July 15, 2020
ICYMI: Superintendent Linda A. Lacewell & Commissioner Michael R. Schmidt's Op-Ed in New York Daily News: A modern tax filing system is long overdue
Millions of Americans are filing their income tax returns this week against a troubling backdrop.
One of the nation’s leading tax preparation companies recently announced its intention to pull out of the Free File Alliance, which provides tax software at no cost to low-income families. The decision by H&R Block is disappointing and revealing — as it exposes a problem in tax administration today.
Why should citizens feel compelled to pay hundreds and sometimes thousands of dollars to private companies to prepare their tax returns? Why can’t there be a simple and free way for people to file their federal and state tax returns online?
Some background: The vast majority of taxpayers — 90% nationwide — either pay for a professional tax preparer or buy do-it-yourself tax software. The result is a $7.4 billion tax preparation industry built largely on fees charged to low- and middle-income Americans. These costs are a hidden tax on working families.
When it was established in 2002, the Free File Alliance promised a measure of relief. Under the program, tax preparation companies agreed to provide free tax filing software to individuals making below a certain income level. (The current threshold is $69,000.) In exchange, the IRS and state tax agencies pledged not to create their own free file products. If they served low- and middle-income taxpayers free of charge, the theory went, tax preparation companies would not face “competition” from government.
Unfortunately, the subsequent years revealed a large gap between theory and practice. In 2019, only 2.5 million of the 100 million eligible taxpayers took advantage of offerings from the Free File Alliance. Why such low participation? There’s no strategy for notifying taxpayers of their eligibility, nor has the IRS marketed the program since 2014. In addition, reports in ProPublica exposed attempts by tax preparation companies to actually suppress participation, prompting Governor Cuomo to call on our agencies to investigate industry practices.
The New York State Department of Financial Services’ investigation found that during last year’s tax season, five leading tax preparation companies that provide software to the Free File program deliberately edited the code of their landing pages to hide those pages from search engine results.
To counter these efforts to suppress program participation, as well as years of underinvestment in promotion by the IRS, the New York State Department of Taxation and Finance launched an aggressive marketing campaign that increased utilization of Free File by 40% and saved New Yorkers an estimated $44 million in tax preparation fees this year.
Against this backdrop, H&R Block’s decision to leave the Free File Alliance is indeed troubling. While the program has underperformed relative to its potential, it still serves millions of taxpayers every year, including hundreds of thousands of New Yorkers. More than 30% of these New Yorkers currently use H&R Block to access Free File. With H&R Block’s departure after this year’s tax filing season, many of these taxpayers are likely to leave the program and will incur significant costs.
The H&R Block action highlights the precariousness of a system that relies on the voluntary participation of private industry to provide free tax filing options to low- and middle-income taxpayers.
To address this situation, we urge the IRS to aggressively market the Free File program. We also urge the IRS to consider a broader solution — the public option. The IRS should develop its own free tax-filing program. States could then integrate with this new federal product, allowing taxpayers to file both their state and federal taxes online for free. The program could be geared towards the kinds of simple, straightforward returns most common among low- and middle-income taxpayers. The IRS and state tax agencies could even use the information they have on hand to pre-populate returns for taxpayers who opt in.
Fortunately, there are indications that the federal government is open to change. Last year, a bipartisan effort in Congress pushed back against industry lobbyists and preserved the IRS’ ability to develop its own online income tax-filing program. And, last month, IRS Commissioner Charles Rettig testified that he was open to the development of such a program for certain tax filers.
In the past, momentum for change has always dissipated. We must not let that happen this time. Free tax filing should not depend on the beneficence of private companies whose primary goal is maximizing shareholder profits. An integrated federal-state free tax filing system is the right path forward.
Schmidt is the commissioner of the New York State Department of Taxation and Finance. Lacewell is the superintendent of the New York State Department of Financial Services.