Using Technology to Simplify Individual Tax Filing

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Using Technology to Simplify Individual Tax Filing

Using Technology to
Simplify Individual Tax Filing

Abstract - Compliance costs of individual tax ﬁling have been
estimated at roughly ten percent of the taxes raised. This ﬁgure
does not include hard–to–monetize costs of anxiety, aggravation
and the like. This article analyzes two related technology–based
programs that promise to reduce these costs. Both programs rely
on the fact that the government already receives the bulk of data
required to populate a tax return. The ﬁrst program would allow the
taxpayer or her preparer to retrieve such data from the government.
Under the second program, the government would give taxpayers
with simple returns the option of receiving not only tax data, but
a pro–forma or tentative tax return based on the data. In a Cali-
fornia pilot program, 50,000 of these pro–forma “ReadyReturns”
were sent to taxpayers in 2004 and 2005. Participants gave high
ratings to the ReadyReturn pilot; however, a number of criticisms
were levied against the program. The major difﬁculty with either
the data retrieval or pro–forma return program is ensuring the
timely availability of data.

INTRODUCTION

T he individual tax ﬁling system imposes substantial costs
upon taxpayers. Estimating those costs is an imprecise
art, which requires a combination of deﬁnitional assump-
tions (e.g., what counts as a cost of ﬁling as opposed to tax
planning) and methodological approaches (e.g., how best
to extract information from taxpayers on time spent ﬁling).
Guyton, O’Hara, Stavrianos, and Toder (2003) have estimated
these compliance costs at somewhere between $67 and
$100 billion a year, or about ten percent of the tax raised.1
Approximately 60 percent of those costs are estimated to
come from taxpayers with self–employment income (e.g., sole
proprietorships). This leaves aggregate costs of approximately
$40 billion borne by individuals with wage and investment
Joseph Bankman
income, for whom the proposals discussed herein are primar-
Stanford Law School,
ily designed.2 In one very important sense, all of these ﬁgures
Stanford University,
Stanford, CA 94305– 1
These estimates are broadly consistent with previous estimates by Slemrod
8610
and Sorum (1984) and Blumenthal and Slemrod (1992).
2
Guyton et al. (2003) give a “mid point” estimate of $39.3 billion dollars for
this group. In fact, the proposals discussed herein would simplify ﬁling
National Tax Journal for those with self–employment income as well, just not by as much. See
Vol. LXI, No. 4, Part 2 discussion at 6, supra. In that respect, the aggregate costs addressed by this
December 2008 paper considerably exceed $40 billion. All ﬁgures are for the tax year 2000,

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NATIONAL TAX JOURNAL

understate the real costs, since they do not ReadyReturn and the promise of pro–
(and cannot) directly incorporate the frus- forma returns.
tration and anxiety with which Americans
view the ﬁling requirement.3 These costs
also fail to capture how anger about the DATA RETRIEVAL: SIMPLIFYING
burdens of ﬁling affects attitudes toward FILING FOR THOSE WITH COMPLEX
the tax system and government—a subject RETURNS
touched upon later in this paper. Illustrative Case
In recent years, efforts to reduce ﬁling
costs through technology have gotten As noted above, the promise of technol-
increasing attention from tax policymak- ogy to simplify ﬁling is most often thought
ers. This is due in part to the changes of in connection with taxpayers with low
technology has wrought in other facets income or simple returns. In fact, technol-
of daily life, and in part to the realization ogy might signiﬁcantly reduce costs borne
that our ﬁling requirements are far more by non–self–employed taxpayers with
onerous than those of virtually any other high incomes and complicated returns. It
nation. We are one of the few nations, will be useful here to discuss this promise
for example, to impose a ﬁling burden in the context of a hypothetical taxpayer
on the ordinary worker. The California with a taxable income of $750,000, and
ReadyReturn project, which used technol- who is loosely modeled to resemble the
ogy to make pro–forma returns available mean taxpayer in this group, as reﬂected
to a sampling of four million Californians by IRS data (U.S. Treasury, 2008a, 2008b).4
with simple returns, garnered attention For convenience, I will call this hypotheti-
even in the popular media (see, e.g., cal taxpayer Leslie.
Halper, 2006) and a program of federal Leslie has salary income, and income
pro–forma returns was put forward by from the exercise of nonqualiﬁed stock
two candidates in the 2008 pesidential race options. She has interest income from at
(Edwards, 2008; Obama, 2008). Technol- least one bank account. She has brokerage
ogy has the potential of reducing ﬁling accounts, which provide her with addi-
burdens on the upper end of the income tional taxable and non–taxable interest
spectrum even more, to the extent that income, qualifying and non–qualifying
we weight taxpayer time by an implicit dividends, and short– and long–term
wage rate and measure simplification capital gains and losses from the sale
in dollars. However, the government’s of publicly traded securities. She has a
ability to reducing filing burdens for state income tax refund, royalty income,
the poor or the wealthy depends on its and is a member of a partnership that
ability to make timely use of third–party provides her with ordinary and capital
reported data. gains and losses. She is married and
The ﬁrst part of this paper discusses has two kids. She itemizes and deducts
the role that technology might play in home mortgage interest, state and local
simplifying ﬁling for those with compli- income and property taxes and charitable
cated returns. The second part discusses contributions.

and would need to be adjusted for changes in preparer costs, changes in wage rates (which dictate cost esti-
mates for taxpayers’ time) and changes in the underlying law.
3
The inability to monetize these forms of costs is explicitly discussed in Guyton et al. (2003). In fact, to the extent
these costs can be/are eliminated through off–loading ﬁling to a preparer, the estimates do incorporate these
costs by including preparation fees.
4
Unless otherwise noted, all ﬁgures are for the 2005 year, which is the most recent for which ﬁgures are avail-
able.

