« The Weeds

Taxes! Let’s get right Intuit.

2022-04-05

Weeds co-hosts Dylan Matthews and Dara Lind are joined by Vox policy editor Libby Nelson (@libbyanelson) to talk about some hot! tax! policy! But mostly, why it’s so annoying to file our taxes every year. The three discuss why the tax code is so complicated to begin with; compare our filing system to other countries; and daydream about what could be done to fix the system. Plus, a white paper about, you guessed it: taxes.

References:

How to get free tax prep, or volunteer to provide tax prep to others

TR Reid’s A Fine Mess

Justin Trudeau’s return-free tax promise

Dylan explaining near-term options to reform tax filing

“What is return-free filing, and how would it work?”

The benefits of return-free filing

Option one: the pre-filled return

Option two: pay-as-you-earn

ProPublica on Intuit/H&R Block lobbying that’s kept taxes complicated

White paper: “Inertia and Overwithholding: Explaining the Prevalence of Income Tax Refunds” by Damon Jones

Does the EITC promote work?

Hosts:

Dylan Matthews (@dylanmatt), senior correspondent, Vox

Dara Lind (@dlind), Weeds co-host, Vox

Credits:

Sofi LaLonde, producer and engineer

Libby Nelson, editorial adviser

Amber Hall, deputy editorial director of talk podcasts

Sign up for The Weeds newsletter each Friday: vox.com/weedsletter 

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This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
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Is just visible. Switch today at visible.com. Rate with service on the Visible plan. For additional terms and network management practices, see visible.com. Actually endorsing here is volunteering to be a tax preparer. Stay with us. Nothing in this episode is tax advice. See a tax professional or your local VITA office for actual tax advice. - Hello and welcome to another episode of The Weeds. I'm your host, Dylan Matthews, and as usual, I am joined by my co-host, Dara Lind. - Hello. - And by Vox Policy Editor, Libby Nelson. - Hello. - And because it's now April, we're going to talk about one of our favorite topics, tax prep. Tax prep is particular.
Close to Libby in my heart because for several years we've been volunteer preparers through an IRS program called volunteer income tax assistance or VITA. VITA and its sister program tax counseling for the elderly or TCE provide free preparation of basic tax returns in the US through a number of community groups around the country for qualifying low-income or elderly people. We do our volunteer. Through Community Tax Aid, which is the DC area nonprofit. It very rewarding and also challenging and valuable intellectually as someone who writes about taxes and has to understand them professionally. If you think you might be able to use the program or if you would like to volunteer for it, I really recommend reaching out. We'll have links in our show notes. But part of doing volunteer tax prep
in an ideal world would be completely unnecessary. Tax prep in the US is just really, really complicated by international standards. Many foreign countries, including Germany, Japan, UK, Spain, Chile, Russia, and all of Scandinavia have some form of return-free tax system. It's not universal. Justin Trudeau has promised return-free filing for a while, but Canada is now stuck in kind of a similar boat to the US. But most of our peers have figured out how to exempt most of their citizens from having to file taxes. TR Reid's book, A Fine Mess, is an excellent guide if you really want to dig deep on other countries and how they do it. But for now, we're going to be talking about how to get to a better, simpler tax filing system for the next hour or so.
So first we're going to talk about some of the things that make the current system so complicated. So Libby, you and I have both done a lot of tax returns over the years. What's been sort of the messiest or hardest part from your vantage point? So I will start to say I'm a total fraud.
Doing this episode, even though I have not done my own taxes for this year yet. So we can all doubt my commitment to tax credit. - I mean, I have done neither mine nor other people's taxes. So, yes. - But the thing I've learned most from doing other people's taxes is something I knew in the abstract already, but that has really been driven home by the process of actually doing it, which is that so much social services aid, so much income support, basically helping people afford things in the US is done through the tax code. And that makes taxes incredibly complicated, often for people who are the least likely to have the time and the money to navigate them. So as we were preparing for this episode, I went back through some of my training tools and some of the quizzes I had to take. There were multiple practice quizzes on education tax credits alone. I covered these tax credits. As a reporter for upwards of five years. I have trained to do people's taxes. I got like maybe a 50% on these review quizzes because there are so many questions.
About, So your scholarship income is this, and you spent this on books and this on this, and this is what your parents do, and this is how much they're supporting you. Which of these several different tax credits should this person claim? And again, this is for people who are training to help people do this, and I'm completely lost on this. And it's something that I, of all people, am really well prepared to understand, and it is just really illustrative to me of how completely confusing and messed up this is. So if you have a scholarship, but you're paying for books, and you're paying for parking, and your scholarship actually covered your tuition, can you claim a tax credit? Do you actually need to pay income tax on your scholarship? This is what we're doing for college students. It's very similar for if you're claiming the child tax credit, the income tax credit.
