The following post is from David Williams, the Chief Tax Officer at Intuit. This post is a response to a post I wrote late last year called H&R Block CEO Asks IRS to Make it Harder to Self-Prepare Tax Returns and Why That’s a Good Idea. As part of the most recent Appropriations bill, Congress has since directed IRS to require that taxpayers have to submit a due diligence checklist (Form 8867) along with their EITC-claiming tax return. Dave explains why he disagrees with my post and the legislation. Instead, he offers suggestions as to how insights from behavioral economics can help the IRS and companies like Intuit promote the preparing and filing of accurate tax returns through better use of questioning and prompts. Prior to joining Intuit, David had a long career in tax policy and tax administration – including fourteen years as a US Senate staffer working primarily on tax issues for the Senate Budget Committee and for Senator Bill Bradley. He also spent more than 13 years at the IRS, where he held a number of positions including Director of the Earned Income Tax Credit office, Director of Electronic Tax Administration and Director of the Return Preparer Office. I note that this post comes at a time of increasing attention on the role of companies like Intuit with the spike in identity theft and other scams relating to self-prepared returns; the issue of identity theft implicates issues that differ from those mainly addressed in this post. Les
An earlier version of this post appeared on the Forbes PT site on March 6, 2015.
I read Les Book’s blogpost that suggests making self-preparation harder for EITC taxpayers by imposing preparer due diligence questions on them is a good idea. I disagree. I’ve worked on EITC policy and administration for most of my career and have wrestled for much of that time with finding ways to reduce the erroneous payment rate, while not discouraging eligible taxpayers from claiming a credit that mean so much to their lives.
I understand the inclination to increase due diligence requirements as a mechanism for addressing the improper payments problem. In fact, I helped put the current requirements in place. While I now work in the private sector at Intuit, I still harbor hopes of solving the EITC problem. But my public sector experience leads me to some different conclusions about the problems in EITC administration.
In brief, I believe making self-preparation harder will likely increase EITC error, not reduce it. It’s also a very bad idea because it puts the burden of tax compliance squarely on lower-income working taxpayers. Finally, I think the software industry must and will innovate to ensure we get the benefits of the kind of error reduction to which we all aspire while still delivering a delightful experience.
Requirements Are Meant to Prompt “Opportunistic Cheaters” to Do the Right Thing
As I read the post, I was struck by how the original thinking behind the due diligence requirements has, over time, been appropriated in ways for which it was not intended. The Government obviously has to have sufficient information about the taxpayer to demonstrate eligibility, and requiring preparers to be diligent in this area makes sense. But making tax compliance ever more burdensome and difficult for the taxpayer is not the prudent path to better and fairer tax administration.
Let’s consider the original thinking behind the EITC due diligence requirements. While most tax professionals take great pride in their work and do a good job, there are certainly preparers who can best be described as “opportunistic”. In other words, they’re willing to put their fingers on the scale for their clients if they think it doesn’t really matter, or that the taxpayer is vulnerable or gullible.
I’m not talking about out-and-out criminal fraudsters. Rather, I’m referring to those people on whom behavioral economics techniques could have some positive effect – folks who will “fudge” a bit if they don’t think anyone is looking, but who would behave differently with the right training, operating model and motivation. In fact, in Les’ original post, he described how insights from behavioral economics suggest that for those who are not out and out fraudsters subtle shifts in the environment can make a meaningful difference in honesty.
These are the people for whom the due diligence reporting requirements were implemented. The requirements tell preparers the IRS is watching. It’s also true that the requirements can be burdensome and, because everyone must complete them, also affect conscientious tax professionals who wouldn’t dream of cheating. But the IRS is confronting a multi-billion dollar improper payment problem and it’s hard to argue that people who make money by preparing tax returns and determining a customer’s eligibility for tax deductions and credits shouldn’t be accountable for their work – particularly in an area as complex and fraught with error as EITC.
Criminal fraudsters are different than opportunistic preparers. For committed fraudulent preparers, it’s as easy to lie about due diligence in refundable credits as it is about any other item on the return. So the requirement that these individuals complete the due diligence checklist has little to no deterrent effect when the problem is personal ethics.
Self-Preparation is Already an Exercise in Due Diligence
So what, then, are we to make of due diligence requirements for taxpayers who chose to do their returns themselves, using software to simplify the process and increase accuracy? Well, first, and most importantly, the entire tax return is an exercise in due diligence – a principle at the heart of Voluntary Compliance — at least in the sense that taxpayers completing the returns themselves are attesting to the truth of the claims they make on every single line.
Even more interesting, most of the questions, or very similar ones, on the due diligence checklist, are already included in tax software – just not in the same format as written by Government regulators on tax forms. It is hardly a secret that the American public often cannot understand Government regulatory language, and the progressive interview at the heart of tax software was invented as a more understandable, innovative way of gathering tax information.
In general, the few areas of inquiry that are not covered apply to professional preparers and wouldn’t make sense for the individual. For example, individual taxpayers preparing their own returns wouldn’t document other questions they asked of themselves to help determine their own eligibility for EITC, the way a preparer would to comply with due diligence requirements.
Software Can Develop an Analog to Preparer Due Diligence
The original idea behind the due diligence requirements – using behavioral economics to prompt “opportunists” to make the right choices – is valid. The history of tax software is all about data-driven innovation where, with each succeeding iteration, the software experience is simpler, clearer and less burdensome.