774
Using Technology to Simplify Individual Tax Filing

Leslie falls in the category of those with information return, thereby triggering a
complicated tax returns. We would expect notice of redetermination from the gov-
her to spend well over $1,000 preparing ernment.
her return.5 Suppose, however, that tax Leslie might, of course, continue to
software allowed Leslie to import all the incur costs associated with tax planning.
data reported in her name by third par- She might consult with an advisor as to
ties onto the correct line item on a return, when she might exercise options, estab-
automatically made simple arithmetical lish, contribute to or withdraw from a
computations (e.g., adding up interest retirement account, and so on. But ﬁling
income), and carried over her personal would require virtually no time and no
data (ﬁling status and dependents and decision–making. It seems plausible to
address, etc.) from the previous year. This imagine that Leslie might replace her
would be similar to what is now possible, accountant with a $60 software program,
for a price, for some limited number of and plausible to imagine that this same
items of income and deduction, through data retrieval program, if made available
programs such as Intuit’s Turbo Tax. The through a paid preparer, would reduce
only thing Leslie would have to add is her the costs of preparation for those who
charitable contributions. The tax software continued to use preparers.
could prompt her to add that and to add The idea of using data retrieval to
the few other items of income or loss that simplify ﬁling is not new. It is a primary
even a small percentage of persons with recommendation of the Electronic Tax
Leslie’s characteristics might have. Once Administration Advisory Committee’s
her contributions were entered, Leslie 2007 Annual Report to Congress (2007).
could hit “calculate” and be done with However, there has been little public or
ﬁling. published discussion of how such a sys-
Leslie would avoid the burden of saving tem might work and what the obstacles
the dozen or so slips of paper that showed are to such a system. The remaining sec-
her wages, interest income, income from tions of this part discuss some of those
the sale of securities, taxes paid and home obstacles, including, most notably, the
mortgage interest. She would also avoid possibility that the Leslies of this world
the time required to determine on which have other sources of income or deduc-
line item each of the ﬁgures on each of tion for which third–party reporting is not
those slips should be entered, to compute available, and the problem of (and pos-
and transcribe totals for each line item, sible solutions to) obtaining timely data.
and (depending on her present method
of tax ﬁling) to compute subtotals to put
Is Most of the Data Taxpayers Need
on various lines on her return. She would
Subject to Third–Party Reporting?
also save the aggravation and anxiety that
comes with these tasks. Leslie would also Each item of income of our hypotheti-
avoid the added costs and anxiety that cal taxpayer, Leslie, was subject to third–
come from having lost a 1099 or other party reporting6 and Leslie has been given

5
According to Guyton et al. (2003) supra note 1, those with adjusted gross income of over $120,000 in 2000
spent an average of about $450 per return and time monitized at a little over $1,000. These ﬁgures would be
adjusted upward to take into account inﬂation and other factors since 2000, and the fact that Leslie has income
far above the $120,000, raising both the level of complexity of her return and the imputed value of her time.
On the other hand, these ﬁgures would be adjusted down to reﬂect the fact that there is no self–employment
income.
6
However, as noted supra at 15, the reporting of capital gains and losses is now incomplete and must be
supplemented before it can be incorporated into a data retrieval system.

775
NATIONAL TAX JOURNAL

every signiﬁcant item of income listed in Rent is also a signiﬁcant source of com-
the IRS summary statistics for her income plexity for taxpayers in Leslie’s cohort.
cohort, save six: pensions and annuities, The income will generally not be subject to
social security beneﬁts, IRA distributions, third–party reporting; and the net income
income from estates and trusts, business must be determined after taking into
income, rents, and sales of non–capital account depreciation and other deduc-
property. The ﬁrst three items—retirement tions. Roughly one–sixth of all taxpayers
distributions and social security—were in Leslie’s cohort will show rental income.
excluded as inconsistent with the assump- Sales of non–capital property are the ﬁnal
tion that Leslie is actively employed. As source of complexity, since such sales may
these items are all subject to third–party not be subject to reporting with respect to
reporting as well, including these items either sale price or basis.
would not change the picture thus far What about deductions? The deduc-
drawn—that Leslie’s return is almost tions listed in IRS statistics for Leslie’s
exclusively a function of ﬁgures already cohort that Leslie does not have include
reported to the government. mortgage interest paid to individuals,
Estate and trust income was excluded points, investment interest expense, medi-
because of its relative rarity. Even in cal expenses above the ﬂoor, and miscella-
Leslie’s income bracket, only about one neous itemized deductions. Less than one
in 30 taxpayers showed income from percent of taxpayers in Leslie’s bracket
this source. However, this income, too, is deducted medical expenses, so this exclu-
subject to third–party reporting. sion seems reasonable. About four percent
Income from self employment (e.g., of taxpayers paid interest to non–ﬁnancial
Schedule C income from a sole proprietor- institutions and about eight percent had
ship) almost always requires computations deductible points. The ﬁrst of these items
based on numerous transactions (such is not subject to third–party reporting. The
as purchase and sale of goods) that are second is, but requires interpretation at
themselves not subject to third–party the taxpayer level. Both, therefore, are a
reporting. This form of income imposes source of some complexity for a minority
extremely high ﬁling costs and (due to lack of taxpayers in Leslie’s situation.
of third–party reporting) cannot be drawn Miscellaneous itemized deductions—
into the data retrieval system outlined comprised primarily of tax preparation
here. Roughly one–ﬁfth of all taxpayers costs and employee business expenses—
in Leslie’s income bracket have business pose another difﬁculty. Only about in one
income.7 The exclusion of this form of in 15 taxpayers in Leslie’s situation received
income is consistent with the focus of this a deduction here. On the other hand, more
paper, which is on the ﬁling costs of tax- than half the taxpayers reported some costs
payers with wage and investment income for these two items. The explanation for
only. To the extent Leslie has business this seeming paradox is that miscellaneous
income, and is included in a data retrieval deductions are deductible only to the extent
program, one very signiﬁcant source of that, in the aggregate, they exceed two per-
ﬁling–related complexity would remain. cent of the taxpayer’s AGI.8 Some taxpayers

7
About one–half of the taxpayers in this group had income from partnerships or S Corporations, which incur
compliance costs at the entity level. A substantial portion of the entity–level income may be realized from
transactions not subject to third–party reporting. As a result, this portion of costs indirectly borne by the
individual taxpayers will not be reducible by a data retrieval system.
8
I.R.C. section 68. The limitation is scheduled to be phased down for the 2008 and 2009 taxable years and then
increased for 2010. The decrease in the two percent ﬂoor would increase ﬁling costs (since more would be at
stake), and vice versa.

