Last week, President Obama's tax reform commission came out with their long-overdue report--buried on a Friday during the August recess.

One area of the report worth exploring is the section on "return free" tax filing--a polite way of saying that the IRS would do your tax return for you, calculate your balance due or refund, and leave it up to you to take on City Hall.  This is a bad idea because it puts the IRS in a conflict of interest.  The IRS has an interest in maximizing the legal amount of tax owed.  Taxpayers have an interest in minimizing the legal amount of tax owed.  This healthy friction, what we've called "benign adversarialism," is what creates our system of voluntary tax compliance.  To upset this balance would also reverse the default assertion (that made by the taxpayer) as the basis for compliance review.  Rather, the new baseline would be the IRS version of the tax return, and it would be up to the taxpayer (with his much inferior resources) to challenge the behemoth.

The Obama tax commission didn't see it that way.

In their "Option Group D" (starting on page 41), they examine the California "return free" system.  In that state, the Department of Revenue sends pre-filled returns to simple taxpayers.  It's up to the taxpayer to dispute the state's findings.  The question is raised as to whether this would be appropriate for the IRS to do.

In examining the report, it's clear that it would not be:

1. The report itself acknowledges that most of the compliance cost burden is carried by taxpayers with complex business returns.  By definition, these taxpayers could never be eligible for a return-free system
2. The conflict of interest for the IRS we discuss above is never mentioned.  Neither is the fact that the instigative of the return shifts from the taxpayer to the IRS.
3. Simple taxpayers already have a wealth of free options, most notably the "Free File" program that personal software providers partner in.  It's not clear how the return free system helps in any way relative to Free File, especially when you consider the conflict of interest problem
4. The same simple taxpayers who have only wage income also often have a complicated return due to federal refundable tax credits.  That takes a lot of the bloom off the rose.

Altogether, this is an idea whose time has not come.

Helpfully, there is a second part of this section which recommends electronic retrieval of tax records.  This is a great idea.  If you can import your Facebook friends to the latest social network, you should be able to download your W-2s and 1099s to your tax return software (or your tax professional's).  This is a tool to make tax compliance easier for taxpayers, not give powers to the IRS that would change the very nature of our tax system itself.

Posted by Ryan Ellis on Wednesday, September 1, 2010 5:09 PM EDT

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