It stands to reason that tax software can employ similar behavioral economics techniques to help reduce EITC over-claims. To that end, innovation in the design of the modern tools for return preparation is a continuous process. Indeed, ongoing improvements in the tax compliance process of the future will not only continue to reduce burden, but continue to increase both ease and accuracy as well.
This tax season, Intuit has partnered with Treasury this year to test an approach to improving EITC accuracy using behavioral economics principles. This test, focused on the residency requirement for qualifying children, is live in our Turbo Tax Freedom edition. Our goal is to test one approach to prompting those opportunistic taxpayers who might fudge if they think no one is looking, to make the right choice.
We’re also looking at the due diligence checklist preparers use and figuring out how we can create a superior software analog – aimed at the same objective of ensuring those potentially opportunistic taxpayers will make the right choice, but without abandoning innovation and burden reduction. It does not serve the taxpayer or the tax system well to instead layer the compliance process with ever more difficult, painful and burdensome requirements, adding complexity on top of complexity.
Indeed, here’s where I part company with the notion that making self-preparation harder will lead to reduced EITC error. First, including the software analog to the preparer due diligence form needn’t make the self-preparation experience harder. It’s much more likely that, building on its record of data-driven innovation, the tax software industry will continue to create an experience that will enable taxpayers to use their products with ever-greater ease.
In other words, the technology industry will continue to innovate as it supports self-preparation to make it easier to meet voluntary compliance obligations and help reduce erroneous EITC claims for the eligible taxpayer population at the same time. Simplification, greater accuracy, and burden reduction are the goals for which they continuously aim, including reducing the cost of compliance. That’s the business they’re in, and it’s what they should do.
Making Self-Preparation Harder Will Actually Increase the EITC Error Rate and Increase Burden on Low-Income Taxpayers
But what if we accept the premise that verbatim preparer due diligence process requirements should make self-preparation harder? Is that really a good thing in the public interest? I believe the answer is a clear and resounding NO. Here’s why:
Broadly speaking, there are three types of EITC claimants: those who absolutely try to comply with the rules; the aforementioned opportunists; and the deliberate fraudsters. It’s very unlikely fraudsters will be deterred by due diligence rules or anything else. So we can rule them out.
That leaves us with folks who want to comply, or who can be prompted to comply, under the right circumstances and with the right motivators. Making the self-preparation process harder may prompt some of them to be more careful, but as noted in the previous posting, it’s likely many will seek a preparer. And that’s where the argument fails.
In order to believe making self-preparation harder is a good thing, you’d have to assume these taxpayers would all seek a really “good” preparer (though, given the already existing complexity in the compliance process, most preparers appear to have significant error rates). But it’s just as likely, if not more than likely, that the taxpayer could end up with someone with a higher risk of error. The IRS’ own statistics bear this out.
Overall, self-prepared EITC returns have a slightly lower over-claim rate than those done by practitioners (47% v. 51%). [Note: For a PT post on the most recent EITC compliance study, see IRS Issues New Report on EITC Overclaims: (Title A).]Though both are higher than they should be, that doesn’t mean the verbatim checklist requirements at the preparer desk has somehow solved the improper payment problem. Within the preparer category, estimates of accuracy vary greatly, but statistics show that the epicenter of error-prone returns are those coming from un-enrolled preparers at 54%, and practitioner “type unknown” at a whopping 72%.
So, in order for there to be any reduction in error, we’d have to believe self-preparers would all consistently go to those preparers whose individual performance has the highest accuracy rate, and that those accuracy statistics would continue to hold. That doesn’t seem realistic.
On top of that, no matter what type of preparer they go to, EITC claimants are likely to face substantially higher fees – both for return preparation in general and, often, for the specific preparation of the form for the Earned Income Credit. If we believe that they all went to the statistically “best” preparers, then at least there might be some reduction in error in return for the increased cost burden on the taxpayer – in this case the low income taxpayer. That’s a big leap in assumptions.
I think it’s more likely that many will chose a preparer with a higher chance of error, and will pay for the privilege. And that, as Martha Stewart might put it, is really not a good thing.
The Tax Industry as a Whole Must Innovate to Reduce Error and Burden
I submit that both preparers and DIY tax software have important roles to play in improving EITC compliance – mostly with regard to behavioral economic principles. and through greater accountability and oversight of the tax preparation community. [Full disclosure – when in Government I also launched the now enjoined IRS return preparer program, and I still believe in the public interest objectives of that effort.] But they can only do so much – particularly when it comes to those who are bent on defrauding the system.
Tax software can and will continue to innovate to capitalize on the same behavioral economics principles that underlie the preparer due diligence requirements. But it will do so in ways that make it easier for both compliant and opportunistic taxpayers to get it right, and at a lower cost. Inserting verbatim tax regulatory language, requiring the taxpayer to cope with Government tax forms, has never been viewed as a constructive or positive objective of tax policy. Instead, innovation and modern technology have transformed both the voluntary compliance process, and the burdens associated with it, including the cost. That’s a track record that needs to continue.
Tax compliance in 2020 should not be stuck in mold of compliance from decades past. The public, tax authorities and policymakers, should be able to count on continued innovation in our tax future, as we do in every other aspect of our lives in the modern world. The public interest lies in that path forward.