776
Using Technology to Simplify Individual Tax Filing

respond to the two percent ﬂoor by decid- in Leslie’s bracket that are not subject to
ing not to keep records of these expenses; third–party reporting. The vast majority
others keep records until it is apparent they of line items reported by a minority of
will fall short of the ﬂoor; still others keep taxpayers in Leslie’s bracket are also sub-
records and report those ﬁgures, learning ject to third–party reporting. However, a
perhaps only through the calculations of half dozen or so line items not subject to
their preparer or software program that the third–party reporting are reported by a
record–keeping was for naught. minority of taxpayers in Leslie’s bracket.
By far the largest miscellaneous item- The data reported by the IRS do not give
ized deduction claimed is tax preparation, a distribution table for the likelihood
claimed by about one–third of taxpayers. that a taxpayer will have one or more of
(It seems likely that virtually all taxpayers these deductions on her return. Perhaps
in this cohort incurred tax–preparation the most that can be said here is that for
costs; the fact that only one–third itemized most very–high–income taxpayers, virtu-
these costs indicates that most taxpayers ally all of the tax return consists of data
in this cohort realized that this deduc- already subject to third–party reporting.
tion, aggregated with other deductions, Automatic retrieval of that data and
would not exceed the two percent ﬂoor.) placement of that data onto tax software
The costs of tax preparation are, of course, should greatly reduce tax preparation
endogenous to the proposal set forth costs even for those taxpayers who have
here. As noted below, an expansive data two or more line items that are not tracked
retrieval system tied to tax software should by third parties.
substantially reduce tax preparation costs.
As the costs fall, the likelihood that total
Is It Possible to Get Third–Party Wage
miscellaneous itemized deductions exceed
Data to the Taxpayer in a Timely Fashion?
the two percent ﬂoor, already low, would
also fall. As that falls, the proportion of It has been commonly thought impos-
taxpayers who bother to track those costs sible to provide taxpayers with timely
or other components of the miscellaneous access to any third–party reporting. The
itemized deductions should also fall. base case here is wage reporting. Wages
The second largest miscellaneous item- provide the bulk of federal revenues and
ized deduction is unreimbursed employee the only source of data needed to pro-
expense, claimed by slightly under 15 vide pro–forma returns for a substantial
percent of all taxpayers in Leslie’s bracket. minority of the population. In a 2003
This deduction is itself a compilation of report on return–free ﬁling, the Treasury
a number of items, none of which can be cited the unavailability of timely wage
gleaned by third–party reporting, and data as a primary difﬁculty in moving
some of which require exercise of judg- to a pro–forma return system (Treasury,
ment or knowledge. On the other hand, 2003). The same issue (unavailability of
the proportion of taxpayers entitled to wage data) would obviously preclude a
claim this deduction should fall if, as meaningful data retrieval system. Pres-
suggested above, the decrease in costs of ently, wage data must be sent to taxpayers
tax preparation will drop many taxpayers by January 31, but is not due to the federal
below the two percent ﬂoor. government until the end of February
In sum, apart from charitable contribu- or, if ﬁled electronically, until the end of
tions, there are no individual line items March.9 The data goes ﬁrst to the Social
reported by the majority of taxpayers Security Administration (SSA) and then,

9
Treasury Regulation 1.6041–6.

777
NATIONAL TAX JOURNAL

in cleaned–up form, to the IRS. The 2003 Moreover, the fact that the data is submit-
Treasury report noted that in 1999 (pre- ted quarterly means that miscoded data
sumably the latest year for which statistics can usually be detected and corrected after
were available at the time the report was one of the ﬁrst three quarters of the year.
written), less than one percent of wage Another factor is that the federal govern-
data was posted to the IRS master ﬁle ment is just now transitioning out of an
by April. old data processing system, which is ill–
The lack of timely data is generally adapted to new tasks. More speculatively,
taken as a given in examining the desir- there may be institutional differences
ability of using such data to simplify between the agencies. The ReadyReturn
filing. In the 2003 Treasury report, for was conceived and developed by person-
example, respondents were polled about nel within the Franchise Tax Board (FTB).
the desirability of a pro–forma system, The agency has given the project priority
and then about the desirability of that and administrators have used considerable
system if it signiﬁcantly delayed refunds. ingenuity in designing around obstacles.
The question on delayed refunds was Looking toward the future, however,
designed to incorporate the fact that, due it is important to note that there is noth-
to a lack of timely data, pro–forma returns ing particularly state–of–the–art about
could not be supplied until after April California’s computing system. Nor does
15. Not surprisingly, enthusiasm waned the month–earlier deadline put any addi-
as refunds were delayed. It came as a tional material burden on employers: the
surprise to many, then, that in 2005 (for data that is required to be transmitted to
the 2004 tax year), the State of California the State on January 31 is the same data
was able to process wage data in time to that must be sent to employees by that
provide pro–forma returns for a sampling same date under both federal and state
of the 20 percent or so Californians whose law. Finally, as noted above, the FTB has
returns the previous year showed only not put signiﬁcant monetary resources
wage income (State of California, 2006). into the ReadyReturn project.
Just as surprising, perhaps, was the fact
that the task took up the time of only a
Improving the Timeliness of Wage Data
handful of employees; and the operat-
ing cost required to make such returns While the California turnaround time
available on–line for nearly one million for wage data is better than the federal
taxpayers is put at only a few hundred turnaround time, obtaining and making
thousand dollars a year.10 use of wage data in a timely fashion is
Why has California been able to imple- still a problem, even in California. There
ment a program the Treasury concluded is over a month gap between the time
could not be done at the federal level? when taxpayers receive their W–2s and
Perhaps the most important reason is that when the ReadyReturn is available. The
California gets wage data earlier, and in primary reason for this is not the time it
“cleaner” form. California employers must takes the data to go through the Employ-
report wage data quarterly; data for the ment Development Department (EDD);
last quarter is due on January 31.11 This is it is the deadline for employers to send
two months earlier than federal deadline. data. As noted above, that deadline gives

10
There is an additional cost of approximately $500,000 to build the system. While the one million returns will
be available on–line, far fewer than one million taxpayers are expected to log on to ﬁnd their return. See www.
ftb.ca.gov/readyReturn/readyreturn.971–3.pdf.
11
See www.edd.ca.gov—Required Filings and Due Dates.

