[Senate Hearing 106-541]
[From the U.S. Government Publishing Office]
S. Hrg. 106-541
INTERNAL REVENUE SERVICE PROGRESS ON INITIATIVES RELATING TO PAPERLESS
FILING, AND THE FEASIBILITY OF IMPLEMENTING A RETURN-FREE SYSTEM FOR
APPROPRIATE TAXPAYERS
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HEARING
before a
SUBCOMMITTEE OF THE
COMMITTEE ON APPROPRIATIONS
UNITED STATES SENATE
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
SPECIAL HEARING
__________
Printed for the use of the Committee on Appropriations
Available via the World Wide Web: http://www.access.gpo.gov/congress/
senate
______
U.S. GOVERNMENT PRINTING OFFICE
63-948 CC WASHINGTON : 2000
_______________________________________________________________________
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC
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ISBN 0-16-060829-5
COMMITTEE ON APPROPRIATIONS
TED STEVENS, Alaska, Chairman
THAD COCHRAN, Mississippi ROBERT C. BYRD, West Virginia
ARLEN SPECTER, Pennsylvania DANIEL K. INOUYE, Hawaii
PETE V. DOMENICI, New Mexico ERNEST F. HOLLINGS, South Carolina
CHRISTOPHER S. BOND, Missouri PATRICK J. LEAHY, Vermont
SLADE GORTON, Washington FRANK R. LAUTENBERG, New Jersey
MITCH McCONNELL, Kentucky TOM HARKIN, Iowa
CONRAD BURNS, Montana BARBARA A. MIKULSKI, Maryland
RICHARD C. SHELBY, Alabama HARRY REID, Nevada
JUDD GREGG, New Hampshire HERB KOHL, Wisconsin
ROBERT F. BENNETT, Utah PATTY MURRAY, Washington
BEN NIGHTHORSE CAMPBELL, Colorado BYRON L. DORGAN, North Dakota
LARRY CRAIG, Idaho DIANNE FEINSTEIN, California
KAY BAILEY HUTCHISON, Texas RICHARD J. DURBIN, Illinois
JON KYL, Arizona
Steven J. Cortese, Staff Director
Lisa Sutherland, Deputy Staff Director
James H. English, Minority Staff Director
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Subcommittee on Treasury and General Government
BEN NIGHTHORSE CAMPBELL, Colorado, Chairman
RICHARD C. SHELBY, Alabama BYRON L. DORGAN, North Dakota
JON KYL, Arizona BARBARA A. MIKULSKI, Maryland
TED STEVENS, Alaska ROBERT C. BYRD, West Virginia
(ex officio) (ex officio)
Professional Staff
Patricia A. Raymond
Tammy Perrin
Lula Edwards
Chip Walgren (Minority)
Administrative Support
Elizabeth Blevins (Minority)
deg.C O N T E N T S
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Page
Statement of Senator Campbell.................................... 1
Statement of Senator Dorgan...................................... 2
Simplicity and paperless tax filing.............................. 3
Statement of Charles O. Rossotti, Commissioner, Internal Revenue
Service, Department of the Treasury............................ 4
Issues in paperless filing....................................... 5
Compliance issues................................................ 6
Prepared statement of Charles O. Rossotti........................ 6
Strategies to reduce taxpayer burden............................. 6
Return-free filing............................................... 8
Previous studies and reports..................................... 9
Year 2000 study and beyond....................................... 10
FASST proposal................................................... 10
Statement of Senator Kyl......................................... 11
Prepared statement of Senator Jon Kyl............................ 11
Impact of paperless filing....................................... 12
Statement of Leonard Burman, Deputy Assistant Secretary of
Treasury for Tax Analysis, Internal Revenue Service, Department
of the Treasury................................................ 13
The British system of paperless filing........................... 14
Withholding and paperless filing................................. 15
Administration of paperless filing............................... 16
Prepared statement of Leonard E. Burman.......................... 17
Current law filing requirements.................................. 18
Types of return-free systems..................................... 19
Administrative issues in shifting to a return-free tax system.... 20
Administration proposals to reduce compliance burdens............ 22
IRS computers and paperless filing............................... 22
Complexity of tax administration................................. 24
IRS responsibilities with paperless filing....................... 25
Louisiana and Michigan paperless filing pilots................... 25
Advantages of Senator Dorgan's plan.............................. 26
Changes to the alternative minimum tax........................... 27
Complexity of the Tax Code....................................... 28
Additional committee questions..............................28
(iii) deg.
INTERNAL REVENUE SERVICE PROGRESS ON INITIATIVES RELATING TO PAPERLESS
FILING, AND THE FEASIBILITY OF IMPLEMENTING A RETURN-FREE SYSTEM FOR
APPROPRIATE TAXPAYERS
----------
THURSDAY, APRIL 13, 2000
U.S. Senate,
Subcommittee on Treasury and
General Government,
Committee on Appropriations,
Washington, DC.
The subcommittee met at 2:51 p.m., in room SD-192, Dirksen
Senate Office Building, Hon. Ben Nighthorse Campbell (chairman)
presiding.
Present: Senators Campbell, Kyl, and Dorgan.
statement of senator campbell
Senator Campbell. The hearing will come to order. Thank
you, Mr. Rossotti, for having patience with us.
Around here, a lot of times when we are the busiest, that
is when the votes occur, and there were three in a row. Senator
Dorgan will be over in just a moment. Oh, he is here, he must
have been running right behind me.
Today we will be talking about ongoing efforts at the IRS
to move to paperless income tax filing. This is a particularly
timely topic. Monday, April 17 will be a busy day and night at
local post offices.
The IRS Restructuring and Reform Act of 1998 set an
aggressive goal for the IRS. By 2003, all tax returns prepared
electronically will also be filed electronically. Electronic
filing saves the IRS time and money and increases the accuracy
of its returns. Taxpayers will also benefit. They get their
refunds faster and fewer mistakes are made.
This afternoon we hope to learn what the IRS is doing and
plans to do to reach that goal. We also hope to learn more
about other ideas to save the Federal Government some money, as
well as relieve some taxpayers of the burden of even preparing
tax returns.
Senator Dorgan has mentioned some of his ideas during other
subcommittee meetings, and is much better versed than I, having
in his prior life a great deal of experience with the IRS, as
you know, Mr. Commissioner. He has also mentioned this on the
floor, too.
I look forward to hearing the testimony. I have a couple of
questions, and I also have a personal problem that I would like
to bring to your attention, but I will do that during
questioning.
Senator Dorgan, do you have an opening statement?
Did I hear that we are going to have another vote at 4:00,
was it?
Senator Dorgan. It will not be 4:00. There is up to 4 hours
of debate. They think it will not take 4 hours, but it is the
budget resolution.
Senator Campbell. I do not know your schedule, but we will
try to get through this as timely as we can.
statement of senator dorgan
Senator Dorgan. Let me also thank our witnesses for their
indulgence. The votes occurring in the Senate are not always
occurring on a timely basis, and so I appreciate your being
here.
Mr. Chairman, I appreciate your scheduling with me this
hearing to review the progress of the Internal Revenue Service
and the Treasury Department to make tax day a paper-free for a
lot of citizens in this country. I want to thank Mr. Rossotti
for being here, the Commissioner, and also Assistant Secretary
Burman for his attendance and participation.
On Monday it is filing deadline for income taxes in this
country. I think many Americans in this country welcome the
opportunity not to have to search for receipts, not to have to
find a line to wait in at the post office on Monday night to
try to get a midnight postmark on their tax return. Many
Americans would be surprised to learn that over 30 countries
that have income taxes have some form of a form-free filing
system, in which you can actually meet your obligation in the
income tax system without filing a tax return. We do not do
that in this country, but in some 30 countries they do.
I have been working on a proposal and, as you know, the
Congress has directed the Treasury and IRS to work on this and
meet certain goals. It is very easy, I know, to pick proposals
apart and much more difficult to construct them. But the
purpose for putting together a proposal that I have developed,
and will be introducing with my colleague Judd Gregg from New
Hampshire and Dick Durbin from Illinois as co-sponsors, and I
hope others, is to see if we cannot simplify the filing
requirement for millions of Americans.
My proposition is very simple. I will just do it in about 3
or 4 minutes, at the most.
It is called the FASST Plan, the Fair and Simple Shortcut
Tax Plan. It would allow up to 70 million Americans, I believe,
to complete their obligations under the income tax system
without actually having to file an income tax return.
How would they do that? They would, if they are eligible,
and they would have to determine whether they are eligible.
Individuals under $50,000 in income or couples with married
filing jointly under $100,000 in income, would be eligible.
They would make an election. Do I want to elect to file under
this plan?
The plan would allow them to file a W-4 form with their
employer that is slightly modified and will take account of
several additional things, such as home ownership. The
withholding table that will come from their income, related to
what they have chosen on their W-4, will be an exact
withholding that will represent their exact tax liability and
they will not have to file a tax return.
Is this too good to be true? Not at all. We can decide to
do this as a country. It is not too difficult.
Not everyone's income fits into this circumstances. Some
have very complicated income sets, they do not fit. Some earn
substantial amounts of other income, non-salary income, they do
not fit.
But if you are under $50,000 single or $100,000 married
filing jointly, and have less than $5,000 of other income from
capital gains and interest income, you would fit and you could
elect to decide I am not going to file a paper return anymore.
My withholding at work will be my exact tax liability.
No more receipts, no more forms, no more waiting in lines
at the post office. This is simplicity as it should be, and
there is no other proposal I know of in Congress that would
really simplify it. Virtually everything we do around here
makes the tax system more complicated.
simplicity and paperless tax filing
I have spent a number of years as a State tax
administrator, I have worked on tax issues for a long, long
time. And I decided a while ago that instead of just talking
about simplicity, we ought to do something that will really
ease the burden for millions of Americans.
My proposal, I believe, will allow about 70 million people
to elect to do this if they choose. That would be a significant
step forward.
Several advantages are a, for the de minimis income, there
is no tax burden. That tends to encourage savings and
investment. It is a terrific thing to do. We would flatten out
the bottom rate so that under $100,000 married filing jointly
or $50,000 single they are all paying the same flat bottom
rate. That extends that bottom rate. I think that is a good
thing to do.
We eliminate the paper, eliminate audits effectively,
assuming there is no fraud. And it is not burdensome for the
businesses that are required to house the W-4s and report them
to the IRS.
I have a whole series of charts but I think, to be
merciful, I will not go through the charts and we will take the
testimony. Then I have some questions and perhaps, as I go
through the questions, I can go through just a couple of these
charts.
But this is a very simple concept. The Congress has
signaled to Treasury and the IRS, I was part of sending that
signal, as was my colleague, Senator Campbell, to say we want
to move in this direction. The question is not whether, the
question is how. And we want you to help us do that.
This is but one plan. There may be others and better plans,
but it is the only plan I know of that would provide real tax
simplification here in the U.S. Senate. This hearing is a first
step to evaluate how we do this.
Why does the Appropriations Committee have a stake in this?
Because you spend a lot of money processing paper. We spend
money allowing you to hire warehouses to put all this paper in.
The fact is, we can eliminate a substantial amount of this
paper for millions and millions of Americans, and we ought to
move in that direction with a simplified income tax system.
Mr. Chairman, thank you. I am anxious to hear the testimony
from both of our witnesses.
STATEMENT OF CHARLES O. ROSSOTTI, COMMISSIONER,
INTERNAL REVENUE SERVICE, DEPARTMENT OF THE
TREASURY
Senator Campbell. Please proceed, Mr. Rossotti.
Mr. Rossotti. Thank you very much.