Credit, almost anything where you might be getting some help. The process of getting that help through the tax code is absolutely insanely complex. - Yeah, well on education, it's not just, we have this whole non-tax system to help people with higher ed. We have loans, PLUS loans, Stafford loans. We have Pell Grants that go directly to the institution. But then we have two separate tax credits that are very different, as you and I have learned. Like the Lifelong Learning Credit and the American Opportunity Tax Credit are not the same. They have very different rules. They have different maximum amounts. They have different refundability rules for how very low-income people who don't have a positive tax burden can claim them. And that's just true across the board. One of the things that is my go-to example in talking about this with Fred, Is that different parts of the tax code have different definitions of what a child is and who gets to claim the child. So there's a definition of child for head of household,
filing status for mostly for single parents or single adults who are caretakers of elderly people, but single parents are the main use case. So that has one definition of if you have a child to qualify. The child tax credit has a different definition of if you have a child to qualify. Before the Trump tax cuts, we had something called a dependent exemption that had its own rules for how to claim somebody. It's a different set of rules. Put them in childcare and a whole set of requirements for that. You have to put the social security number of your childcare provider as an anti-illegal immigration measure, which is super fun to ask people. Preparing these returns is what we can tell you. We're in a tiny office sitting one by one. With someone you've never met before, asking the most impossibly intimate questions you can about their lives. And so, like, just sitting down--
the stranger and be like, hey, do you happen to have, like, your nanny social security number? It's like, it's a ridiculous-- So I want to rewind a little bit just to like focus on these like the panoply of scholarships and education tax credits is kind of an object. Lesson here because like as we were talking about last week in our episode with Christine Imba, like you can understand politically how this kind of welfare via the tax code emerged, right? It's honestly this very 90s consensus where like center-left Democrats don't like and like helping people. Republicans are willing to go along with tax cuts. That has since been somewhat challenged and we'll be getting into this in later episodes in Tax Month by the Of resurgent Republican idea that everyone needs some skin in the game, that there shouldn't be people who don't pay any income taxes. But you know, thanks to this you have a lot of things being rooted through the tax code.
Politically that could, you know, instead of being stood up as new HUD or HHS. Programs. And you can argue that from the perspective of administrative burden as terrible as all of this is, it would be even more terrible if the kind of education, okay you were getting non-tax benefits. Also tax benefits also existed for all of these other things. If instead of the EITC being like the main anti-poverty program in the federal government, you had several different things being administered that you then had to question whether they were going to be counted as income or not. But when you're talking about competing definitions within the tax code itself, like the definition of child or different eligibility requirements for these education tax credits, my kind of dumb question is, is this a problem where Congress is creating all of these things and just not going back and
Looking at the existing structures and just creating everything ex nihilo is the problem that the IRS is doing that? Where is this kind of disconnect coming from? - Yeah, it's Congress. Talking about this reminds me of something I don't think I've ever ranted about on the weeds before, The stupidest policy idea ever floated on the West Wing. The guy last night in the bar. Matt Kelly. Daughter to visit colleges, he said it needs to be just a little easier. Not a lot easier, a little. Toby, every nickel spent on college tuition should be 100% tax deductible. Not capped and indexed and bracketed. Every nickel, 100%! - Steam comes out of my ears watching that episode. - That's also like perfectly targeted at the people who watch the West Wing and not the people they want to help. - But that's to say to your point, like yes,
Democrats in the 90s loved to tax credit, absolutely loved to tax credit. Because of how we make policy, we're making tax policy and we're making higher education policy on two separate tracks. So there's not like an incentive to be like, hey, what if instead of creating the Hope and Lifetime Learning Tax Credits, we just made the Pell Grant bigger because of the-- way the Pell Grant, you know, the main way that people get cash up front to pay for college. Because of the way policymaking works and taxes and tax credits are sort of on a different track, often actually, you know, running through different committees, literally like happening in a different way than Discretionary spending, there is no like, Hey, let's step back and look holistically at all of the ways that we help people pay for college. Can we maybe make there be fewer of them? And instead, you can just pile on another tax credit.
And then if anything has changed, it's also changed through the process of like tax cuts, tax reform, and tax simplification, which is still separate from the policy process of like, how are people paying for college? Should we help them do more? Well, and some of it comes down to literal committee structure. So my understanding is that Pell Grants are discretionary spending. Are they discretionary or mandatory? Discretionary spending goes through the appropriations committees, which is distinct from both the Ways and Means finance committees, which control the tax code, and the Health, Education, Labor, and Pensions Committee, which is supposed to set sort of overarching education policy. Like the level of coordination needed to pass any laws in the US in general is extraordinarily high, but the level of Coordination needed to get the approps chair, the help chair, the finance chair. All on the same page on that and like moving in lockstep is extraordinarily high.