778
Using Technology to Simplify Individual Tax Filing

taxpayers until January 31 to send data dollar amounts reported. An employer
to the government. Most taxpayers in the may ﬁnd that a sum should be put in
ReadyReturn population have refunds taxable pay rather than a pre–tax depen-
coming. Many of these taxpayers wish to dent care account, for example. Another
ﬁle a return as soon as possible after receiv- cause of correction, though, would be a
ing their W–2. By the time a ReadyReturn change of name due to marriage. A large
is available, many of these taxpayers employer will ﬁle corrections on less than
will have already filed their return. In 0.5 percent of employees. An employer
the ReadyReturn pilot program, the will typically hold corrections and make
unavailability of the ReadyReturn early only a single ﬁling of W–2cs a few months
in the ﬁling season was one of the biggest after its initial submission. There is much
single reason participants did not use the less information in a W–2c ﬁling than in
ReadyReturn (State of California, 2006). the initial transmission of wage data. The
Do the present reporting requirements veriﬁcation and transmission process may
and deadlines make sense? To understand take only ten minutes or so.
the issue better, it will be useful here to We are now at the point where we can
brieﬂy discuss the reporting process. The analyze the effect of the extended dead-
focus here will be on the federal deadline line on the employer. Under current law,
and on processes used by companies an employer needs to send wage data to
with over 500 employees. Such compa- employees before the end of January and
nies collectively employ the majority to the government by the end of March.
of American workers. Moreover, many If a mistake is discovered after the wage
smaller employers (as well as many larger data is sent to the taxpayer but before the
employers) outsource the reporting task end of March, the employer must provide
to payroll management companies that the taxpayer with a corrected W–2. The
use these same processes. Transmission of employer makes a corresponding correc-
data requires the employer to download a tion on the ﬁle that will be transmitted to
veriﬁcation program from the SSA. Data the government. It does not need to ﬁle a
is run through the veriﬁcation program W–2c since it has never ﬁled an incorrect
and then transmitted (in veriﬁed form) to record with the government.
the SSA. The process for an employer with Suppose now the employer were
20,000 employees might take a few hours of required to send out its wage data to the
computing/transmission time. The process government as well as the taxpayer by the
takes a few minutes for someone in the end of January, and that a mistake is dis-
payroll department to initiate, and a few covered after the wage data is sent out but
more minutes to monitor periodically. After prior to the end of March. As before, the
an initial run, the employer might ﬁnd that employer would have to send a corrected
a few ﬁles must be corrected. A representa- W–2 to the employee and make the cor-
tive cause of correction here might be the rection on government ﬁle. But now the
fact that an employee’s name contains an employer would also have to ﬁle a W–2c
apostrophe and the SSA does not accept with the government. Presumably, we
that punctuate mark in names. Correction would allow the employer to aggregate all
may take ten minutes or so, after which the mistakes and ﬁle only a single W–2c at the
process is repeated. In all, the transmission end of March. This would be consistent
process for the entire company might take with the current practice, described above,
an hour of one employee’s time. for mistakes that are discovered after the
If a mistake is found in the data after February transmission. These mistakes are
it is submitted to the SSA, the employer corrected in a single batch ﬁling of W–2cs
will ﬁle a W–2c. Some mistakes affect the at the end of the following quarter.
779
NATIONAL TAX JOURNAL

The net cost to the employer, then, rected information return now requires an
of a stepped–up deadline would be the amended tax return. Under a carryover
possibility that mistakes are discovered provision, smaller corrections would sim-
between the end of January and end of ply be added to or subtracted from income
March, and that these mistakes require the following year. Taxpayers would
an employer to spend the half hour or so receive an additional net beneﬁt, compared
transmitting the additional W–2cs. As a to the present system, in the form of not
social matter, these costs are low: in the having to file an amended return. The
context of a big ﬁrm, these costs might program could be made even more attrac-
aggregate to about a penny per employee. tive, at a small cost to the ﬁsc, by providing
However, as a political matter, leaving interest on any deferred downward adjust-
these costs on the employer for a beneﬁt ment to liability and not charging interest
that is enjoyed by a diffuse group of tax- on any upward adjustment.
payers might stimulate opposition even to It is possible that the savings to the
a plan that is manifestly desirable. It might government in combining error correction
be useful, then, to tie the requirement of with a single annual ﬁling might offset
more timely ﬁling to a reimbursement that asymmetric treatment of interest.
scheme for the costs of an additional set More generally, timely data should help
of corrections. the government by alerting it to errors
It would be possible to eliminate even before sending out refund checks. The
this slight additional cost. For example, California experience has been that once
an employer might be allowed to combine money is sent out, it is difﬁcult to reclaim.
W–2cs for mistakes discovered prior to the Timely wage data limits erroneous
reporting deadline with W–2cs for mis- refunds and is thought to save the State a
takes discovered after March 31, and ﬁle considerable sum.
those documents at the time it now ﬁles Concurrent submission to employees
its W–2cs. Assume, for example, that this and the government would accelerate
would occur in late April. If this approach wage data by a few weeks to California
is taken, then employees who receive and by as much as ten weeks to the federal
W–2cs should receive a notice stating that government. However, the federal data
they cannot rely on the W–2 data normally would still contain more errors, since it
downloadable, and instead should use the arrives annually and mistakes such as
ﬁgures on the W–2c. Here, the only cost badly coded data for new employees can-
is that borne by the rare employee who not be cleaned up in an earlier submission.
receives a W–2c; the cost entailed is that One solution to this problem is to require
they cannot take advantage of the data employers to report quarterly to the fed-
retrieval program for wage data. eral government, as they do to California
It might even be possible to provide and other states. Other solutions might
timely data retrieval and reduce the net involve strengthening or making manda-
social costs of information corrections, by tory the current E–verify program that
allowing errors beneath a certain threshold provides for early imput of social security
to carry over to the following taxable year. data on new hires.12
The advantage to the employer would
be small—it would be the savings of the
Other Common Sources of Data
costs of any extra transmissions of W–2c
data. The advantage to employees would The most common source of non–wage
be large. The reason for this is that a cor- income reported on tax returns for all