Before I start, I just wanted to wish the chairman a happy
birthday. I heard on the radio this morning that it was your
birthday, Mr. Chairman. I hope it was a correct report.
Senator Campbell. That is what the elevator operator tells
me. I do not keep track myself.
Senator Dorgan. It is your birthday today?
Senator Campbell. Yes.
Senator Dorgan. Happy birthday.
Senator Campbell. Happy anniversary.
Senator Dorgan. It is my 15th anniversary.
Mr. Rossotti. I am glad that that was an accurate report.
Senator Campbell. It was an accurate report, so they tell
me.
Mr. Rossotti. I would be embarrassed if it was not.
Senator Campbell. We were so poor when we were kids, I was
in an orphanage when I was a little guy. We did not celebrate
any special days. I guess I grew up without even thinking about
it. Unless somebody tells me, it just goes right on by.
Sometimes they have to tell me how old I am, as well as it is
my birthday.
Mr. Rossotti. I am very pleased to be here to talk about
return-free filing. Of course, I do want to stress to all
taxpayers as we approach the deadline, that we already have
some important improvements in place that can help taxpayers do
electronic filing. I just wanted to note that it looks like we
are going to be up about 17 percent this filing season,
electronic filing. It will be close to 35 million returns. So
we have made some headway in that regard.
But going beyond that, and looking longer term, we do note
that the restructure format says that the Secretary of the
Treasury will develop procedures to implement a return-free
filing system for appropriate individuals by 2007 and we are
required to make reports beginning this year to the tax-writing
committees on the progress in this regard.
We have started on that work. The first report will be due
later this year and we will, at that point, focus on reviewing
past studies and looking at, in particular, taxpayer attitudes.
Because we want to make sure that if we design something it is
what taxpayers actually want.
I will just give you a little interim report here that we
have completed preliminary analysis of some of our work on
taxpayer attitudes with some focus groups. Interestingly, the
preliminary returns here show that taxpayers this time seem to
have a more positive attitude about this idea than they did the
last time it was studied some years ago, which was fairly
negative actually. I guess that reflected the idea that somehow
people did not trust the IRS to somehow prepare their tax
return.
This time, at least so far, we have gotten about an equal
split between those that are favorable and those that are less
favorable. It is not a statistically valid sample yet, but this
is at least a preliminary indication that there is a more
positive point of view on the part of the public towards this
idea.
We have also had an opportunity to briefly review the draft
legislation written by Senator Dorgan. We have had an
opportunity briefly to chat about it. I think it is
unquestionable that this bill provides some important
simplification proposals and possibilities for making things
easier for taxpayers. It does raise some administrative issues
and I just want to stress, as I said to the Senator, we would
welcome the opportunity to work with you to review these issues
and get your input and try to figure out how we could solve
these problems as part of our overall requirement under RRA to
study return-free filing.
issues in paperless filing
I will just mention briefly what I consider the three sorts
of categories of issues that we have to deal with as we move
forward on this proposal. One is just to define the content of
the election certificate or the document that the taxpayer
would file with the employer, which would allow then the
employer to calculate the exact amount of tax. There are some
issues here. For example, we would have to decide how
taxpayers, whether they would provide some of the data on
Social Security numbers and other information that is now
required for dependents and for determining who is a qualified
child under the EIC program.
We also have to discuss how to handle certain kinds of
employment and filing scenarios, such as when employees have
more than one employer during the year, married filing joint
filers where both spouses are working, and taxpayers who
divorce or separate during the year. Those are some issues we
would have to deal with in that area.
Another area is to define a little bit about the process
that we would need to verify in some form the amounts that were
withheld by the employer and what to do with the certificates
or other documents, whatever they would be, that would be filed
by the employer with the employees during the year.
Currently the IRS does not receive W-4 forms. They are just
held by the employer. So we would have to determine when and
how these documents might be sent to the IRS and whether we
would process them when we did.
Of course, one of the issues that I think we talked about
with the Senator is if the taxpayer did have a balance due or a
refund after we did the verification, even though it would be
the expectation that the withholding would be the exact amount,
in the exception cases we would have to determine when we dealt
with those.
Right now, because of when we receive the information from
the Social Security Administration and the employers, we would
not be able to do that until around October or November. We
would have to make sure that was acceptable to the taxpayers.
compliance issues
Finally, there are some compliance issues that we would
have to study, such as the issue of what to do about one of the
more common situations that arise, where the taxpayers submit
certain data on either dependents or qualifying children or
other people that are qualifying for certain credits. This is
one of the more common errors that occur and we currently
verify a lot of these things during the return processing
process and get back to the taxpayer to make corrections. So we
would have to determine how we would do that sort of
verification.
So I just wanted to briefly mention, those are kind of the
general categories of issues. I am not suggesting that any of
these cannot be solved, but they would require some work, I
think, to work with the committee and other parties to resolve
them.
So just to conclude, I want to stress that we in the IRS, I
think, view it as one of our major missions in life to figure
out how to reduce taxpayer burden using whatever tools and
resources we have. We are already doing some things in that
regard, I think, effectively with respect to electronic filing
and making that easier and more accessible. And now following
the direction of Congress in the Restructuring Act, with the
assistance of this committee, we will continue to work on this
return-free concept using whatever research we have and the
inputs of Senator Dorgan and others to try to come up with the
best solution possible.
Thank you.
[The statement follows:]
Prepared Statement of Charles O. Rossotti
introduction
Mr. Chairman and distinguished Members of the Subcommittee, I am
pleased to testify today on return-free tax filing, specifically as it
relates to the Internal Revenue Service's mandate under the IRS
Restructuring and Reform Act of 1998 (RRA 98), and within the broader
context of easing taxpayer burden and improving tax administration.
As we approach this year's April 17th filing deadline, let me
reemphasize the IRS' commitment to reducing taxpayer burden and
providing taxpayers top quality service. Although we have taken some
important first steps, the IRS still does not meet the legitimate
service expectations of America's taxpayers. We must take advantage of
new technologies and best business practices to improve service and
reduce the broad spectrum of taxpayer burden--not just when taxpayers
file their returns, but throughout the year.
strategies to reduce taxpayer burden
Interacting with taxpayers is a three-part process: (1) Pre-
filing--services provided to a taxpayer before the return is filed to
assist in filing a correct return; (2) Filing--services provided to a
taxpayer in the process of filing returns and paying taxes; and (3)
Post-filing--services provided to a taxpayer after a return is filed,
such as to identify and correct possible errors or overpayments and
underpayments.
One of the overriding themes of the IRS modernization plan is
shifting from addressing taxpayer problems well after returns are filed
to addressing them earlier in the process. Indeed, we want to prevent
problems wherever possible throughout the filing process, which gives
us some enormous opportunities to reduce taxpayer burden. Let me
briefly discuss four areas in the pre-filing and filing processes where
we can make improvement.
First, the IRS communicates with millions of taxpayers each year
through multiple channels: mail, telephone, Internet and in-person.
These communications range from tax forms and publications describing
how to file, to phone calls setting up installment agreements, to in-
person meetings to resolve longstanding issues and disputes.
From the taxpayer's point of view, the quality of these
communications has been well below expectations. Enhancing the
convenience and quality of our communications with taxpayers, and
thereby reducing taxpayer burden, is a critical component of our
modernization plan.
In the past two years, we have made some significant progress on
the communications front, including expanding the hours of phone
service during filing season to 24 hours a day, seven days a week,
providing Saturday hours at more than 275 walk-in sites throughout the
country, and rewriting some notices and forms to make them easier to
understand and use.
The IRS web site (the ``Digital Daily'') has also proved to be a
very successful, convenient and popular communications tool, providing
immediate access to all forms and publications, as well as answers to
many tax questions. In 1999, the Digital Daily had over 767 million
``hits'' during which taxpayers downloaded more than 57 million forms
and publications.
Our long-term goal is more ambitious. We must organize
communications so that taxpayers can get accurate and prompt
information and correct resolution of issues in a time and manner most
convenient for them. Given the scale and complexity of our operations,
this is a multi-year task requiring fundamental change in all aspects
of IRS' operations, including organization and management, training of
front-line personnel, internal and external distribution of
information, information technology and performance measurements.
Second, one of the keys to easing taxpayer burden, particularly in
filing, is expanding the use of electronic tax administration.
Electronically-filed returns improve service for taxpayers and boost
productivity by reducing errors, speeding refunds and reducing labor
costs. Although electronic filing has been increasing rapidly, 77
percent of returns are still filed on paper.
Reaching the RRA 98-mandated goal of 80 percent electronically-
filed returns will require many improvements within the IRS. An
effective and efficient electronic filing system depends on replacing
IRS' archaic technology and implementing new business practices. These
improvements include: enhanced technology to allow filing of a full
range of returns and schedules; resolution of security issues to
eliminate requirements for separate signature documents; tailoring of
marketing and education programs to attract taxpayers and practitioners
with varying needs; and broadening the number of effective payment
options in conjunction with filing.
The opportunities to improve business practices through electronic
communications with customers and practitioners go far beyond the
filing of returns. As previously discussed, customer education and
assistance programs through the IRS web site, such as distribution of
forms and publications and answers to tax law questions, are growing
rapidly. Eventually, secure communication over the Internet with
practitioners and taxpayers will be used to resolve taxpayer account
issues, facilitating resolution of examinations, providing taxpayers
authorized transcripts of their accounts and generally improving the
timeliness and quality of the full range of IRS interactions with
taxpayers.
Third, we can also help reduce taxpayer-filing burden by leveraging
IRS resources through effective partnerships. There are many
organizations and groups that are actively involved in tax
administration and interact regularly with taxpayers. For example, the
Electronic Tax Administration Advisory Committee (ETAAC) serves as a
public sounding board for our electronic filing programs. Historically,
the IRS has worked with many of these organizations to share
information about IRS programs and taxpayer concerns and, in the case
of states, to exchange information for compliance purposes.
In the future, the IRS must place a far greater emphasis on forming
partnerships with all of these groups to reach solutions on taxpayer
issues, and especially to improve taxpayer education and assistance.
Many of these organizations have established communications channels
with millions of taxpayers and are enthusiastic about working with the
IRS to help their members avoid tax problems and relieve their burden.
A large number of taxpayers are also more likely to listen to and trust
information that comes from organizations with which they deal on a
regular basis, rather than directly from the IRS.
We also want to energize our volunteer return preparation programs,
such as Volunteer Income Tax Assistance (VITA) and Tax Counseling for
the Elderly (TCE), and co-locate these activities at our Taxpayer
Assistance Centers. This will not only help taxpayers with the filing
process, but it will allow the IRS to focus on simple account and
collection issues.
Furthermore, we have opened up VITA and TCE offices in locations
that are close to our assistance centers and offices observing EITC
Awareness Days, providing an additional avenue of support to taxpayers
visiting an IRS office for EITC assistance.
In addition to this type of volunteer assistance, our outreach
program targeted expanding EITC education and assistance. We identified
EITC coordinators in our offices who are responsible for the full
complement of EITC outreach activities. While no data is available yet
for fiscal year 2000, this program reached 174,067 EITC taxpayers
during fiscal year 1999 through social workers, community
organizations, homeless shelters and faith-based organizations.
Our challenge for the 2000 filing season was to provide volunteers
with the necessary tools to assist taxpayers. To this end we loaned
5,300 computers and 3,400 printers and provided software (TAXWISE) to
volunteer sites. We are also identifying communities that would benefit
from EITC programs and recruiting volunteers through the Internet.
The states offer special opportunities for using resources and
improving service to taxpayers. Since most taxpayers deal with at least
one state as well as the IRS, there is a great deal of overlapping
information, providing significant opportunities for reducing taxpayer
burden.
