The highs of large refunds and the lows of burdensome tax filing are only amplified for low-income tax filers. I’ve seen this phenomenon firsthand as a volunteer in a nationwide effort, the Volunteer Income Tax Assistance program. Through this program, tax filers who make less than $54,000 can access free tax preparation services. My volunteer experience was quite rewarding: Through very little effort of my own, I was able to hand over thousands of dollars in sorely needed tax refunds. The clients were keenly aware of the value of unlocking their refunds, and in many cases, they had already planned how the money would be spent. They were often very disappointed if the refund amount turned out to be lower than expected.
There are a number of reasons low-income households receive such large income tax refunds. A major factor is that in the United States, we channel most of our income support for low-income households through the tax code, in the form of refundable credits like the earned income tax credit and the additional child tax credit. That means an income tax refund can be the single-largest payment of the year for many tax filers in this group — and it often helps families make a down payment on a car or new apartment, pay off existing bills and debt, or purchase healthier foods.
Likewise, the hurdles standing in the way of receiving a refund are particularly steep for poorer households. Inspired by my time as a tax preparer, I now teach a course at the University of Chicago’s Harris School of Public Policy where students spend half the course learning about inequality and tax policy. During the other half of the course, the students serve as volunteer tax preparers with a local nonprofit, the Center for Economic Progress. My students observe many barriers facing these tax filers.
First, the free tax preparation services offered at Volunteer Income Tax Assistance sites can only accommodate so many. Relying mainly on volunteer labor, these sites typically serve less than 4 percent of all filers earning less than $50,000, and no more than 2 percent of all filers. In many cases, the volunteer centers can find themselves with packed waiting rooms and long wait times. Despite the free service, taking off a few hours in the evening to meet with a volunteer tax assistant represents a costly sacrifice for a single-earner household with multiple children, the most common type of filer to visit the sites.
For those who are not able to take advantage of free preparation services, there are for-profit tax preparers. Although these companies do offer free online preparation for lower-income filers, there are plenty of opportunities for upselling customers who need hands-on assistance. While the “big box” commercial tax preparers offer high-quality products, the industry is largely unregulated, featuring just as many “mom and pop” tax shops that have much less savory reputations and are plagued by relatively high error rates. By the time the fees are tallied, low income tax filers lose a good portion of their refunds and leave themselves exposed to excess risk in the event of an audit.
Finally, the Protecting Americans from Tax Hikes Act of 2015 included special provisions for tax filers who receive refundable tax credits. These tax filers must undergo an additional delay of some weeks in receiving their income tax refund so the IRS can conduct additional fraud checks. While it is true that credits like the earned income tax credit can be prone to filing errors, this is in part due to the complexity of figuring out whether filers are eligible for it. This recent development is likely to steer taxpayers toward for-profit tax preparers, who offer refund anticipation loans that allow a taxpayer to receive cash before the tax return is processed.
A simpler system could benefit tax filers across many income levels, not just low-income families. For any taxpayers who take the simple, standard deduction, the IRS actually doesn’t need any additional information beyond the income data it already receives automatically from employers and banks. Prefilled tax returns are already the norm in many countries, including Great Britain, Finland and Sweden, and the approach has also been piloted in California with the state income tax. In California, the pilot was met with overwhelmingly positive feedback by taxpayers.
The total savings to all Americans could be enormous — U.S. taxpayers spend nearly 7.6 billion hours preparing their tax returns and additional fees on lawyers and tax preparers. In all it costs us somewhere between $140 billion and $215 billion per year in time and money to file taxes. Prefilled tax returns also are likely to involve fewer errors than self-prepared returns, recouping more of the “tax gap” — the difference between the amount of taxes owed by taxpayers and what the IRS actually collects every year.
It’s true that this simpler approach would not work for everyone, as some taxpayers have complex deductions and liabilities. But with the recent Tax Cuts and Jobs Act making it more likely that middle-income filers will claim the standard deduction, more and more people stand to benefit from a prefilled tax return.
Politicians often claim that tax simplification is a universally held goal of tax revisions. Why not take this very feasible and very concrete step in that direction?