12
See http://www.ssa.gov/employer/ssnvadditional.htm.

780
Using Technology to Simplify Individual Tax Filing

taxpayers is interest income, followed by Ideally, basis reporting of publicly
dividends, state tax refunds, annuities and traded securities would be accompanied
pension distributions and social security by a related reform. Taxpayers are now
receipts; the most common source of given the choice of ﬁrst–in–ﬁrst–out (FIFO)
deductions are those for taxes and home or pick–and–choose inventory rules. Bro-
mortgage income. The analysis of ﬁling kerage houses, which provide the data to
deadlines for employers applies with taxpayers, make tax calculations based on
respect to these other common sources of FIFO. Presumably, this same rule would
income and deduction. A ﬁling deadline apply (as a default at least) with respect to
tied to the release of data to the taxpayer third–party reporting of basis. This would
would make government data much more leave the taxpayer who wants to minimize
usable to taxpayers. tax liability with the time–consuming task
of redetermining basis using pick–and–
choose, and then choosing between FIFO
Sales of Securities
and pick–and–chose. It would be better, as
Filing a Schedule D for the sale of secu- a social matter, to remove the pick–and–
rities and other capital assets is perhaps chose option and, if need be, compensate
the single most time–consuming task for investors (on an ex ante basis) through a
upper–income taxpayers. Taxpayers have lower capital gain rate, reduced holding
to know the rules governing categoriza- period, or increased offset allowable for
tion of property, calculate holding period, capital losses as against ordinary income.
and make numerous calculations. The If pick–and–chose were eliminated, there
task is made immeasurably harder by the would be no need or incentive for most
fact that third–party reporting is limited taxpayers to revisit the calculations of gain
to sales. This leaves the taxpayer with and loss made by their brokers.
the task of determining basis—a tedious
process for nearly all taxpayers and an
Data that Is Not in the System or Is
extremely difﬁcult process for taxpayers
Submitted Late
with frequent sales or long–held property
in companies that have merged, split off As a practical matter, it seems likely that
and so forth. Jay Soled and Joe Dodge some sorts of data will simply not be in
have argued that, in addition to making the system, at least during the early years
ﬁling harder for honest taxpayers, the of operation. This might happen because
lack of basis reporting leads to signiﬁcant the dollars involved are low and the cost
understatement (Soled and Dodge, 2006). of ﬁtting the data into the system high. In
Basis reporting for the sale of publicly general, this should not reduce the beneﬁt
traded securities has been proposed and of providing other data to the taxpayer.
supported as a revenue raiser by mem- Data retrieval is not an all–or–nothing pro-
bers of both parties and appears to have posal. Indeed, as noted above, there will
a substantial chance of enactment.13 That always be some data (such as charitable
reform should substantially reduce ﬁling contributions) that are not in the system.
costs and could easily be incorporated in It will be important, however, to warn
a data retrieval system. For other assets taxpayers against relying on the system
(such as art), neither basis nor proceeds to provide this data. Thus, users need to
is or is likely to be made subject to third– be alerted to what data can and cannot be
party reporting. retrieved through the system.

13
See, e.g., Treasury Department, General Explanation of the Administration’s Fiscal 2009 Revenue Proposals
at 64; H.R. 5720 (Housing Assistance Act of 2008), Section 301, introduced by Charles Rangel.

781
NATIONAL TAX JOURNAL

A related set of issues are raised by data The fact that pro–forma returns and
that is, as a class, in the system, but is miss- data retrieval lie on a continuum can be
ing in a particular case because a provider illustrated by imagining four types of
has not sent it out to either the taxpayer government–assisted return preparation
or the government in a timely fashion. A programs. The ﬁrst would consist only
taxpayer whose W–2 is not sent out by the of data retrieval on a “regular” 1040. The
employer until March 5 will not be able to second would customize returns based on
go on the system on January 30 and ﬁnd third–party information the government
his W–2. But this problem exists under the received. Taxpayers whose only reported
current system as well: a taxpayer cannot information was wages would ﬁnd their
now ﬁle until all necessary documents data on a 1040A or 1040EZ form. In effect,
have been provided. An intriguing issue the government would use knowledge
is whether the government might alert a from its data–retrieval capacity to limit the
taxpayer by email when it has received an scope of items the taxpayer would need
item of third–party reporting in his name. to consider. The third program would
This would make it easy for taxpayers to be identical to the second, except that it
know when it is appropriate to ﬁle. A less would explicitly note that, as far as the
ambitious role for the government might government knew, all necessary data had
be to alert taxpayers when it has received been entered on the return, and that after
an item of third party reporting only if reviewing the information for accuracy
the taxpayer has already ﬁled. Thus, the and missing data, the taxpayer need only
government might notify a taxpayer who hit calculate to determine her tax liability.
has ﬁled on March 10 that it has received a A sample note might read as follows: Last
1099 in his name on March 15. This would year you ﬁled a return that showed only wage
enable the taxpayer to ﬁle an amended income and you did not take any itemized
return prior to April 15 and, thus, avoid deductions. This year we have no record of any
any interest or penalties. The email here other source of income. We do not have record
would obviate the need for the govern- of any mortgage interest paid or other expenses
ment to send a notice of redetermination. that would make itemizing deductions worth-
while for you. We have ﬁlled out your return
with the wage data we have received and have
PRO–FORMA RETURNS relisted the information you provided last year
as to your marital status and dependents and
Relationship with Data Retrieval
given you the election to take the standard
The possibility of providing estimated, deduction. Carefully review this information.
or pro–forma, returns ﬂows directly from If it is correct, and you have no other sources
the data retrieval proposal outlined above. of income and no other itemized deductions,
High–income taxpayers will need to add you can simply hit calculate to determine your
only a few items of additional informa- tax liability. If the information is incorrect,
tion before hitting the calculate button you can type in the correct information and
on their computer. A substantial portion hit calculate to determine your tax liability.
of low–income taxpayers, or taxpayers The note might also contain assurances
with simple returns, will not need to add that the taxpayer need not ﬁle the govern-
any information before calculating their ment–supplied form—that she could ﬁle
taxes. For these taxpayers, the government her taxes by any other method.
can go further and provide not only data As is the case with the data–retrieval
retrieval, but estimated tax liability. In program outlined above, the taxpayer
effect, the government can provide them could elect to retrieve data through Turbo
the data and then hit the calculate button. Tax, Tax Cut, any other do–it–yourself
782
Using Technology to Simplify Individual Tax Filing