For example, last year, the IRS and the Montana Department of
Revenue tested a Simplified Tax and Wage Reporting System (STAWRS)
where Montana employers were able to take advantage of combined Federal
and State filing. STAWRS reduced taxpayer burden on small businesses by
combining into one tax return the information contained in the IRS
employment tax return (Form 941), the Montana withholding return and
the Montana unemployment insurance return. State government partnership
programs will enable us to meet our joint mission as tax administrators
to reduce employer burden while improving the efficiency and
effectiveness of government operations.
Fourth, just as companies develop particular products and marketing
programs to reach customers with differing needs, so must the IRS
tailor practices and strategies based on specific taxpayer needs and
problems.
Tailoring IRS services to particular groups of taxpayers is a
cornerstone of how we can dramatically improve our service to
taxpayers, and reduce burden, as well as increase productivity within
the organization. Virtually all IRS services can be improved using this
principle. Pre-filing assistance programs, such as customer education,
telephone and Internet assistance and publications and form design, all
represent obvious opportunities for clearer and more effective
communications.
Filing-related programs, such as electronic filing, telephone
account assistance and notices also need to be tailored to suit the
needs of individual, small business and large business taxpayers.
Return-free tax filing would fall into this category especially as we
determine ``the appropriate individuals'' best suited to use such a
program.
In addition, post-filing compliance programs offer major
opportunities to allocate resources more effectively based on knowledge
of specific issues affecting taxpayers in particular industries or
business situations. In turn, the post-filing knowledge gained from
working with taxpayers in examination and collection can be used to
develop improved guidance and education programs to prevent future
problems, thus reinforcing the problem prevention strategy.
Understanding taxpayer problems and needs, and tailoring and
improving programs to meet these needs, is so fundamental to meeting
IRS' strategic goals that it must be a key organizing principle for the
way the IRS is managed.
return-free filing
Section 2004(a) of RRA 98 states that the Secretary of the Treasury
or the Secretary's delegate shall develop procedures for the
implementation of a return-free tax system for appropriate individuals
for taxable years beginning after 2007. The Secretary is also required
to make the first report on the development of the return-free tax
system to the tax-writing committees by June 30, 2000. The report will
include the following information:
--What additional resources the IRS would need to implement such a
system;
--The changes to the Internal Revenue Code of 1986 that could enhance
the use of such a system;
--The procedures developed;
--The number and classes of taxpayers that would be permitted to use
the procedures.
Also, the first report will review prior studies that were
conducted to determine the feasibility of a return-free tax system and
to discuss the concerns and issues that were raised.
previous studies and reports
The return-free tax system concept has been a topic of discussion
in this country for the past 20 years. There have been various studies
and reports issued concerning this system; notably two General
Accounting Office (GAO) reports issued in October 1996 and May 1992, as
well as IRS studies dating back to 1984. I would like to briefly
discuss the IRS reports.
Final Report on Implementing a Return-Free Tax System (September 1985)
This first report identified a number of key issues relating to
return free filing that would also be raised in future studies, e.g.
timeliness of refunds, change in filing date of information returns,
resource implications, and the link between Federal and State tax
systems.
The report concluded that a return-free tax system would indeed be
revolutionary and the ramifications would extend to legal,
administrative and taxpayer behavioral issues. It was believed that the
system would require acceleration of processing, which in the long run,
would permit quicker and better enforcement action and would strengthen
compliance. The major concern was that the success of such a system
would greatly depend on basic elements such as public opinion and
acceptance, and the quality of information reporting.
IRS Feasibility Study (October 1987)
The IRS considered the Return-Free Tax System concept during the
drafting of the Tax Reform Act of 1986. As noted, the concept had been
a topic of discussion at IRS for several years and a task force
developed a detailed design of such a system in 1984; another task
force followed up with a detailed cost estimate for the aforementioned
1985 report. The two reports were used as the basis for the 1987
Feasibility Study.
The system described in the 1987 report assumed eligible taxpayers
would elect to allow the IRS to prepare their returns and compute any
liability using information provided to IRS by employers and payors. In
order to participate, taxpayers would have to return a postcard to IRS
containing their filing status, Social Security number, whether they
were dependents on someone else's return and certifications of their
eligibility. The taxpayer-supplied information would be matched with
the employer/payor information and a return would be generated based on
this information. Either a refund or a balance due notice would be
issued.
The study concluded that the Return-Free Tax System was not
feasible at the time. The key issues identified included:
--Timing of information return processing would delay refund
generation;
--Accuracy of information returns was a concern;
--Participants would not receive their IRS prepared tax returns in
time to file their state returns;
--Additional costs could be incurred by the IRS.
Moreover, at that time, the IRS was in the process of expanding its
electronic filing program. Electronic filing was viewed as the best way
to reduce costs as well as to speed up the existing filing of
individual returns, most notably the time it would take to get refunds.
IRS Value Tracking Focus Group (1993)
The IRS conducted 20 focus group sessions with individual and small
business taxpayers to explore their perceptions about the Agency and
the services it provided, as well as new services being considered at
the time, including alternative filing methods. One of the alternative
filing methods discussed by the participants was return-free tax
filing. It should be noted, however, that during the focus group
testing, taxpayers were asked only how they would feel about the IRS
preparing their returns based upon information received by the IRS from
third parties. Taxpayer reaction was extremely negative, based in part
on a general distrust of the IRS. A few of the issues the taxpayers
cited were:
--A lack of trust in the IRS' ability to prepare their taxes
accurately;
--Dissatisfaction with receiving tax refunds later in the year; and
--The feeling of giving complete control to the IRS.
Very few participants supported the return-free concept as
presented to them. They believed that its greatest advantage was
reducing taxpayer burden when preparing returns. However, even those
supporting the method emphasized the importance of being able to
challenge the IRS' assessment if they disagreed with it, or if their
tax situation changed.
year 2000 study and beyond
Mr. Chairman, the IRS recently completed an attitudinal study on
return-free filing. It consisted of four focus groups in New York City,
Ft. Lauderdale, Dallas and Los Angeles. This ``qualitative'' phase was
undertaken to evaluate taxpayer reaction to the concept of a return-
free tax filing system, and particularly, if taxpayer perceptions had
changed since the 1993 focus groups conducted by the IRS. We will apply
what we learn from this phase to the ``quantitative'' telephonic survey
that will begin later this spring.
While we are still analyzing the results of the focus groups, I can
say that participants were most interested in the return-free tax-
filing concept. Furthermore, the initial reaction was equally mixed
between positive and negative responses. However, once again, I want to
stress that this was a qualitative study that was intended to explore
perceptions rather than to provide the statistically valid database on
return-free tax filing we hope to achieve with the quantitative
telephonic study.
fasst proposal
Mr. Chairman, the IRS has reviewed the draft legislation written by
the distinguished Ranking Minority Member Senator Dorgan proposing a
return-free tax system, also known as the ``Fair and Simple Shortcut
Tax Plan'' (FASST).
Although the IRS cannot discuss the tax policy aspects of the
proposed legislation, we certainly understand and appreciate the
taxpayer's point of view when it comes to ease of filing, especially
the ability to file one election form at the beginning of the year and
not have any further filing responsibilities.
The draft legislation is most thought provoking, and raises a
number of interesting topics that I would like to briefly discuss
today. The IRS would also welcome the opportunity to sit down with
Senator Dorgan, potential co-sponsors and staff to work through these
questions as the present draft of the bill is fine-tuned.
The first topic is the new FASST election certificate that
employees would have to fill out and provide to their employers. It
posed a number of questions including the following:
--What exactly would a taxpayer file with the employer?
--What information would the taxpayer have to provide to an employer?
--How would FASST deal with the administrative challenge of an
employee having multiple employers?
--What happens under FASST if both spouses are working?
--How would the IRS get the information it needs to determine whether
there is an overpayment or underpayment of taxes?
Our second topic focuses on the W-2 form that taxpayers now receive
in January containing critical filing information. The draft
legislation raised some interesting questions about how this
information would be provided to FASST taxpayers.
--Unless the W-2 form is modified, what could be done to ensure that
employees would receive a record of important deductions and
credits that their employer took into account, such as EITC,
child care credit and homeowners' expense deduction?
--Since the IRS does not receive the W-2 tape from the Social
Security Administration until August, what can we do to provide
timely refunds to FASST taxpayers, or notices of additional tax
due?
--What can we do to help employers and employees quickly resolve
potential disputes over amounts or credits reported on a W-2?
--What can be done to minimize the costs to employers of changing
their systems to be able to provide new information on W-2s?
Our third topic involves how the IRS would actually go about
administering a system as different and unique as FASST while still
maintaining the existing system for non-FASST taxpayers. In this
regard, we have a few basic questions, such as:
--Given its enormous importance to reducing taxpayer error and
boosting compliance, what could be done to ensure that the IRS
continues to receive Social Security numbers for dependents
claimed as exemptions and qualifying children for EITC?
--What could be done to help employers when a FASST taxpayer loses
eligibility, but fails to notify his/her employer(s)?
--What can we do to minimize the impact on both FASST taxpayers and
the IRS when there is a dispute over IRS' computations of an
underpayment or overpayment?
Once again, these are some very broad topics raised by the FASST
legislative proposal. We are most grateful for the opportunity to
review this legislation in its draft form and to work with Senator
Dorgan and all interested parties to provide some answers to the
questions we posed today.
conclusion
Mr. Chairman, in conclusion, the IRS is committed to reducing
taxpayer burden at every possible opportunity using every tool and
resource at our disposal. Following the clear directions set forth by
Congress in the Restructuring Act, we will use the research now
underway as the foundation to further explore the return-free system as
another means of reducing taxpayer burden. Thank you.
statement of senator kyl
Senator Campbell. I wonder, Senator Kyl, do you have an
opening statement before we ask some questions?
Senator Kyl. I do, Mr. Chairman. Let me just make a brief
statement and ask that a complete statement be put in the
record.
I appreciate what Senator Dorgan is trying to do here, but
I have a big concern about what the effect will be. Everyone
wants to minimize the impact on taxpayers. There is one respect
in which minimizing the impact on taxpayers is not a good idea,
and that is if they no longer have an idea of how much they are
paying in taxes. I think the more they understand what their
taxes really are, the more careful they are about who they
elect to public office, what decisions they make, what they
support, because they see a closer relationship between what
they earn, what they have to pay in taxes, and decisions that
are made.
The more we remove taxpayers from that, the further away
they get from having the knowledge base for their judgments.
And tax withholding today, income tax withholding today, masks
to some extent the burden. My staff, we did a little survey and
only about a third of my staff knew how much was withheld from
their paycheck.
Other taxes are masked, as well. The employer share of FICA
taxes, you do not even see that on your pay stub, even though
it is a dollar for dollar reduction in pay, and so on.
So Mr. Chairman, and with all due respect to Senator
Dorgan, I understand what he is trying to do here to minimize
the work of taxpayers, and we all share that goal. I do not, at
the same time, want to minimize their ability to see very
clearly what they are paying in income taxes to the Federal
Government. It seems to me that we should work to make that
part of any solution that aims to reduce their burdens, as
well.
Thank you.
[The statement follows:]
Prepared Statement of Senator Jon Kyl
Mr. Chairman, I want to thank you for convening this hearing today
to hear from Commissioner Rossotti and Deputy Assistant Secretary
Burman about the Internal Revenue Service's review of initiatives
relating to paperless filing and the feasibility of implementing a
return-free system for certain taxpayers.
