U.S. GOVERNMENT PRINTING OFFICE

63–948 cc WASHINGTON : 2000

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

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

For sale by the U.S. Government Printing Office

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ISBN 0–16–060829–5
(II)

COMMITTEE ON APPROPRIATIONS

TED STEVENS, Alaska, Chairman

THAD COCHRAN, Mississippi

ARLEN SPECTER, Pennsylvania

PETE V. DOMENICI, New Mexico

CHRISTOPHER S. BOND, Missouri

SLADE GORTON, Washington

MITCH MCCONNELL, Kentucky

CONRAD BURNS, Montana

RICHARD C. SHELBY, Alabama

JUDD GREGG, New Hampshire

ROBERT F. BENNETT, Utah

BEN NIGHTHORSE CAMPBELL, Colorado

LARRY CRAIG, Idaho

KAY BAILEY HUTCHISON, Texas

JON KYL, Arizona

ROBERT C. BYRD, West Virginia

DANIEL K. INOUYE, Hawaii

ERNEST F. HOLLINGS, South Carolina

PATRICK J. LEAHY, Vermont

FRANK R. LAUTENBERG, New Jersey

TOM HARKIN, Iowa

BARBARA A. MIKULSKI, Maryland

HARRY REID, Nevada

HERB KOHL, Wisconsin

PATTY MURRAY, Washington

BYRON L. DORGAN, North Dakota

DIANNE FEINSTEIN, California

RICHARD J. DURBIN, Illinois

STEVEN J. CORTESE, Staff Director

LISA SUTHERLAND, Deputy Staff Director

JAMES H. ENGLISH, Minority Staff Director

SUBCOMMITTEE ON TREASURY AND GENERAL GOVERNMENT

BEN NIGHTHORSE CAMPBELL, Colorado, Chairman

RICHARD C. SHELBY, Alabama

JON KYL, Arizona

TED STEVENS, Alaska

(ex officio)

BYRON L. DORGAN, North Dakota

BARBARA A. MIKULSKI, Maryland

ROBERT C. BYRD, West Virginia

(ex officio)

Professional Staff

PATRICIA A. RAYMOND

TAMMY PERRIN

LULA EDWARDS

CHIP WALGREN (Minority)

Administrative Support

ELIZABETH BLEVINS (Minority)
(III)

CONTENTS

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

(1)

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.
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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
3

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
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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 returnfree 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.
5

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.
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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.
7

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 frontline 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.
8

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 returnfree 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.
9

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.
10

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.
11

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.
12

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,
13

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 returnfree 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.
14

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 socalled 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 applica-
15

tion 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 returnfree 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.
16

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 returnfree 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 returnfree 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.
17

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
18

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.
19

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
20

not typically targeted by income. Similarly, deductions are not subject to incomebased 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 returnfree 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 accu-
21

rately 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.
22

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.
23

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.
24

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.
25

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,
26

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.
27

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.
28

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:]
29

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 recommendations).

There is already one GS–14 branch chief working

in North Dakota. We don’t need additional GS–14

or GS–15 positions. We need field staff who do

the work!.

To provide the greatest assistance, we decided to

have at least one TEC territory in each state,

which will be managed by a GS–15 TEC manager. 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 education/communication at the GS–11 or GS–12 level.SB/SE and W&I will each have communications and

education 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) staffing for

fiscal year 2001 by one.

We are still working on the final design, and will

consider your comments before finalizing the

staffing.

Need additional RO positions to cover western ND

and be stationed at Grand Forks.

While we do not plan to add revenue officer (RO)

positions 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-ofduty. 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).
30

Recommendation Action

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 Forks ..................... Currently there is one CSR in 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 having a walk-in

manager.

W&I organization design calls for 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.
31

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.
32

[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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