program, or authorize her preparer to The California ReadyReturn Pilot
retrieve data on a program of the pre- Program
parer’s choice.
Pro–forma returns have been used
The fourth program would provide the
in the Scandinavian countries for over
taxpayer with the wage data and tax liabil-
a decade and in recent years have been
ity and would come with a note pointing
adopted for use in other European, South
out that the tax liability was based on
American and Asian nations. (OECD,
information the government had received;
2006). The most relevant experience for
that the taxpayer must review the infor-
U.S. purposes, however, is the California
mation for accuracy; that if information
ReadyReturn, discussed brieﬂy above.
were inaccurate or missing, the taxpayer
ReadyReturns were sent to 50,000 partici-
must supply it. A sample note might read
pants in the ﬁling season for the 2004 and
as follows: Last year you ﬁled a return that 2005 tax years. Participants were chosen
showed only wage income and you did not among the 20 percent of Californians who
itemize deductions but instead chose to take filed the simplest returns. These were
the standard deduction. This year we have no individuals who, in the previous year, had
record of any other source of income for you. ﬁled returns as single individuals, with no
We do not have record of you paying mortgage dependents, no itemized deductions and
interest or having other expenses that would only wage income. Participants received
make it worthwhile for you to itemize your a letter explaining the program and a pro–
deductions. We have ﬁlled out your return forma return, called the ReadyReturn.
with the wage data we have received and have They were also given instructions on how
relisted the information you provided last year that data might be accessed on–line. No
as to your marital status and dependents and other state funds were expended to pub-
we have calculated your taxes based on that licize the program and, prior to the results
data. Carefully review this information. If it at the end of the ﬁrst ﬁling season, the
is correct, and you have no other sources of program received little publicity from the
income and no other reason to itemize deduc- media. Participation was 22 percent and
tions, you can simply sign your return and pay 23 percent, respectively, for the two years
the tax due/receive the refund shown on line of the study, slightly above the predicted
___. If the information is incorrect, you can 20 percent participation.14 Reasons given
type in the correct information and hit calcu- for lack of participation included satisfac-
late in order to receive the correct statement tion with a current preparer, reluctance to
of your tax liability. Taxpayers would be send information over the internet, per-
given the same assurance as listed above ceived ineligibility for the program (e.g.,
with respect to the third option—that due to additional sources of income or
they could ﬁle taxes by any other method expense), and that taxpayers had already
without increasing the likelihood of audit. ﬁled prior to receiving the ReadyReturn.
It should be readily apparent that the This last reason underscores the problem
differences between the third and fourth caused by the late employer deadline for
approaches are not great, and that the reporting wage data to the government.
statements that accompany the return Because employers provide employees
will affect the way taxpayers regard the wage data in early January but are not
program. required to provide that same data to the

14
All information in this section is taken from Franchise Tax Board 2006. The decrease in the participation rate
during the second year of the pilot was due to the fact that returns were made available at a later date so as
to ensure that the returns incorporated late–arriving wage data. The ﬁnal study focuses on the 2004 results
and the statistics presented are for that year. However, 2005 results seem very similar to 2004 results.

783
NATIONAL TAX JOURNAL

state until the end of that month, the FTB that one rarely associates with either
could not send out ReadyReturns until tax or government services.16 A repre-
late February or March, by which time sentative sample from the ﬁrst page of
many returns had been ﬁled. Roughly comments on the 2004 tax year includes
ten percent of those who did not use the following:
their ReadyReturn marked, as one of the
reasons, a reluctance to accept a return Great Pilot. Makes my life easier.
prepared by the government. In addition This is great and easy.
to the reasons stated, participation was Wonderful. Wish the feds would make it this easy.
presumably reduced by the lack of public- Was not clear what a PIN number was. I
ity and the reluctance of taxpayers to be thought it was something in the letter. Looked
“ﬁrst movers” on a new program. Given all over for it. Finally found it in the FAQ.
the positive response of the early adopt-
ers, described below, it seems likely that The results and comments are all
many of those who did not participate in the more striking because ReadyRe-
the initial program would in time choose turn was a pro–forma return only for
to participate. Participation would also California taxes. Pilot participants still
increase if, as suggested above, the dead- had federal taxes to do. The comments
line for reporting tax data to the govern- suggest that the costs of ﬁling are not
ment were moved up. Federal adoption of limited to time and money but include
a pro–forma return should also increase anxiety and aggravation. These feelings
participation on the state level. The pos- may be in part attributable to the low
sibility of extending the program to the functional literacy of many taxpayers,
federal level and its effect on participation and the difﬁculty these taxpayers have
is discussed below. understanding documents. A leading sur-
Those who participated rated the pro- vey of adult literacy gave approximately
gram very highly. Ninety–nine percent of one–third of adults basic or below–basic
the on–line ﬁlers reported they were very document literacy skills.17 Approximately
satisﬁed or satisﬁed with the program; half of the population document was
98 percent of those taxpayers said they rated at a skill level below that which
would use the program again next year.15 would allow one to ﬁnd the time a tele-
The median user reported saving 40 min- vision show ends, using a newspaper
utes and $30. television schedule.18 Not surprisingly,
Perhaps the most striking survey results the survey found that skills decline with
were the qualitative comments of users. income.19
About ten percent of the comments dealt The early adopters of ReadyReturn
with easily corrected ﬂaws in the beta appear (by their comments) to be quite
version of the program. The remaining literate. The gratitude with which they
comments exhibit a kind of enthusiasm viewed the program indicates how
15
The ﬁgures for paper ﬁlers are similar—98 percent were very satisﬁed or satisﬁed and 97 percent said they
would use the program again the following year. Since the program that is to go into effect, and that I have
outlined here, would be web–based, I have consistently used the responses for the on–line ﬁlers (where those
are separately broken down).
16
User comments are listed in their entirely at www.ftb.ca.gov/readyreturn/user_fdback.shtml
17
Kutner, M., Greenberg, E., Jin, Y., Boyle, B., Hsu, Y., and Dunleavy, E. (2007). Literacy in Everyday Life: Results
From the 2003 National Assessment of Adult Literacy ( NCES2007— 480). U.S. Department of Education. Wash-
ington, D.C.: National Center for Education Statistics, at 35.
18
Id. at 7, 12 (Mean document literacy 271 on a scale of 1 to 500, scale with 269 described as the ability to ﬁnd
the ending time of a television show using a newspaper guide.).
19
Id. at 31.