A return-free system may well be an easier and more convenient way
for taxpayers to satisfy their tax obligations. Millions of taxpayers
would no doubt welcome a simpler system. As it stands now, individuals
and businesses are having to deal with 481 separate IRS tax forms for
1999. That is up 20 percent since just 1990.
The IRS estimates that Americans will spend 6.1 billion hours--over
three million person-years--to comply with the Federal tax system.
Compliance alone will cost taxpayers in the neighborhood of $200
billion, and that is before they even satisfy their tax obligations.
Mr. Chairman, a return-free system may prove more convenient for
taxpayers, but I, for one, want to urge caution here and express some
concern about the idea. I know Senator Dorgan is well intentioned in
his desire to simplify compliance for taxpayers, but I believe the idea
will have some unintended results.
This morning, I conducted an informal survey of my staff to see
whether they pay attention to how much is withheld from their paychecks
or whether they just focus on take-home pay, since that's what they
depend on to make ends meet. Only about a third knew exactly how much
was withheld. My guess is that is representative of taxpayers at large.
They're more concerned about making ends meet, and they assume taxes
are a given anyway.
The point is, income-tax withholding as it exists today already
helps reduce the visibility, and minimize our awareness, of making tax
payments. FICA taxes paid by an employer on behalf of an employee never
show up on a worker's pay stub at all, even though they reduce wages
dollar for dollar. Corporate income taxes and the cost of government
regulations imposed on business certainly add to the price of every
good and service that a consumer purchases. Sales taxes are accepted as
part of the price of consumer goods. By the time Election Day rolls
around, even the pain of filing one's income-tax return is long
forgotten. Election Day could hardly be farther away from April 15.
There is good reason for that. Politicians don't want to ask for
people's votes when the tax burden is still fresh on their minds.
I've actually advocated moving the deadline for filing income-tax
returns from April 15 to Election Day as a way of helping to focus
people's attention on their tax burden at the very time of year they
have the most opportunity to do something about it.
Mr. Chairman, we need to make taxes more visible, not less visible.
It seems to me that a return-free system would eliminate the end-of-
year accounting that lets people see just how great a tax burden the
government is imposing on them. I know that is not the intent of
advocates of this proposal, but I think that will be the result. It
will also make it easier for the government to increase that burden in
the future, when taxpayers are not focused on what their liability is.
There are some other problems with a return-free system that should
be considered, as well. Perhaps the foremost concern involves privacy.
This is something that Deputy Assistant Secretary Burman touched on in
his written testimony.
Taxpayers would have to share more personal and financial
information with their employers in order to determine the correct
withholding allowances. Would taxpayers really want to share private
information with their employers? I think there will be a lot of
concern about that.
Second, with a return-free system in place, would the IRS notify
people when they have had too much tax withheld? It is my understanding
that about 1.7 million taxpayers either overlooked, ignored, or
otherwise failed to claim the child-tax credit allowed them under the
law in 1998. That means an estimated $1 billion in excess taxes were
collected by the Treasury.
The Inspector General for Tax Administration has recommended that
these taxpayers be sent an informational notice about their entitlement
to the child-tax credit. This notice would be similar to the notice
that has been used to inform taxpayers that they may qualify for the
Earned Income Tax Credit.
I have been advised, though, that IRS management is resisting
sending such notices. I hope Commissioner Rossotti will address this
during his comments today. If the IRS won't tell taxpayers now that
they've paid too much, what incentive will they have if a return-free
system is in place, when taxpayers won't ever have to sit down and
reconcile their tax liability? What happens when people forget to
change their withholding to reflect changes in family circumstances--a
new child, a new home, or devastating, unforeseen medical expenses?
Mr. Chairman, I really believe we need to proceed very carefully.
Simplifying compliance is one thing, but we should not make it easier
for Washington to take even more from hardworking Americans when
they're not looking.
impact of paperless filing
Senator Campbell. Let us talk about the impact a little
bit.
As I understand it, one of the benefits of Senator Dorgan's
proposal is to reduce the paperwork processing at the IRS,
which would in turn save money. What impact would that have on
your personnel needs and on your budget? I know it is pretty
hard to guess.
Mr. Rossotti. We clearly do not know until we define the
proposal a little bit. I think that the biggest part of this
idea is to eliminate the burden on the taxpayer to have to
prepare a return. In some sense, it actually adds some things
to what we have to do, in the sense that we then have to,
instead of just verifying, actually compute what this liability
is, at least the sense of verifying it at the end, even though
hopefully in most cases it would not require sending anything
back to the taxpayer.
One of the key issues in costs is what we would have to do,
as I mentioned this is one of the issues we have to study, what
we would do with the election certificates or enhanced W-4
forms, as they are called I guess, that the taxpayer would have
to file with the employer. Because they would file them with
the employer in order to determine what their tax was for
withholding.
Right now, those kind of forms are just held by the
employer. Nothing is done, we do not even receive them. So I am
not sure yet at this point, without further study, what would
actually have to be done with those.
If we assume that we might have to receive those forms from
the employer, otherwise we would not have any information to
verify how the liability was computed, then in effect what we
have done is we have substituted that form for processing the
tax return, and we sort of balance those out to some degree.
So I guess what I would say is that I, from what little
study we have done so far, this is in an early stage, I really
see that the benefits of this proposal have to do more with
reducing the burden on the taxpayer than they do with reducing
the cost to the IRS. That is as best as I can answer your
question at this point.
Now I do not necessarily think that is bad, because I think
generally what we are trying to do is reduce the burden on the
taxpayer, which is a much bigger number than what the cost is
in the IRS. I mean, some people say that the total cost of
compliance for the whole tax system may be as much as eight to
nine times what the cost is for the IRS budget.
So that is really the big number out there, as opposed to
what the IRS budget is.
Senator Campbell. I have a few more questions. Do you have
a statement, Mr. Burman? Go ahead and proceed with it.
STATEMENT OF LEONARD BURMAN, DEPUTY ASSISTANT SECRETARY
OF TREASURY FOR TAX ANALYSIS, INTERNAL
REVENUE SERVICE, DEPARTMENT OF THE TREASURY
Mr. Burman. Mr. Chairman, Senator Dorgan, Senator Kyl, I
appreciate the opportunity to participate in this hearing on
return-free tax systems. I want to thank the chairman for
calling a very important hearing, and Senator Dorgan for his
leadership in this area.
The goal of tax policy is to raise revenue in an equitable,
efficient and simple manner. Often, the goals of equity,
efficiency, simplicity, and fiscal responsibility are in
conflict. The tax system that is perceived as equitable may be
complicated, while a system that is simple may be unfair or
inefficient.
The individual income tax which finances the largest share
of the Federal Government's operations is the fairest and most
progressive broad-based tax. In fact, the Federal income tax
burden for a median income family of four is lower today than
it has been since 1965. Nearly 70 percent of files have a
statutory marginal tax rate of 15 percent or lower.
The income tax makes important adjustments to reflect
differences in ability to pay. In addition, the income tax
provides taxpayers with important incentives for saving,
investment, for charitable contributions, and rewards work by
low income people. It helps people pay for essential needs,
such as child care, home ownership, education, and health
insurance.
However, this flexibility comes at a cost, as many perceive
the current system to be complex and income tax compliance to
be burdensome. Thus, this hearing which examines ways to reduce
taxpayer compliance burdens without undermining the basic
fairness of the income tax is extremely important.
What is the best way to make income tax compliance less
burdensome? One option that has been adopted by more than 30
countries is a return-free filing system. In most of these
countries, taxpayers meet their tax obligations entirely
through tax withholding payments made throughout the year.
Other countries rely on so-called tax agency reconciliation in
which tax authorities prepare tax returns for individuals based
on information returns from employers and others and send
taxpayers a completed tax form for their review.
In the United States, this administration proposed to
reduce taxpayer burdens by simplifying the tax law, encouraging
electronic filing, telefiling, and the use of tax preparation
software. As described by the Commissioner, the IRS has
underway a number of innovations designed to makes its contact
with taxpayers less burdensome. It is in the written version of
his testimony.
My oral testimony will very briefly discuss the trade-offs
that must be considered in moving toward a return-free system,
summarize the British experience with their system, and discuss
the potential for removing American taxpayers from the filing
roles.
the british system of paperless filing
The British system illustrates the important trade-offs
required to move to a return-free system. As in many so-called
pay as you earn systems, the unit of taxation in the United
Kingdom is the individual. The system has fewer rates with
about 80 percent of taxpayers taxed at the basic rate of 22
percent. Taxes on interest and dividends are withheld at the
source at the basic rate. Capital gains on owner occupied
housing are completely exempt from tax. Other capital gains are
indexed for inflation and subject to a generous annual
exemption.
Fewer deductions are allowed than in the United States and
taxpayers claim these deductions through different mechanisms.
For example, mortgage interest relief is provided at the source
at a 15 percent rate. There are fewer tax preferences and they
are not typically targeted by income.
As a result of these features, about two-thirds of British
taxpayers are able to avoid filing tax returns. Those who have
to file are largely high income taxpayers with asset income,
those with capital gains above the exempt amount, and those
with self-employment income.
Further, while low income families do not have to file a
tax return in order to claim the British EITC, which is called
the working family tax credit there, they must submit a
separate application that looks a lot like a tax return to
Inland Revenue twice a year.
Neither an exact withholding or tax agency reconciliation
system, which is in effect in only Denmark and Sweden, provides
an easy way to handle capital gains, business income, alimony,
or other payments between individuals, employee business
expenses, moving expenses, contributions to individual
retirement accounts, most itemized deductions or most tax
credits.
If the United States were to adopt either system, many
taxpayers would still be required to file a return, even with
significant structural changes to the tax code. Most systems
also raise administrative concerns. I turn next to a discussion
of these issues. I should emphasize at the outset that this
discussion is basically aimed at framing issues that need to be
addressed. They are not necessarily criticisms of the concept.
The first issue concerns the withholding formulas
applicable to wage income. In 2001, approximately 21 million
taxpayers out of 128 million will have income solely from
wages, will claim no credits other than the child tax credit,
will not itemize deductions, and will be in either the zero or
15 percent tax bracket. For these taxpayers, tax liabilities
equal 15 percent of wage income above the standard deduction
plus exemptions less than $500 per child tax credit. Because
almost all wage income is subject to withholding already, these
taxpayers could most readily be shifted into a return-free
system.
withholding and paperless filing
Even though most wages are subject to withholding, the
current system would have to be modified in several ways in
order to make withholding exactly match tax liability for most
of these taxpayers. Additional information and computations
would be required on the form W-4 to accurately adjust
withholding for the child tax credit.
Further, the current withholding formulas are not designed
to be exact for dependent filers, dual career couples, or
taxpayers who do not work all year or have more than one job
during the year. If only non-dependent files with income solely
from one job were exempted from the return filing requirement,
only about 8.5 million taxpayers would quality.
Withholding formulas could be modified to meet the needs of
most taxpayers but at the cost of some complexity. Under an
exact withholding system, some workers would have to file forms
W-4 more frequently during the year, whenever their family or
financial status changed in a way to affect tax liability, for
example if they married, divorce, or have a baby. They might
also have to share more personal and financial information with
their employers in order to determine the correct withholding
allowances. This would raise concerns about privacy.
Although the United States has never had a return-free tax
system, we did try to implement more exact withholding rules in
1987, as required by the Tax Reform Act of 1986. The accurate
but complex form W-4 had to be withdrawn in response to
complaints from taxpayers, employers and the Congress who found
the improved form unfathomable.
Expanding the scope of mandatory withholding raises a
second set of issues. If withholding at the source were
extended to interest dividends, pensions, IRA distributions and
unemployment insurance benefits, 43.5 million taxpayers could
be eligible for a return-free system.
