As Americans struggle to complete their 2020 federal income tax returns by the pandemic-extended May 17 deadline, they likely wish there was an easier way. A new study by Bucknell Freeman College of Management Professor James Lawson, accounting, suggests that another way is possible.
Lawson and his co-authors Marcus Doxey and Shane Stinson, both accounting professors at the University of Alabama, examine the effects of prefilled tax returns on individual decision making. Under a prefilled system, the government fills in lines on each individual's tax return and sends it to the individual for review. Upon receiving the prefilled return, the taxpayer has the option to accept it or make corrections before signing.
Prefilled returns are common in many European countries. The Tax Filing Simplification Act of 2019, which was sponsored by prominent senators including Elizabeth Warren and Bernie Sanders, would also allow the U.S. government to prefill tax returns for a variety of individuals.
In their study, published last month by the Journal of the American Taxation Association, the authors explain the benefits of a prefilled system. The average American spends 11 hours completing a tax return with an out-of-pocket cost of $210, and a prefilled system could drastically reduce this burden of compliance. The Internal Revenue Service (IRS) also currently estimates that $441 billion in tax revenue goes uncollected each year due to non-compliance, and prefilled returns could potentially reduce this "tax gap," making a significant impact on the nation’s federal budget.
"The largest component of the tax gap is due to individuals not reporting income on their tax returns," Lawson says. "In the paper, we conclude that accurate prefilled returns can increase compliance — so increase revenue collected by the government — and also decrease the burden faced by individuals in collecting and preparing information throughout the year."
To conduct their study, the authors employed several experiments with a national sample of more than 1,000. The experiments tested respondents on their likely tax compliance and willingness to report previously unreported income through the use of prefilled tax returns.
The researchers found that the key to making prefilled tax returns work for all parties, in theory, came down to estimating undocumented income accurately.
While there are advantages to a prefilled system, new issues could potentially arise. According to Lawson, the previous "bare-bones" Senate proposals wouldn't reflect undocumented income accurately on prefilled returns. And consistent with psychology's omission theory, the experiment showed that respondents likely wouldn't report additional income themselves when their prefilled returns omitted it.
"People might not be inclined to lie, but they might not correct a lie — that's the omission bias. When you fill out a return, you're attesting to the government that you reported everything," Lawson says. "But it might be a little different if all of a sudden the government sends you something that doesn't include your undocumented income and you say, 'Oh, you left this information off, I'm just going to accept it and say it's accurate.' We actually found that to be the case, and in those cases, taxpayer compliance decreased."
But when prefilled returns accurately estimated undocumented income, the researchers found increased compliance through respondents. They also documented some potential benefits to taxpayers in the paper.
"It could be a win-win. The IRS collects more of the taxes owed, so government revenue actually goes up," Lawson says. "As one example of a benefit for the taxpayer, consider the earned income tax credit, which is predominately for low-income tax filers. Claiming that credit can be pretty complicated and the IRS itself estimates that 20% of the people who qualify don't claim it — leaving up to $3,600 on the table for families. In theory, with a prefilled return that correctly populates all of the information, someone could claim and benefit from the earned income tax credit when they didn't even know about it."
Lawson acknowledges that lobbying efforts by large tax-preparation entities would be an obstacle to future prefilled tax return legislation in the U.S. Still, with Democrats now in control of the presidency and both houses of Congress — and previous proposals coming from prominent Democratic senators — the political climate may be right for renewed interest in a prefilled tax return proposal.
"It would be more likely to be brought up in Congress than it was previously," Lawson says. "Whether or not there is enough support to pass the bill is certainly debatable. But it's at least more likely than it would have been two years ago."
Lawson also speculates that advances in reporting technology and increased reporting requirements for businesses and banks would raise the likelihood of prefilled returns being implemented in the U.S.
"The idea behind prefilled returns — ensuring that everyone pays what they actually owe while reducing the heavy burden of compliance — is admirable," he says.