784
Using Technology to Simplify Individual Tax Filing

unpleasant (and perhaps confusing) ﬁling tion of a ReadyReturn–type system. The
is even for that class of taxpayers.20 federal return lacks the renters credit that
An intriguing possibility, suggested the California return contains, but, more
by the comments, is that a workable signiﬁcantly, includes an earned income
pro–forma return program may have a tax credit. Gooslbee (2006) concludes
spillover effect on the way taxpayers feel that the earned income tax credit could
about the tax system or (to a much lesser be incorporated in a pro–forma return.
extent) government. “Wow!,” wrote one However, the earned income tax credit
respondent, “Government doing some- requires additional items of information.
thing to make life easier for a change.... It seems unlikely, therefore that an initial
The Feds should take notice.” “Thank pro–forma return program would incor-
you so much, FTB,” one taxpayer wrote, porate an earned income tax credit.21
“You’re great.” Another said, “Whoever In one respect, the proportionate sav-
thought of this deserves a big, fat RAISE.” ings from a federal pro–forma return
Another praised California Governor program is apt to be greater than from
Arnold Schwarzenegger, whose represen- the ReadyReturn program. While the two
tative had, in fact, supported the program: forms require similar information, it seems
“Go Governator!” likely that most taxpayers regard their fed-
Ironically, as discussed in the next sub- eral return as their primary return. Such
section, the possibility that the program taxpayers are apt to base ﬁling decisions
leads taxpayers to feel better about the tax on the federal return and, therefore, be
system is at the core of one of the objec- uninterested in a separate program for
tions to the program. the state return. As a result, the partici-
pation rate in a federal pro–forma return
program is apt to be higher. The California
Extension to Federal Returns
taxpayers who used ReadyReturn, but
As discussed above, a pro–forma return regard the federal return as primary, may
program is closely related to, and cannot have already ﬁlled out their federal return
exist without, a data retrieval system before reviewing their ReadyReturn. This
for wages. The impediments that must would leave some portion of the ﬁling
be overcome before that system can be cost that is common to both returns (e.g.,
implemented, together with proposals for ﬁlling in wage data) a marginal cost of the
removing some of those impediments, is federal return. In general, to the extent
also discussed above. taxpayers base ﬁling decisions on their
The federal return also differs from federal return, and complete their federal
the California return in a few ways that return ﬁrst, the ReadyReturn experiment
would be relevant to the federal adop- would understate the participation rate

20
It is possible, of course, to avoid some of these costs by hiring a preparer and the great majority of Americans
do rely on either preparers or electronic software to help them ﬁle. But even taxpayers who take this route are
still left with record–keeping tasks, the task of ﬁnding the right preparer and (for some) the uncomfortable
feeling that they do not know enough to make informed choices. The perceived difﬁculty of ﬁling may lead
some taxpayers to become non–ﬁlers. In California, at least, the majority of non–ﬁlers have refunds coming.
21
This is in fact the conclusion Gooslbee reaches. Goolsbee proposes four waves of pro–forma returns. The ﬁrst
wave would encompass only wage income; the second would include interest and other forms of income
subject to third–party reporting, and capital gains; the third would include the EITC; and the fourth would
include certain items of deductions, such as mortgage interest. See Goolsbee (2006) at 11. Most ReadyReturn
participants had income far in excess of the maximum allowable under the EITC, suggesting the existence of
a sizeable population of that could beneﬁt from a wages–only pro–forma return modeled on the California
pilot. Goolsbee reaches a similar conclusion, putting the maximum population of the “ﬁrst wave” of
pro–forma– return recipients at over 17 million. Goolsbee at 9.

785
NATIONAL TAX JOURNAL

and cost savings from a federal program. report such amounts and, a fortiori,
The fact that federal return preparation no reason to believe that a pro–forma
is generally more expensive than state return would incorrectly overstate such
return preparation would add to this amounts. If pro–forma return eligibility
result. On the other hand, some taxpay- is determined with respect to last year’s
ers might use one pro–forma return to tax data, it is possible that a return would
help complete the other non–pro–forma be sent out to a recipient who in the pres-
return. This would increase the beneﬁts ent year had additional deductions and
of a federal pro–forma return in states would be better off itemizing. By far the
in which there is no existing pro–forma most likely additional deductions would
return, and vice versa. There are other be home mortgage interest and (at the
potential interactions between a state and federal level) an increase in state tax paid.
federal returns. For example, it is possible Overstatements of net income would be
that some taxpayers would require both possible only if the taxpayer had in fact
state and federal pro–forma returns before incurred those additional expenses and
using either pro–forma return. This would did not correct the return. If, as recom-
not affect the net beneﬁt of a pro–forma mended in the ﬁrst section of this article,
return system, but would make any allo- pro–forma returns were accompanied by
cation of that beneﬁt arbitrary. a data retrieval system, even this possibil-
ity could be eliminated. The data retrieval
system could be used to check for these
Objections to Pro–Forma Filing
two additional deductions. If pro–forma
Despite its apparent success, ReadyRe- returns were limited to non–itemizers, the
turn was subject to considerable criticism. taxpayer with these deductions would not
Presumably, these same criticisms would receive the return in the ﬁrst place.
be levied against any other pro–forma Overstatement of tax liability might also
returns. occur if the taxpayer married or acquired
additional dependents in a taxable year.
Effect on Taxes Paid This is true because the tax liability on the
The ReadyReturn has been criticized returns would be based on the prior year’s
by Grover Norquist and others as a reported marital status and dependent
disguised increase in taxes (Norquist, information. Instructions accompanying
2005; California State Senate Republican a pro–forma return would need to ﬂag
Caucus, 2006). This claim appears to be this issue. Of course, there is no reason
based on the assumption that at least to believe that, on the whole, incorrectly
some ReadyReturns will overstate income reported marital status or dependent
and that recipients themselves accept the information would increase, rather than
(incorrectly high) tax amount stated on decrease, tax liability.
the return. In fact, it is much more likely that pro–
In fact, the likelihood that income forma returns will lead to a (small) reduc-
might be signiﬁcantly overstated by the tion, rather than increase, in tax paid. The
ReadyReturn or any other pro–forma reason for this is two–fold. First, taxpayers
return is quite low. The pro–forma return will be less likely to report income from
would include only the income reported moonlighting and other sources that is
on the W–2 or (depending on the scope not subject to third–party reporting. The
of the pro–forma return) other sources difference should be minor, however,
of income subject to third–party report- because taxpayers do not now generally
ing. There is no reason to believe that report cash income, presumably because
a pro–forma return would incorrectly they know that such tax is not subject to
786
Using Technology to Simplify Individual Tax Filing