Mandatory withholding has other advantages. For example, it
would improve compliance, but it is controversial. Past
attempts to extend withholding requirements to non-wage income
have met with significant resistance from banks, financial
institutions, and other businesses. However, it is possible
that the increased usage and substantially lower cost of
computer processing of business financial records can make
withholding more feasible than when it was last attempted 20
years ago.
To further reduce administrative costs, relatively small
payments and some payers, such as individuals who hold seller-
financed mortgages, could be exempted from the withholding
requirements. But that would either require more recipients to
file or the exemption of such income from tax.
A 13.5 million more taxpayers could be exempted from a
return filing requirement if eligibility for the EITC could be
determined without a tax form. Administering the EITC in the
absence of a return filing requirement raises other issues.
Eligibility and credit computations are very sensitive to
changes in family status and income during the year, making it
difficult to accurately predict a taxpayer's credit amount in
advance.
The British have addressed this problem by establishing a
separate claims application process for their WFTC. Thus, they
have not been able to totally eliminate some form of filing
requirement.
administration of paperless filing
In sum, depending on the extent of changes to current tax
administration, the final tax return requirement could be
eliminated for between 8 and 57 million taxpayers, or up to 44
percent of the tax filing population without making any
structural changes to the code.
While these taxpayers would be spared the cost of preparing
a final return, the net reduction in burden might not be that
great. Most of these 57 million taxpayers currently file the
relative simple 1040A and 1040EZ. Even under a return-free
system, these taxpayers would still be required to provide some
of the information from these forms to the IRS on a regular
basis. In fact, the return-free process may be more complex
than filing for some taxpayers.
There are additional concerns, including the extent to
which some administrative costs would merely be shifted from
taxpayers to their employers, other payers, and the IRS.
Adoption of an exact withholding system means shifting some
costs to taxpayers and employers by expanding the scope and
precision of withholding. This is likely to meet with some
resistance.
In the alternative tax agency reconciliation system, one
billion information returns would have to be filed earlier and
processed and perfected much sooner by the IRS in order to
complete returns by April 15, and refunds might be paid out
slower than under the current system.
States whose tax systems piggyback on the Federal tax
return would also incur additional costs or delays under either
system. A key issue in either system is who would bear
responsibility for mistakes on the tax form prepared by the tax
authority or mistakes in exact withholding made by either the
tax authority or the employer or payer.
I raise these issues not as obstacles but as design issues
that must be addressed before we could adopt a return-free
system. Many of these issues were first considered in a report
issued by the IRS in 1987. In that report, the IRS found that
there were serious timing and accuracy problems in implementing
a return-free system, but that technological improvements in
IRS' processing could make a return-free system more feasible
in the future.
We are working with the IRS to explore all of these issues
as part of the process of answering the mandate the
Commissioner spoke about.
This concludes my remarks. We look forward to working with
the Congress to make the tax system work better for all
Americans. I appreciate the opportunity you have given me to
testify and I would be happy to answer questions.
[The statement follows:]
Prepared Statement of Leonard E. Burman
Chairman Campbell, Senator Dorgan, and Members of the Committee: I
appreciate the opportunity to participate in this hearing on return-
free tax systems. I want to thank the Chairman for calling this very
important hearing and Senator Dorgan for the leadership he has shown in
this area.
The goal of tax policy is to raise revenue in an equitable,
efficient, and simple manner. Often, these goals--equity, efficiency,
simplicity, and fiscal responsibility--may be in conflict. A tax system
that is perceived as equitable may be complicated, while a system that
is simple may be unfair or inefficient.
The individual income tax, which finances a large share of the
Federal government's operations, is the fairest and most progressive
broad-based tax. By basing tax liability on income and certain personal
characteristics, it provides a mechanism to adjust for differences in
ability to pay. However, this flexibility comes at a cost, as many
perceive the current system to be complex and income tax compliance to
be burdensome. Thus, this hearing, which examines ways to reduce
taxpayer compliance burdens without undermining the basic fairness of
the income tax, is extremely important.
What is the best way to make income tax compliance less burdensome?
One option that has been adopted by over 30 countries is a return-free
filing system. In most of these countries, taxpayers meet their tax
obligations entirely through tax withholding payments made throughout
the year. Other countries rely on tax agency reconciliation, in which
tax authorities prepare tax returns for individuals based on
information returns from employers and others, and send taxpayers a
completed tax form for their review. In the United States, this
Administration proposed to reduce taxpayer burdens by simplifying the
tax law and encouraging electronic filing, telefiling, and the use of
tax preparation software. As described by the Commissioner, the IRS has
underway a number of innovations designed to make its contact with
taxpayers less burdensome.
A number of issues must be considered in evaluating options to
implement a return-free filing system.
--What changes in tax law and procedures would be required to
facilitate a return-free filing system? How would these changes
affect other objectives of the tax system, such as equity?
--Would a return-free system shift compliance burdens from individual
taxpayers to employers and financial institutions?
--Would such a system result in a loss of privacy, because
individuals might, for example, have to report to their
employers information about their family circumstances and
other sources of income to enable exact withholding?
--To what extent would taxpayers have to file some sort of report
during the year, containing some of the same information
currently included in tax returns, to establish the proper
withholding schedule or their eligibility for credits, such as
the earned income tax credit (EITC)?
--What would be the role of the IRS, and what additional resources
would be required to implement and operate a return-free
system?
--What would be involved in coordinating State income tax systems
with the new return-free apparatus?
--Are there other ways to achieve the benefits of a return-free tax
system at less cost and without sacrificing other goals?
In my testimony today, I will address the sources of taxpayer
burden in the current system, alternative models of return-free systems
and the experience of other countries in implementing such systems, and
the potential effects of such systems in the United States. Finally, I
will briefly discuss the Administration's legislative proposals that
would reduce taxpayer compliance burdens.
current law filing requirements
Every income tax system imposes certain obligations, beyond the
actual payment of taxes, on taxpayers, government agencies, and third
parties. Individuals must provide the tax agency and possibly their
employers with some basic information about their income and family
status. Employers and other third parties withhold taxes on income, and
must report both the amount of income paid and taxes withheld to the
taxpayer and the tax agency. The tax agency must compute the
individual's taxes to determine if the correct amount has been paid.
Income tax systems around the world obtain the required information and
collect taxes in different ways.
As the Commissioner has described, in the United States, taxpayers
interact with the IRS in three stages: pre-filing, filing, and post-
filing. The pre-filing stage often begins the day taxpayers start work,
when they compute the number of withholding allowances they are
entitled to claim. Taxpayers may also pay estimated taxes in quarterly
installments throughout the year. They may also need to keep records
documenting expenses and other items that affect their tax liability.
Throughout the year, businesses, non-profit organizations, and
Federal and State government agencies also incur tax compliance costs.
Employers must withhold Federal income taxes on wages and transmit
these amounts to the Treasury. Under certain circumstances, income
taxes may also be withheld during the year on unemployment benefits,
distributions from pensions and individual retirement accounts,
interest, dividends, and large gambling winnings. During the first
three months of each year, businesses and other payers send over a
billion information reports (Forms W-2, 1099, and others) to taxpayers,
the IRS, and the Social Security Administration (SSA), showing the
amount and type of income received and taxes withheld, if any, during
the preceding year.
This filing season, about 127 million taxpayers will complete the
second stage of tax compliance by completing and filing a tax return.
Through tax returns, taxpayers notify the IRS of their actual income,
filing status, and dependents, and they reconcile the amounts of taxes
paid during the year with the amounts they owe the Federal government.
Over 85 percent of these filers are legally required to file a tax
return. In most cases, they are required to file because they incurred
a positive individual income tax liability, but 7 million filers are
required to file even though they do not owe income taxes in order to
claim a dependent or to pay self-employment income taxes or other
special taxes. About 15 percent (over 18 million filers) file a return
even though they are not required to do so in order to obtain a refund
of overwithheld income taxes, the EITC, or for other reasons.
The third stage of tax compliance--post-filing contacts--may begin
shortly after the IRS receives a return. During processing, the IRS may
detect mathematical or clerical errors and send notices to taxpayers
advising them of adjustments that have been made to their tax returns.
Later in the year, when SSA and IRS have finished processing and
editing information reports, the IRS will match Forms W-2 and 1099 to
tax returns, contacting taxpayers if discrepancies are found. After
further review, the IRS may identify other returns as being
questionable, and as a consequence, an audit may be initiated,
resulting in the issuance of a notice of deficiency to the taxpayer.
Altogether, about 9 million notices will be sent this year. Less than 7
percent of tax filers will actually have contact with the IRS during
the post-filing stage.
In differing degrees, each of these three stages imposes burdens on
individuals, employers, other third parties, and the Federal
government. The cost of administering all Federal taxes is reflected in
the $8.6 billion budget of the IRS, but we cannot easily disentangle
the costs to the Federal government of operating just the individual
income tax. Costs to individuals, employers, and other third parties
are even more difficult to measure.
Recently, significant technological advances have likely lowered
taxpayer compliance burdens. Personal computers and tax software have
become more widespread, powerful, and cheap. Tax software enables
taxpayers to input data, and let the computer do complicated
computations. It also simplifies information reporting by businesses.
Technology has also helped tax professionals do research through the
creation of on-line services and CD-ROMs. The IRS has built on these
technological advances to reduce taxpayer compliance burdens. During
the 1999 filing season nearly one out of every four taxpayers (over 29
million) filed electronically, including about 6 million taxpayers who
telefile their return over the phone. Some States now allow taxpayers
to file their Federal and State taxes in one electronic transmission.
An IRS web site enables taxpayers to download forms and publications to
their own computers. This site registered over 750,000 ``hits'' during
fiscal year 1999.
The costs of administering the current tax system should be weighed
against the benefits of the current system. In fiscal year 2000, the
Federal government will raise nearly half of total Federal receipts--
$951.5 billion--from the individual income tax system. The tax is fair,
contributing significantly to the overall progressivity of the U.S. tax
system, without placing undue tax burdens on typical families. In fact,
the Federal income tax burden for a median income family of four is
lower today than it has been since 1965. Nearly 70 percent of filers
have a statutory marginal tax rate of 15 percent or lower. In addition,
the income tax provides taxpayers with important incentives for savings
and investment, for charitable contributions, and for work effort by
low-income individuals.
types of return-free systems
In contrast to the U.S. system with its end-of-year reconciliation
on tax returns, over 30 countries exempt some of their taxpayers from
the requirement to file a tax return. During the past decade, two
States--Michigan and Louisiana--have enacted ``no-form'' pilot
programs. There are two types of return-free tax systems, exact
withholding and tax agency reconciliation, with many possible
variations on each type.
Exact withholding.--In an exact withholding system, the tax agency
attempts to insure that the exact amount of tax liability is withheld
so that taxpayers are not required to file returns at the end of the
year to obtain refunds or pay a balance due. Over 30 countries operate
exact withholding systems. These systems require taxpayers to report
some information to either employers or the tax authorities at the
beginning of the tax year. The information is used to calculate
withholding allowances by either the employer or the tax authority (who
must then report the applicable withholding rates back to the employer
in a timely fashion). Taxpayers may be required to report this
information on a regular basis or whenever there is a change in their
circumstances that affects income tax liability.
Several types of exact withholding systems exist. Cumulative
systems (used in the United Kingdom) aim to withhold exactly the right
amount of taxes at each point in the year. Final withholding systems
(used in Germany and Japan) make adjustments to the final paycheck in
the tax year to achieve exact withholding. Exact withholding systems
typically apply a PAYE (``pay as you earn'') tax withholding plan for
wage income.
