How Could We Improve the Federal Tax System?

Many countries have made it simpler for taxpayers to pay income taxes by either sending them partially or fully prepopulated tax returns. That approach depends on the tax authorities receiving sufficient and timely information about taxpayers’ income and expenditures from independent third parties.

As with those other countries, the IRS gets a massive amount of information from third parties. In 2022, the IRS received 5.5 billion information returns—W-2s, 1099s, and similar forms—from employers, financial institutions, and other organizations. The IRS also obtain some personal information about taxpayers (such as age) from the Social Security Administration.

Solely on that availability of third-party information, the United States could follow the lead of other countries and adopt a simpler filing regime. One study found that 42 to 48 percent of US federal income tax returns could be accurately prepopulated under 2019 law using information returns and personal information reported on prior year returns.

But the study highlighted the challenges of prepopulating individual income tax returns in the United States without fundamental changes to the tax code. While the accuracy rate was highest for taxpayers who did not have dependents or are unmarried, it declined as income rose—a reflection, in part, of the increased likelihood at higher incomes of having sources of income, dependents, or deductible expenses that are not independently reported to the IRS.

Moreover, the study was conducted under 2019 tax law, when the temporary income tax provisions in the 2017 Tax Cuts and Jobs Act (TCJA) were in effect. By increasing the standard deduction and diminishing the tax benefits of certain itemized deductions, TCJA significantly reduced the number of itemizers. The study’s estimates of accuracy rates would likely be smaller if those estimates were based on the tax law in effect after 2025 when many of the provisions in the 2017 Tax Cuts and Jobs Act (TCJA) expire and the tax benefits of itemizing the less-transparent deductions rise again.

Prepopulating tax incomes would present administrative challenges, even if the tax code was simplified. Over five billion information reports would have to be filed earlier and processed much sooner than is currently done by the IRS in order to complete pre-populating returns by April 15 (with refunds to follow later).

Changes in a household’s composition—for example, divorce or a child’s birth—since the prior year’s tax return would also contribute to inaccuracies unless the IRS had a portal for taxpayers to report those changes during the tax year. And if the taxpayer moved since the last tax return was filed, prepopulated returns might be sent to the wrong address,

But the IRS has some experience in adapting to changes in taxpayers’ circumstances. The IRS built a smaller-scale portal in 2022 for the administration of monthly advanced payments of an expanded child tax credit. Before creating the portal, the IRS could only deliver the advanced payments based on information reported in prior year tax returns or other government data. Errors were to be corrected when taxpayers filed their returns. The portal enabled taxpayers to report some changes in their household circumstances during the year and thereby avoid having to make repayments or claim delayed payments at filing time.

A similar portal could be constructed on a larger scale if returns were prepopulated. However, there is no guarantee that taxpayers would use the portal.

Prepopulating returns could either increase or decrease tax compliance. Prepopulating tax returns would enable the IRS to preemptively fill out returns for millions of people who otherwise would not file tax returns but either owe taxes or appear to be eligible for refunds and tax credits. But some taxpayers might view the prepopulated tax return as a signal of how much or little the IRS knows about their taxable income and choose to report only the portion of their income that is shown on the prepopulated returns. Underreporting of income not reported by third parties, already a significant source of noncompliance, could increase if prepopulating returns confirms the IRS’s incomplete knowledge of taxpayers’ circumstances.

Updated January 2024