[Senate Hearing 106-541]
[From the U.S. Government Publishing Office]




                                                        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

                                 ______

                    U.S. GOVERNMENT PRINTING OFFICE
63-948 CC                   WASHINGTON : 2000
_______________________________________________________________________
            For sale by the U.S. Government Printing Office
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                                 20402
                          ISBN 0-16-060829-5





                      COMMITTEE ON APPROPRIATIONS

                     TED STEVENS, Alaska, Chairman
THAD COCHRAN, Mississippi            ROBERT C. BYRD, West Virginia
ARLEN SPECTER, Pennsylvania          DANIEL K. INOUYE, Hawaii
PETE V. DOMENICI, New Mexico         ERNEST F. HOLLINGS, South Carolina
CHRISTOPHER S. BOND, Missouri        PATRICK J. LEAHY, Vermont
SLADE GORTON, Washington             FRANK R. LAUTENBERG, New Jersey
MITCH McCONNELL, Kentucky            TOM HARKIN, Iowa
CONRAD BURNS, Montana                BARBARA A. MIKULSKI, Maryland
RICHARD C. SHELBY, Alabama           HARRY REID, Nevada
JUDD GREGG, New Hampshire            HERB KOHL, Wisconsin
ROBERT F. BENNETT, Utah              PATTY MURRAY, Washington
BEN NIGHTHORSE CAMPBELL, Colorado    BYRON L. DORGAN, North Dakota
LARRY CRAIG, Idaho                   DIANNE FEINSTEIN, California
KAY BAILEY HUTCHISON, Texas          RICHARD J. DURBIN, Illinois
JON KYL, Arizona
                   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           BYRON L. DORGAN, North Dakota
JON KYL, Arizona                     BARBARA A. MIKULSKI, Maryland
TED STEVENS, Alaska                  ROBERT C. BYRD, West Virginia
  (ex officio)                         (ex officio)

                           Professional Staff

                          Patricia A. Raymond
                              Tammy Perrin
                              Lula Edwards
                        Chip Walgren (Minority)

                         Administrative Support

                 Elizabeth Blevins (Minority) 
                           deg.C O N T E N T S

                              ----------                              
                                                                   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

                               (iii) deg.

 
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.
    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 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 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 
return-free 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.
    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.


                           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.
    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 
front-line 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.
    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 return-free 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.
                      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.
                       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.
                               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.
    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, 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 
return-free 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.
    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 so-called 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 application 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 return-free 
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.
    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 return-free 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 return-free 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.
    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 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.
    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 not 
typically targeted by income. Similarly, deductions are not subject to 
income-based 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 return-free 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 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 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.
    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.
    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.

                    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.

               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, 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.
    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.

                       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:]

                 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           To provide the greatest
 recommendations). There is already     assistance, we decided to have
 one GS-14 branch chief working in      at least one TEC territory in
 North Dakota. We don't need            each state, which will be
 additional GS-14 or GS-15 positions.   managed by a GS-15 TEC manager.
 We need field staff who do the work!.  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         SB/SE and W&I will each have
 education/communication at the GS-11   communications and education
 or GS-12 level.                        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)  We are still working on the final
 staffing for fiscal year 2001 by one.  design, and will consider your
                                        comments before finalizing the
                                        staffing.
Need additional RO positions to cover  While we do not plan to add
 western ND and be stationed at Grand   revenue officer (RO) positions
 Forks.                                 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-of-duty.
                                        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).
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       Currently there is one CSR in
 Forks.                                 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     W&I organization design calls for
 having a walk-in manager.              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.
------------------------------------------------------------------------

                              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.
    [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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