Tax systems that rely on exact withholding often have structural
features that facilitate taxation at source. For example, the
individual--not the married couple--is generally the unit of taxation.
Interest and dividend income is often made exempt or taxed at the
source at a flat rate. Relative to the U.S. income tax system, PAYE
systems are also characterized by fewer rates, fewer deductions, and
fewer tax credits. This means that employers and other payers can
withhold the appropriate amount of tax from taxpayers without obtaining
significant amounts of personal and financial information from
taxpayers (such as spousal income, medical expenses, or child care
costs).
The British system illustrates the important relationship between
tax structure and tax administration. As in many PAYE systems, the unit
of taxation in the United Kingdom is the individual. The system has
fewer rates, with about 80 percent of taxpayers taxed at the basic rate
of 22 percent. Taxes on interest and dividends are withheld at the
source at the basic rate. Capital gains on owner-occupied housing are
completely exempt from taxes, as compared to the United States, where
gains under $500,000 ($250,000 if unmarried) are exempt. Other capital
gains are taxed on an inflation-adjusted basis and only realized gains
in excess of 7,200 pounds (about $11,400) per person are subject to
taxation. There are also fewer itemized deductions, and the manner in
which taxpayers may claim these deductions differs from the U.S.
system. For example, mortgage interest relief is provided at the source
at a 15 percent rate. There are fewer tax preferences, and they are not
typically targeted by income. Similarly, deductions are not subject to
income-based caps.
In net, about two-thirds of British taxpayers were able to avoid
filing tax returns for tax year 1999-2000. Those who have to file are
largely high-income taxpayers with asset income (which are subject to
tax withholding at the basic marginal rate), those with capital gains
above the exempted amount, and those with self-employment income.
Further, while low-income working families do not have to file a tax
return in order to claim the EITC-like ``Working Family Tax Credit,''
they must submit a separate return-like application at the end of each
six-month period to Inland Revenue.
Tax agency reconciliation.--Taxpayers may be relieved of the burden
of filing even in systems that do not have exact withholding. In tax
agency reconciliation systems, taxpayers can elect to have the tax
agency prepare their return, with tax filing occurring in four steps.
First, electing taxpayers provide basic information to the tax
authority. The tax authority then calculates tax liabilities, given the
information returns it receives from employers, financial institutions,
and other payers, and the information obtained from the taxpayer. The
taxpayer then has a chance to review (and contest) these calculations.
Finally, refunds or tax payments are made.
Because withholding does not have to be exact, tax agency
reconciliation systems may not place as great a burden on employers and
other payers as exact withholding systems. Moreover, it may be easier
in a tax agency reconciliation system to apply progressive rates to a
combination of income derived from different sources and to allow
taxpayers to claim certain types of deductions or credits. But tax
agency reconciliation systems are not costless to employers, other
third party payers, or the tax authorities. In order to ensure timely
payment of refunds and balances due, payers must report payments to the
tax authorities as close to the end of the tax year as possible, while
the tax authorities must quickly absorb, process, and match a large
number of information returns. Taxpayers must review these calculations
and institute procedures, if necessary, to contest erroneous
calculations.
Only two relatively small countries, Denmark and Sweden, operate
tax agency reconciliation systems. About 85 percent of Denmark's
taxpayers and 74 percent of Sweden's taxpayers had their returns filled
out by the tax authorities in 1994.
Neither an exact withholding nor tax agency reconciliation system
provides an easy way to handle capital gains, business income, alimony
or other payments between individuals, employee business expenses,
moving expenses, contributions to individual retirement accounts, most
itemized deductions, or most tax credits. If the United States were to
adopt either system, many taxpayers would likely still be required to
file a return, even with significant structural changes to the current
tax code. Both types of systems also raise new administrative concerns.
We turn next to a discussion of these issues.
administrative issues in shifting to a return-free tax system
The Internal Revenue Service Restructuring Act of 1998 requires the
Secretary of the Treasury to develop procedures for the implementation
of a return-free system for ``appropriate'' individuals by 2007. Until
then, the Secretary is required to report annually on the additional
resources the IRS would need to implement a return-free tax system, the
changes to the Internal Revenue Code that would enhance such a system,
the procedures developed for the implementation of a return-free tax
system for appropriate individuals, and the number and classes of
taxpayers that would be permitted to use these procedures.
Today, I would like to preview some of the administrative issues
that we will examine in this year's report as we begin to identify
individuals for whom a return-free tax system would be appropriate
under the current individual income tax.
The first issue concerns the withholding formulas applicable to
wage income. In 2001, approximately 21 million taxpayers (out of 128
million taxpayers) will have income solely from wages, will claim no
credits other than the child tax credit, will not itemize deductions,
and will be in either the 0- or 15-percent tax brackets. For these
taxpayers, tax liabilities equal 15 percent of wage income above the
appropriate standard deduction and exemption amounts minus the $500
child tax credit. Because almost all wage income is subject to
withholding already, these taxpayers could be shifted into a return-
free system more easily than the rest of the filing population. An
additional 1.5 million taxpayers have all of the above qualifications
but face a marginal tax rate higher than 15 percent.
Even though most wages are subject to withholding, the current
system would have to be modified in several ways in order to eliminate
a filing requirement (or to minimize refunds or balances due) for most
of these 21 million taxpayers. Additional information and computations
would be required on the Form W-4 to accurately adjust withholding for
the child tax credit. Further, the current withholding formulas are not
designed to be exact for dependent filers, dual-career couples, or
taxpayers who do not work all year or have more than one job during the
year. If only non-dependent filers with income solely from one job were
exempted from a return-filing requirement, only about 8.5 million
taxpayers would qualify.
The withholding formulas could be modified to meet the needs of
most taxpayers, but the additional precision would make the computation
of withholding allowances on Form W-4 more complex. Under an exact
withholding system, workers might have to file Forms W-4 more
frequently during the year, whenever their family or financial status
changed in a way to affect tax liability (for example, if they marry,
divorce, or have a baby). They might also have to share more personal
and financial information with their employers in order to determine
the correct withholding allowances, raising privacy and security
concerns.
Although the United States has never had a return-free tax system,
we have had experience trying to fine-tune withholding formulas. When
the IRS introduced a new, more precise Form W-4 in 1987, as required by
the Tax Reform Act of 1986, it was quickly withdrawn in response to
criticism from taxpayers, employers, and the Congress who found the new
form complicated and burdensome.
Expanding the scope of mandatory withholding raises a second set of
issues. If withholding at the source were extended to interest,
dividends, pensions, individual retirement account distributions, and
unemployment insurance benefits, the number of taxpayers eligible for a
return-free tax system would increase to 43.5 million. Mandatory
withholding would expand the scope of a return-free system and could
improve compliance, but would create new administrative costs for
financial institutions and other payers.
Past attempts to extend withholding requirements to non-wage income
have met with significant resistance from banks, financial
institutions, and other businesses. The increased usage and
substantially lower costs of computer processing of business financial
records may have made withholding more feasible than when last
attempted nearly 20 years ago. To further reduce administrative costs,
relatively small payments and some payers (such as individuals who hold
seller-financed mortgages) could be exempted from the withholding
requirements, but that would either require more recipients to file or
the exemption of such income from tax.
An additional 13.5 million taxpayers could be exempted from a
return-filing requirement if eligibility for the EITC could be
determined through other means. Administering the EITC in the absence
of a return-filing requirement raises a third set of issues.
Eligibility and credit computations are very sensitive to changes in
family status and income during the year, making it difficult to
accurately predict a taxpayer's EITC in advance. The British have
responded by establishing a separate claims application process for the
Working Family Tax Credit (WFTC). Thus, they have not been able to
totally eliminate some sort of filing requirement for WFTC claimants.
In sum, depending on the extent of changes to current tax
administration, a final tax return requirement could be eliminated for
between 8 and 57 million taxpayers, or up to 44 percent of the tax
filing population, without making any structural changes to the tax
code. While these taxpayers would be spared the costs of preparing a
final return, the net reduction in burden may not be great. Most of
these 57 million taxpayers currently file the relatively simple 1040A
or 1040EZ. Even under a return-free system, these taxpayers would still
be required to provide some of the information from these forms (for
example, filing status and dependents' identification) to the IRS on a
regular basis. In fact, the return-free process may be more complex
than filing for some taxpayers.
Additional concerns include the extent to which some administrative
costs would merely be shifted from the taxpayers to their employers,
other payers, and the IRS. Adoption of an exact withholding system
means shifting some costs to taxpayers and employers, by expanding the
scope and precision of withholding. This is likely to meet with some
resistance. In a tax agency reconciliation system, one billion
information reports would have to be filed earlier and processed and
perfected much sooner by the IRS in order to complete returns by April
15, and refunds might be paid out slower than under the current system.
These requirements would add to the burden on employers, other third
parties, and the IRS, and yet taxpayers may be reluctant to participate
in the new system because of possible delays in their refunds, even
with the acceleration of delivery and processing of information
reports. States whose tax systems piggyback on the Federal tax return
would also incur additional costs or delays under either system. A key
issue in either system is who would bear responsibility for mistakes on
the tax form prepared by the tax authority or mistakes in exact
withholding made by either the tax authority or the employer/payer.
I raise these issues not as obstacles but as design issues that
must be addressed before we could adopt a return-free system. Many of
these issues were first considered in a report entitled, ``Current
Feasibility of a Return-Free Tax System, prepared by the IRS in 1987.
In that report, the IRS found that there were serious timing and
accuracy problems in implementing a return-free system, but that
technological improvements in IRS's tax processing could make a return-
free system more feasible in the future.
As I discussed earlier in my testimony, there have been significant
technological improvements that have eased compliance burdens, even
with a return-filing requirement. It is possible that these new
technologies will also enable us to make the transition to a return-
free filing system with minimal burden to certain categories of
taxpayers. It is also possible that these technological advances will
allow us to find other ways to reduce compliance burden while
maintaining an end-of-year filing requirement.
administration proposals to reduce compliance burdens
In the meantime, there are a number of steps that can be taken to
reduce taxpayer compliance burdens without sacrifice of other policy
goals. In his testimony, Commissioner Rossotti has described
administrative steps taken by the IRS to lessen these burdens.
The fiscal year 2001 budget contains a number of proposals that
will reduce taxpayer compliance burdens by simplifying the tax laws.
Most notable among these is a proposal that would build upon the
temporary AMT reforms enacted on a bipartisan basis last year. This
proposal would permanently modify AMT calculations by removing the
dependent personal exemption as a preference item. By 2010 when it is
fully phased in, this change would reduce the number of taxpayers
affected by the AMT by over one-half. In addition, the fiscal year 2001
budget would reduce the number of itemizers by 4 million and the number
of dependent filers by 400,000 by increasing standard deduction
amounts. Other proposals would reduce recordkeeping for taxpayers by
simplifying the child dependency tests and indexing the maximum
exclusion for capital gains on the sale of personal residences.
Some progress has already been made. President Clinton proposed and
signed into law 40 tax simplification measures as part of the Taxpayer
Relief Act of 1997. As a result of that simplification, 99 percent of
homeowners will not have to pay capital gains tax when they sell their
home; 9 out of 10 corporations no longer have to worry about complex
AMT calculations; and many dependent children are able to earn more
income without being subject to tax.
Technological advancements provide other means to reduce taxpayer
compliance burdens, rather than through eliminating a filing
requirement. Electronic filing eases tax computations and reduces both
taxpayer errors and the need for subsequent contacts between the
taxpayer and the IRS. It also permits taxpayers to receive their
refunds faster and provides taxpayers with immediate proof of filing.
