Thx to Forbes:
It’s Tax Day, and many of you are probably rushing to complete your returns before the filing deadline. At Slate, Matt Yglesias points out that this process doesn’t have to be so difficult. The IRS has much of the information they need to fill out your tax return, so why don’t they just send you a partly or fully completed return for your review? Indeed, such a system has been proposed federally and adopted in at least one state (in California, it’s called ReadyReturn) but Congress has refused to move forward.
Yglesias focuses on a public choice problem—tax filers are made a little bit better off by this policy, but tax preparers are made a lot worse off, so they lobby to block ReadyReturn and similar programs. He also notes that some conservatives oppose pre-filled returns on the grounds that they might reduce public opposition to income taxes.
But I have a separate concern about ReadyReturn—what if it undermines tax compliance?
The key feature of the income tax that encourages compliance is two-party reporting. You send the IRS a Form 1040, and the people who paid you during the year send Forms 1099, W-2 and the like. If you lie about your income, the figures reported by your employers and clients will expose you.
But what if, when filing your return, you already know that one of your clients has failed to report what he paid you? In a ReadyReturn system, the government has to lay its cards on the table—before the taxpayer files, he knows exactly what the government knows about his earnings, and what it doesn’t know.
Today, if a taxpayer doesn’t get a 1099 form that he’s expecting, he probably asks his client where it is—he doesn’t want the IRS to get a copy of a form that he doesn’t have. But with the knowledge that the IRS never got a copy, either, he might just go ahead and underreport his income. An “oopsie” defense would likely work just fine for omitted 1099s that later came to light, so long as they did not amount to a substantial underreporting of income (that is, 10 percent or $5,000, whichever is less). After all, you didn’t prepare your taxes—the IRS did.
It’s a lot like when you check out of a hotel and review your bill. If you notice the hotel charged you for an extra night of parking, you’ll complain and get the charge taken off. But let’s say you notice that they’ve accidentally omitted to charge you for one night of parking. Do you call the clerk’s attention and ask for a parking charge to be added? Be honest.
Maybe this wouldn’t be that big a problem because there aren’t that many payer-side reporting errors. Or maybe the reduction in tax compliance costs from ReadyReturn would outweigh any increase in tax evasion. But I do worry that ReadyReturn would, at least to some degree, undermine the advantages of two-party reporting and increase the tax gap.