third–party reporting and, therefore, not dent’s Advisory Panel on Tax Reform, for
likely to be detected by the government example, former Deputy Assistant Secre-
(Bankman, 2007). Moreover, to reduce tary for Tax Analysis Eric Toder suggested
the amount of this form of non–reported that the ﬁling process might serve as an
income, instructions to pro–forma returns occasion for ﬁnancial planning (Toder,
might speciﬁcally state that this income 2005). Others have stated that ﬁling con-
must be reported, and state penalties nects citizens to the tax system and their
for not reporting such income. A second government and that active participation
possible source of reduction in taxes paid in ﬁling, like active participation in voting,
is that taxpayers will correct errors only is a good merit.
when doing so is in their favor. This dif- A primary difﬁculty with either objec-
ference, too, should be small, because the tion is that ﬁling itself is mostly an exercise
most likely source of error is the W–2 data, in reading comprehension, numeracy
and erroneous W–2 data, unless corrected, and transcription, as taxpayers read the
will generate the same error whether or instructions, copy the numbers on forms
not the taxpayer ﬁlls out her own return onto the corresponding lines of their
or ﬁles a pro–forma return. Consistent return, and perform certain arithmetical
with this analysis, a follow–up study to operations. If ﬁnancial planning were the
the California ReadyReturn pilot program goal, we would be much better off reliev-
showed the program reduced revenues ing taxpayers of the ﬁling burden and
by a few dollars per return (Franchise providing them one or two tips toward
Tax Board, 2006). In one respect, this fol- ﬁnancial literacy. Similarly, if education
low–up study exaggerated costs, since in about the tax system education were the
California there was no contemporaneous goal, we would be better off providing
check to see whether the taxpayer received with a pro–forma return a statement of
interest income. Instead, the State relied the taxpayers’ average and marginal tax
on the fact that during the previous year rate, and an explanation of why each is
the taxpayer received no such income. important—or perhaps a chapter from
Thus, the few dollars per taxpayer cost Joel Slemrod and Jon Bakija’s terriﬁc book,
probably reflected undetected interest Taxing Ourselves.
income. If pro–forma filing were con- The fact that most Americans have
nected to the data–retrieval system out- already relieved themselves of full par-
lined above, such interest income would ticipation in the ﬁling process by hiring
be “in the system” prior to the time the preparers probably also militates against
pro–forma return is made available to these objections. To the extent that hiring
the taxpayer. It would either be reﬂected a preparer reduces the financial plan-
in the return or (if eligibility were limited ning or participatory values in ﬁling, the
to those without interest income), taxpay- pro–forma return program would merely
ers with such income would not receive a allow the poorer class of taxpayers eli-
pro–forma return. As a result, this source gible for pro–forma returns to do what
of potential understatement of income a wealthier class of taxpayers is already
would be eliminated. doing.

Paternalistic or Citizenship–Related Downsides Tax Reform and Attitudes Toward Government
to Pro–Forma Returns One of the stated reasons for opposing
In private and public comments, a num- the ReadyReturn was that it is “not real tax
ber of people have expressed the belief reform” (California State Senate Repub-
that something is lost if the ﬁling process is lican Caucus, 2006). Presumably, this
simpliﬁed. In comments before the Presi- argument is not based on the premise that
787
NATIONAL TAX JOURNAL

the ReadyReturn or any other pro–forma To prevent even the remote possibility of
return system directly precludes any other compromised data, it may be sensible to
tax reform—clearly it does not and would provide taxpayers who do not wish to par-
not. Instead, the argument appears to be ticipate in the program the option of hav-
that a pro–forma return system reduces ing their data stored on separate servers.
citizens’ anger at the tax system, which
in turn reduces impetus for other, more
CONCLUSION
desirable reforms; and that the net result
is a worse, rather than better, tax system. The enthusiastic user response to the
The ﬁrst of these assumptions—that a California ReadyReturn pilot shows the
pro–forma return program reduces tax- promise of using third–party data to
payer anger—is probably correct. That, calculate estimated tax liability for taxpay-
at any rate, is the reading of the taxpayer ers with simple returns. The social gains
responses to the ReadyReturn project set from using third–party data to populate
forth in the ﬁrst subsection of this second more complicated returns should be even
section of the paper. The second and third greater. Implementation of either pro-
assumptions—that absent such a program posal, however, will require changes in
we would adopt more desirable reforms— reporting deadlines, additional resources
rest on unstated and as yet unsupported devoted to verifying, storing and trans-
theories of political economy. mitting data, solutions to numerous
smaller problems that are sure to arise,
Privacy and Security Concerns and the support of the legislature and
The ReadyReturn was attacked by executive branch.
Grover Norquist and others as increas-
ing government collection of data and
REFERENCES
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In fact, the ReadyReturn and the kind of Bankman, Joseph.
pro–forma returns suggested here do not “Eight Truths About Collecting Taxes from
require collection of any new information. the Cash Economy.” Tax Notes 117 (October
In one sense, these programs enhance 29, 2007): 506.
privacy values by giving the taxpayer Blumenthal, Marsha, and Joel Slemrod.
access to the information already collected “The Compliance Costs of the U.S. Indi-
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California Public Interest Research Group California State Senate Republican Caucus.
(CALPIRG). “Brieﬁng Report: ReadyReturn.” February,
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