Recognizing these benefits, the 1998 Act sets a goal for the IRS of
having 80 percent of tax year 2006 returns filed electronically.
To help achieve that goal, the Administration has proposed in the
fiscal year 2001 budget a new temporary, refundable tax credit for
electronic filing of individual income tax returns. The credit would be
$10 for each electronically filed return and $5 for each TeleFile
return filed for tax years 2001 through 2006.
This concludes my remarks. We look forward to working with the
Congress in making the tax system work better for all Americans, for
example, by enacting simplification provisions contained in the fiscal
year 2001 budget. Thank you once again for providing me with the
opportunity to testify. I would be pleased to answer questions.
irs computers and paperless filing
Senator Campbell. Thank you.
For either of you, the IRS is currently working to develop
a modern computer system and this committee has provided a
considerable amount of money in the last few years. If the tax
laws are changed significantly to accommodate this, or any
similar proposal, is that computer system going to have the
flexibility to adapt to this new system?
Mr. Rossotti. I certainly hope so, and it should.
Senator Campbell. Me, too.
Mr. Rossotti. I think that, having said that, it does not
mean that there would not be additional work that would be
required. Because what you would have essentially, depending on
the details, is you would still have all of the issues that you
have today because it would be an elective system. And then you
would have to add some additional requirements or additional
features really, just to deal with the second process, that
elected for the return-free process.
So I do not think it would make obsolete, or in any way
impair at all, the investment that we were making in
modernizing our systems. I think that would be a great
platform, an essential platform really to do these new things.
But there would be some additional work that would be required.
Senator Campbell. If we went to a flat tax system, or
simplified it with something along that line, would that mean
the computer system would also be simplified?
Mr. Rossotti. I think there are certain aspects of the
computer system that would be simplified, but I think one thing
to understand is that the actual application of the rate is a
relatively small matter. That is a computational matter. Most
of the computer systems investment, most of the processing
investment, in fact most of the IRS budget does not go to
simply computing that number. It goes, first of all, to just
processing the data, especially verifying the data that goes
into the income which the rate is then applied to.
So I think that certainly having anything that simplifies
the system is better from an administrative point of view. No
one can say that is not the case. But simply changing the rate,
by itself, only affects one of the variables.
Senator Campbell. I see. Well, the individual would not
have to file a tax return but the IRS would still be
responsible for preparing the necessary tax tables. So you
would have to move some people around. Some would have to be
moved up and some down and we, at this point, would not have
any idea about how it would affect your manpower; is that
correct?
Mr. Rossotti. I think that what we could say is that it
very much depends on what would happen with the taxpayers and
how exactly we would handle the taxpayers who elected to have
this return-free system. More specifically, what would have to
be done with the election certifications or W-4s, whatever
forms they filled out with the employers.
If you assume that what would happen is they would send
those forms to us, either the employee would or the employer
would, if that is what we would assume because that is what we
would need to verify at some point, the accuracy of the
withholding, then we would have to have employees and we would
have systems to process those forms.
But I think it is not clear at this point exactly how that
process would work.
Senator Campbell. Since this is Senator Dorgan's idea, I
probably should have asked him rather than you. But I do not
have any further questions, I am sure the Senator does.
complexity of tax administration
Senator Dorgan. Mr. Chairman, thank you.
Within the last month I was in a manufacturing plant that
produces rockets and rocket engines. As I was walking around
that plant, I was marveling at how incredibly complicated it is
to manufacture a rocket, a Titan rocket, to lift a payload and
deposit a satellite or something else into space. Building a
rocket is complicated, a tax system is not. That is simply
creating an administrative procedure.
Having been a tax administrator, I can tell you that it is
easy for us to claim it is complicated but in fact, it is not.
We can create a system that does what we want it to do. And all
of those things that we do that are different require different
challenges that we meet.
But the purpose of this is to respond to this circumstance.
Total number of pages of Federal tax rules going from 1913 to
2000, you see the graph, what is happening here, of course. And
we are doing this.
Senator Campbell. It was not complicated in 1913.
Senator Dorgan. It was not very complicated in 1913. This
is not your fault, this is a result of rules and regulations
that respond to laws that we pass. And the tax system is
increasingly complicated, there is no question about that.
With respect to Senator Kyl's comments, he is absolutely
correct. We do not want to do anything that would prevent
taxpayers from understanding what their obligation is. But
making things more complicated or less complicated and making
the right choice between more and less complicated has nothing
to do with whether taxpayers understand their obligation.
All taxpayers under the current system get a W-2 form. It
shows what their income was and how much they had withheld for
Federal income taxes. And they will, under this system, get a
W-2 form with exactly the same information. It seems to me if
you are facing a choice of more complicated or as complicated
or less complicated, you would always choose a system that is
less complicated, providing the taxpayers still understand
their obligations. So I think that is not of interest as a
concern here.
Commissioner Rossotti, in your testimony, I think you were
anticipating that a return-free system would necessarily have
the Internal Revenue Service computing the tax. That is not
necessarily the case. There are two ways to do a return-free
system.
As I think has been testified to by Mr. Burman, over 30
countries have some version of a return-free income tax system.
One approach is an exact withholding approach, and the other is
where the tax agency actually reconciles and prepares the tax
return. I think there are two countries in which the tax agency
solely reconciles and prepares the return.
But that is not my proposal. You understand, do you not,
that there are different approaches?
Mr. Rossotti. Yes.
Senator Dorgan. I am not suggesting that you reconcile and
prepare the tax return.
irs responsibilities with paperless filing
Mr. Rossotti. No, I think I did. I guess what I am still
not sure of is what our responsibilities would be with respect
to verifying the amount withheld. I think that is just a matter
that would have to be studied some more because, somehow or
other, I am assuming that if an employee filed something with
their employer and that resulted in exact withholding, that we
would still have an obligation in some way to verify that.
Otherwise, there would be no independent check on whether that
was the correct amount or not.
And it is really in that context that I was talking about
it. And only if there was a difference would we do something
about it. I guess I thought I understood the bill, but maybe I
misread it, that if there was a difference outside a certain
dollar amount we would then either send the taxpayer a refund
or a bill.
But it was really in the context of verification that I was
making my comments. I am just not sure quite how that would
work at this point.
Senator Dorgan. Mr. Burman, are you familiar with the work
of Mr. Gail, William Gail at the Brookings Institute?
Mr. Burman. I am.
Senator Dorgan. I assume you are. He has done a fair amount
of work, as I think one of your colleagues has, with Mr. Gail.
You raised as the Commissioner did, a number of considerations
and I think all of those are valid issues. You raise, for
example, the consideration of withholding on non-salary income.
My proposal would not suggest that because you would not be
able to elect to use the return-free system that I have
described unless you were under the de minimis level of other
income, $5,000 for married filing jointly or $2,500 for single.
So you would not have to be concerned about withholding at
the source of non-salary income if you adopted a system of the
type I have described; is that not correct?
Mr. Burman. That is right, as long as the non-salary income
is below the de minimis amount.
Senator Dorgan. And so that would only be a concern if
someone described a system that is different than I have
described.
louisiana and michigan paperless filing pilots
Let me ask you, the two States that have adopted a pilot
project on a return-free system, are they Michigan and
Louisiana?
Mr. Burman. Yes.
Senator Dorgan. Often we find interesting things happening
on a pilot basis in the State governments. And having been a
State official, I can tell you there is some source of pride in
the States because they are able to move a bit more quickly,
they are a bit more flexible, they are not quite as muscle
bound as we are at the Federal level.
So two States have now begun to move saying, at our State
income tax level, we want to do a return-free system. Can you
give me any information about what these States are doing and
what their experience is?
Mr. Burman. My understanding is that Michigan enacted and
actually implemented a pilot, a no-form option for wage
earners, which had a small, I think $100 non-wage income
exemption, $200 for joint returns in 1996. The experience in
Michigan suggests that you might need to do some outreach to
employers. Our understanding, based on a phone call just a day
or two ago was that they have actually suspended the program
because there are only 128 people who are taking advantage of
it.
They do not really know why, and that is what they are
trying to find out right now. Their suspicion is that employers
just basically do not want to take on the burden of trying to
get withholding exactly right for their employees.
Louisiana enacted a program but they actually have not
implemented it yet.
Senator Dorgan. But you understand that exact withholding
is not so much a function of the employer as it is the
withholding table described by the Internal Revenue Service. I
have met with many employer groups, NFIB, the Chamber, and so
on about this issue. The slight modifications in the W-4, and
they are not significant, the slight modifications in the W-4,
can be offset by some additional help to the businesses in the
form of a tax credit for preparation and so on.
Mr. Burman. Your proposal does that.
Senator Dorgan. Yes, and my proposal has that. But the
Internal Revenue Service would actually create the withholding
table to say this is the exact withholding that is necessary
given this salary and these checkmarks on the W-4. So it is not
the employers responsibility and would add no burden to the
employer with respect to the actual withholding computation or
calculation.
Mr. Burman. The employer does need to know a little bit
more information. They need to know the number of children, for
example. Under your plan they would need to know whether that
person was eligible for the child tax credit.
Senator Dorgan. That is correct.
You have described some numbers here. There are a group of
people in this country whose sole income characteristic is
largely wages. They do not have complicated incomes. They have
a job, they go to work, they get paid a wage, and there is
nothing very complicated with respect to their income
situation. They do not have a lot of other income, perhaps
hundreds, perhaps $1,000 or $2,000 of interest of capital
gains, but very straightforward.
In those circumstances, where you do not have other kinds
of peculiar issues, it is very easy to create a return-free
system, is it not? Just in those circumstances?
Mr. Burman. Right, as long as they are not taking advantage
of education credits, child dependent care tax credit, things
like that.
advantages of senator dorgan's plan
Senator Dorgan. When someone has a more complicated income
picture, it can become very difficult if not impossible to
create a return-free system. You would agree with that, as
well?
Mr. Burman. There also is a complication created by the
Earned Income Tax Credit, as I mentioned.
Senator Dorgan. That is correct.
Mr. Burman. The British do deal with that, but it requires
additional reporting over the course of the year.
Senator Dorgan. Let me go through just a couple of charts
in just a couple of minutes, if I might, because I did not
describe this in full detail. I will just take about 2 or 3
minutes, because I think it is important to do.
The goals of a fair and simple tax system are no obligation
to file a tax return for those who would qualify, to elect to
choose this approach, no difficult calculations, no last minute
searches for records, and no anxiety about major audits because
there is really nothing to audit. If they have not defrauded,
with respect to the information about children and so on, there
is nothing to audit.
Who could participate, families earning up to $100,000 with
up to $5,000 in other income. The advantage to this is it does
provide tax-free income as a result of savings and investment,
which I think nurtures exactly the right influences, and
individuals $50,000 and up to $2,500 in other income.
In addition to that, the taxpayers who would use this would
be taxed at a single rate of 15 percent. So you flatten the
rate at the bottom. They are permitted, with adjustments in W-
4, the standard deduction, personal exemptions, child tax
credit, deductions for home mortgage interest and Earned Income
Tax Credit.
They are exempt from Federal income taxes on other
qualifying income, up to the level I have described. And they
are exempt from the AMT and they are relieved of the marriage
penalty because in this circumstance there is no marriage
penalty.
One of the other advantages of this approach is there is no
marriage penalty for anyone who elects to use this form of
filing. Married filing jointly has exactly double the standard
deduction.
changes to the alternative minimum tax
And finally, those remaining under the current system, who
have decided they could not elect this because their income
characteristics do not fit this, they would be exempt from the
AMT provided they earn $1 million or less annually. The reason
I propose this change is I was part of the group that in 1986
wrote the Tax Reform Bill. I was on the Ways and Means
Committee at the time. We have too many people now caught in
the Alternative Minimum Tax calculation that were never
anticipated to be caught in that circumstance. This bill would
create a $1 million threshold.
