doug Shulman’s term is ending soon, and he wants to leave a lasting legacy. In other words, reach for your wallet, because Shulman wants to implement what is called a real-time tax system.

Currently, the IRS can only check tax returns for accuracy after the fact. A real-time tax system would have employers and taxpayers report information to the IRS throughout the year, so the IRS can conduct audits in real time, supposedly to increase compliance.

Besides the obvious privacy concerns and the huge burden of merely complying with the reporting requirements, real-time taxation is a Trojan horse that opens the door to an even worse policy: a return-free tax system.

Shulman has long favored a return-free tax system, under which the IRS would collect information about you and fill out your returns for you, and send you your tax bill. It’s being sold as a way to simplify your taxes. It isn’t, and that’s why return-free legislation has stalled in Congress. So instead, Shulman is now pushing for a real-time tax system, which uses similar technology.

A return-free system would save some taxpayers the trouble of filling out their Form 1040s, but it would leave the tax code untouched. The actual disease of tax code complexity would lie untreated and continue to worsen. And if you want to stay on the right side of the law, you would need to calculate your own taxes anyway, defeating the system’s very purpose!

Worse, the IRS is hardly a model of efficiency, so much of the information it collects will be incomplete, outdated, or both. As a result, taxpayers will find it harder to correct mistakes. In the United Kingdom, where a similar system already exists, the errors made by Her Majesty’s Revenue and Customs Service — and they make a lot of them — are overwhelmingly in the government’s favor.

Return-free taxation is unpopular across the political spectrum. Many progressives and civil libertarians have privacy concerns. The IRS would need to collect a massive amount of personal information in order to run such a system. Many of the agency’s 106,000 employees already make a living by snooping around in taxpayers’ personal lives. A return-free system would only add to their number.

A return-free system is also inherently regressive, which is another concern for progressives. The system only applies to people with simple tax situations, such as those with only one source of income and few or no investments. The IRS would have no incentive to find all the deductions for which these taxpayers qualify, so many low-income people would end up paying higher taxes than they do now.

Return-free would also do nothing to address progressives’ complaints about the tax code’s legions of special deductions and tax credits, which allow large corporations and the rhetorical one percent to reduce their tax bill, thus paying a lower effective rate than everyone else.

Conservatives argue that a return-free system would unduly burden businesses. Collecting all the necessary information and reporting it to the IRS would put enormous strain on human resources departments across the country. Return-free would be especially harsh for small businesses, which lack the accounting departments and economies of scale that larger businesses enjoy. According to Joseph Cordes of George Washington University and Arlene Holen of the Technology Policy Institute, the increased paperwork burden of a return-free system would cost businesses between $500 million and $5 billion per year. Conservatives also worry about the IRS’s increased size and scope under a return-free system.

A return-free tax system is a terrible policy that has little appeal to anybody — except the IRS itself. Progressives see it as an encroachment on privacy; conservatives consider it an assault on economic freedom. They should oppose a real-time tax system with equal vigor. Once the databases and reporting software are in place, it will be easy for the IRS to implement return-free. A better solution for increasing compliance and making it easier for taxpayers to fill out their returns is actually quite simple — simplify the tax code.

Ryan Young is a Fellow in Regulatory Studies at the Competitive Enterprise Institute. David Deerson is a Research Associate at CEI.