We would provide a 50 percent tax credit, up to $500 in tax
preparer expenses for those that cannot elect to use this
system, provided their returns are provided electronically. We
will have their marriage penalty reduced by making the standard
deduction for them double what it is for single filers, and
they will be exempt from Federal income taxes up to $1,000 in
dividend and interest income.
These are simply additions that do not really have much to
do with the FASST plan but say to those who cannot elect to use
the FASST plan here are some other considerations that we think
are valuable and useful.
As I indicated, when I introduced this legislation, Senator
Gregg from New Hampshire will be a cosponsor and Senator
Durbin, and we are looking for others, Mr. Chairman, but I will
not impose that request at the moment.
Senator Campbell. First you have to understand it.
complexity of the tax code
Senator Dorgan. It is a circumstance where, as I mentioned,
people now in this country use 6 billion hours to calculate
their income taxes, 6 billion hours, with a ``B'', and spend
$75 billion to comply with this system. I have already shown
the graph of the pages of rules and regulations.
I would like to meet one living person in this country who
understands the tax code. I am willing to bet there is no one
on the face of the earth that understands the United States
Internal Revenue Service Code. Certainly you do not,
Commissioner, and you do not, Mr. Secretary, and I do not.
Mr. Rossotti. I would not claim I do.
Senator Dorgan. My expectation is that you do not have one
person working there that understands it all because we have
created here in the Congress a labyrinth of laws and
regulations, all from good intentions, but all in a way that
has created a very complicated system.
And my hope and desire would be to say to the American
people, at least for a good number of you, there is an
alternative way to comply and to reduce the amount of paper and
to follow the lead of some 30 other countries and say you can
comply with your income tax responsibilities without having to
file an annual return, using the withholding slightly adjusted
as the exact liability.
Is it more of a rough justice system? Yes, it is because
you are exempting certain other income up to $2,500. But it is
rough justice in a way that is advantageous to the taxpayer and
also advantageous to those who do not want to kill any more
trees for the purposes of creating tax returns to be filed and
stuck in a vault somewhere.
Your testimony, I think, provides us with some additional
information about considerations that ought to be evaluated
with respect to processing and the administration of the code
itself. I think that is valuable.
I would encourage you to continue to work as Congress has
instructed you to work, to get to a return free system for as
many Americans as we can. And as I introduce this legislation
in Congress, with Democrat and Republican support, I hope it
contributes to a discussion that will lead to some compromise
approaches so that in the future tens of millions of Americans
who now file an annual return April 15th will be relieved of
that burden.
Mr. Chairman, thank you.
Senator Campbell. Thank you. You have convinced me that
when I was in college I should not have majored in P.E.
Additional committee questions
Thank you for appearing today, Commissioner. I am sorry
again that we had to hold you up, but we do certainly
appreciate you waiting around a bit.
[The following questions were not asked at the hearing, but
were submitted to the Department for response subsequent to the
hearing:]
Questions Submitted by Senator Dorgan
irs staffing in north dakota
Question. It is my understanding that the IRS reorganization
efforts may change IRS staffing levels for walk-in customer service in
North Dakota as well as the use of mobil units. Would you please
provide details of these plans as well as their effect on current IRS
staffing in North Dakota?
I have a paper which provides more detail on this and would
appreciate your looking into this and getting back to the Subcommittee.
(Paper was provided to the Commissioner separately).
Answer. The Modernized Internal Revenue Service (IRS) is being
designed with emphasis on its customers. Although staffing numbers have
not yet been finalized, the chart below addresses the issues in North
Dakota and our proposed actions.
------------------------------------------------------------------------
Recommendation Action
------------------------------------------------------------------------
Unnumbered (1st paragraph of To provide the greatest
recommendations). There is already assistance, we decided to have
one GS-14 branch chief working in at least one TEC territory in
North Dakota. We don't need each state, which will be
additional GS-14 or GS-15 positions. managed by a GS-15 TEC manager.
We need field staff who do the work!. We feel strongly about having a
separate manager because of the
importance of education and
outreach in the new IRS. The TEC
Territory Office will stand up
by October 1, 2002. A Compliance
Territory Manager will replace
the GS-14 branch chief position
currently in North Dakota.
Staff a dual position taxpayer SB/SE and W&I will each have
education/communication at the GS-11 communications and education
or GS-12 level. functions (TEC and SPEC
respectively) in North Dakota.
TEC will have the following
positions: one GS-07, three GS-
12, two GS-13 and one GS-15 in
Fargo; and will also have two GS-
12 in Bismarck. This territory
is scheduled to stand up by
October 1, 2002. Until then, the
St. Louis Office will service
the taxpayers. SPEC will have
two GS-13 Partnership
Specialists in Fargo. This
office is scheduled to stand up
by October 1, 2001. Until then,
the Minneapolis Office will
service the North Dakota
taxpayers.
Increase the Information Systems (IS) We are still working on the final
staffing for fiscal year 2001 by one. design, and will consider your
comments before finalizing the
staffing.
Need additional RO positions to cover While we do not plan to add
western ND and be stationed at Grand revenue officer (RO) positions
Forks. in Grand Forks at this time, we
will consider your
recommendations as we finalize
our staffing plans for the
future. The current SB/SE design
reflects a Compliance Territory
for North Dakota, and includes
employees in four posts-of-duty.
Currently, there are revenue
officer positions in the
following posts-of-duty: Fargo
(6), Bismarck (1), Dickinson
(1), and Minot (1). Even though
we do not plan to put an RO in
Grand Forks, we will be adding a
new position which will handle
some duties of an RO (see Item #
6).
Hire two additional CSRs in Minot.... Instead of hiring additional
CSRs, we will provide service to
Minot and Williston by a mobile
van, one day a week at both
locations throughout the year.
These mobile units are self-
contained, and have the ability
to set up as stand-alone units
at libraries, shopping centers,
etc., or to set up displays at
requested and/or pre-determined
locations. The objective of the
W&I Field Assistance design is
to locate services within a
reasonable commute of the
taxpayers it serves who still
require face-to-face contact
with the IRS. These taxpayers
are the low to mid-income
individual income tax return
(Form 1040) filers who require
significant return preparation
assistance, and who are in the
young and middle age groups. W&I
also plans to offer assistance
with kiosks as well as the
combination of traditional fixed
sites and mobile units.
Hire one additional CSR in Grand Currently there is one CSR in
Forks. Grand Forks. Early in fiscal
year 2001, our plan calls for
two Taxpayer Resolution
Representative (TRR) positions
in Grand Forks. The newly
created TRR position will
combine most aspects of the
traditional walk-in assistor,
the tax auditor, and limited
duties of the revenue officer,
thus providing a greater range
of services in our walk-in
offices and minimizing the need
for referrals. When offices are
fully staffed by TRRs, we will
no longer require detailing
compliance personnel to provide
assistance during filing season.
As discussed earlier, we will be
analyzing the best method to
service taxpayers at each
location, but have not completed
our analysis of Devils Lake.
Hire one additional CSR in Fargo..... By the end of fiscal year 2001,
our plan calls for six TRRs in
Fargo, and service to both
Jamestown and Wahpeton by mobile
van one day a week each,
throughout the year. Currently
there are three Contact
Representatives and two Tax
Examiners in Fargo. On October
1, 2000, there will be four CSRs
in Fargo.
Hire one additional CSR in Bismarck.. The current CSR staff of one GS-
08 will be maintained for
Bismarck. Dickinson will be
serviced by a mobile van one day
a week, throughout the year. We
will consider changes in the
future depending on workload and
budget availability
Hiring additional CSRs may justify W&I organization design calls for
having a walk-in manager. a GS-13 walk-in manager in
Fargo. The Belcourt area will be
serviced by a mobile van, one
day a week, throughout the year.
We plan to maintain the current
staff of seven Customer Service/
Taxpayer Service/Office
Collection Representatives (CSRs/
TSRs/OCRs) at stand up on
October 1, 2000. By the end of
fiscal year 2001, our plan calls
for increasing the staffing to
13, and expanding the
responsibilities and authority
of the employees.
------------------------------------------------------------------------
tax returns
Question. How many hours does the IRS estimate American taxpayers
will spend this year in complying with the federal tax laws? What is
the cost of the federal compliance?
Answer. The total estimated burden hours that taxpayers spend in
complying with all IRS forms and regulations through the end of fiscal
year 1999 is approximately 5.8 billion hours. We do not have an
estimate of the cost of the federal compliance.
Question. How many 1040EZ forms does the IRS expect will be filed
for this year. How many 1040A forms, and how many for 1040s?
Answer. As of June 2, 2000, we had received the following counts of
Tax Year 1999 returns filed on paper: 10.7 million paper 1040EZ; 13.8
million paper 1040A; and 45.6 million paper 1040.
Question. How long does the IRS estimate it takes for a 1040EZ
filer to keep records, learn about the law, prepare the forms, copy,
assemble and send this form to the IRS? How about the 1040A, and the
1040?
Answer. The time estimates as published in the Tax Year 1999
instructions books are as follows:
----------------------------------------------------------------------------------------------------------------
1040EZ 1040A 1040
----------------------------------------------------------------------------------------------------------------
Recordkeeping................................................. 5 min 1 hr., 11 min 3 hr., 15 min.
Learning about the law........................................ 1 hr., 34 min 2 hr., 42 min 2 hr., 39 min.
Preparing the form............................................ 1 hr., 47 min 4 hr., 31 min 6 hr., 22 min.
Copying, assembling, and sending the form to the IRS.......... 20 min 35 min 35 min.
-------------------------------------------------
Total................................................... 3 hr., 46 min 8 hr., 59 min 12 hr., 51 min.
----------------------------------------------------------------------------------------------------------------
Question. How many pages are the instructions for the 1040EZ, the
1040A and 1040.
Answer. The 1999 Tax Year 1040 family tax booklets had the
following page counts:
1040EZ............................................................ 32
1040A (including the instructions for schedules 1 and 2).......... 68
1040 (not including any instructions for schedules)............... 72
Question. Because of this burden on filing, how many taxpayers use
a paid tax professional to help prepare their tax returns?
Answer. Our reports show that 57 percent of taxpayers used a paid
tax professional for Filing Season 2000.
Question. Of these estimated 127 million individual tax returns,
how many will be filed in the traditional manner (i.e. on paper,
through the mail)? How many will be filed electronically this filing
season?
Answer. For 2000, we project 92.1 million paper returns and 35.3
million electronic returns will be filed.
Question. How many people does the IRS employ to process the non-
electronically filed returns?
Answer. At filing season peak, there are approximately 30,000
people on roll in the submission processing function at the service
centers.
Question. What proportion of your budget is dedicated to processing
the non-electronically filed returns? How much does that cost?
Answer. Approximately 11 percent of the total budget is associated
with processing non-electronic returns. That equals $896.5 million.
Question. How many processing centers are there nationwide?
Answer. There are 10 service centers.
Question. I understand that some of these centers are very old and
in need of repair. How much does it cost to operate all of these
centers?
Answer. For this fiscal year, a total operating cost of $204.4
million is designated.
conclusion of hearing
Senator Campbell. With that, this subcommittee is recessed.
[Whereupon, at 3:40 p.m., Thursday, April 13, the hearing
was concluded, and the subcommittee was recessed, to reconvene
subject to the call of the Chair.]
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