Given that appropriations rarely happens through the actual appropriations process anymore. It happens through an escalating cycle of omnibus, like continuing resolutions and stop gap spending measures. And I think also there's a dynamic of individual instance rationality adding up to a systemic problem. If you look at any of these measures in isolation, like the American Opportunity Tax Credit, generous higher ed credit was created in the 2009 stimulus. And I think that was like it had been a long Democratic wish list item to have more sort of refundable tax credits as part of the spirit of the 90s. I think this was in like John Kerry's 2004 platform. Stuff. And so they're writing a stimulus bill and they're like, why not throw that in there? And, um, and it was written very, very quickly passed by February, 2009. Ran for a few years, and so by the time it was time to renew, whereas Biden passed everything for once.
One year and so it was easy to let it lapse. This has been going on for a while. People started to count on it. I claimed it. Since I was in college around that time. - I love that you were doing your own taxes while you were in college and claiming your own tax credits. I got audited by the IRS for my American Opportunity Credit in 2012 because they were like, You did not pay for college out of your own pocket. Your parents paid for college. I'm like, You're absolutely correct. But nowhere in the documentation for this tax credit does it say, to have endured these expenses. And they went through it. Did you win? I won. I got a letter from the IRS saying, we have reviewed your application. You owe $0. It didn't say you win in big numbers, but that was what it felt like. Laminate this and just put it on your desk when you're doing VEDA. Like here, here's why you should trust me. I fought the IRS and I won. - I bilked $4,000 out of the IRS. uh...
Tax your viewer if someone were to bring you a tax return on which they did this. Would you be like, Yes, seems cool and good? I think they might have fixed the loophole that— I exploited it. Ah, the Matthews loophole. Yeah. But, but yeah, to return to the semblance of a-- - That's the point I was making. It's a series of game time decisions that don't add up to a cohesive strategy. Like a few years later, you're trying to renew all these aspects of the stimulus, including other things that are maybe better thought through. They're like, Sure, let's go.
Throw that in there, let's renew it. And at each of those moments, it's better-- it feels better if you're someone who wants to subsidize higher ed to renew it than to not renew it. And there are people, I think, really well-meaning, high-impact people-- I think this is something the Center on Budget and Policy Priorities does well-- who are just experts in these small niche provisions and optimizing them and are eager to jump at any opportunity to boost them. And I think that's great and noble. it does mean that there are fewer opportunities. These to look at the whole safety net cohesively and try to sort of simplify and consolidate. - Can I galaxy brain for a second and you guys can tell me if I'm way off base? - So I am, like Dylan, a pretty big grump about the continued tendency of Congress. To legislate through emergencies. But it does seem to me that as long as we're no longer doing 12 appropriations bills moving separately through the
appropriations process every year, that like there theoretically could be an opportunity here to actually look at how various tranches of that interact. And you could imagine like a center on budget or some other think tank putting. Out like, hey, you know, here is every single thing that we have put into education approach or into the tax code to help this specific group of people. Like, here are some very easy technical fixes to consolidate those populations. And that could just kind of get written into the next omnibus bill. Is that not a like tell me why this is a dumb idea. - It's not a dumb idea. It's something I would maybe try if people were dumb enough to elect me to Congress. But I think the problem-- Is that each of these individual things develops their own constituency and develops their own like champions. And so a good example of this...
Was was Mitt Romney's child allowance plan. I love Mitt Romney's child allowance plan but it is just like uh God it's it's like A slaughterhouse of sacred cows. It kills Tana. The one remaining cash welfare program, it slices into their earned income tax credit and uses it to boost the child credit. It kills the state and local tax. And some of that is like to get him some right wing cred. But I think it like genuinely helps kill the project because like there are EITC defenders who like don't give a shit about this guy's like new child credit. They're like their job is to defend the EITC and their TANF defenders whose job is to defend TANF. This is like the arguments over the universal basic income, right? That like, in theory, why not have this new thing and also keep these existing things?
Unless you're trying to build a coalition that gets right-wing Republicans on board. Right, right. Yeah, well and I think, oddly, the best simplification effort, which is not going to win me a lot of liberal fans, but the most serious effort to simplify the tax code in recent years, in years was the Trump tax cuts. And I think that was like a genuinely meaningful and significant simplification. The biggest thing was that they got rid of exemptions, boosted the child credit, and dramatically increased the standard deduction. And dramatically increasing the standard deduction means that itemized deductions just mattered.
Dramatically less for all kinds of people. But even there, they tried to do things like kill the state and local tax deduction entirely, and they couldn't do that. There were big limits to what even sort of unified Republicans trying to cut taxes, their most favorite thing in the world to do, could do in terms of simplification. - This makes me think of one thing that was really unusual about the COVID relief bills last year was that it really approached the question of what can we do to help people in a way that incorporated
both the tax code with the child tax credit and non-tax code things. And we saw a little bit of that with the stimulus bill in 2009 as well. But it feels like outside of those really extraordinary moments of emergency, it is very rare to be like, let's help people pay for college and while we're doing it, figure out if the system that we have of six tax credits and different grants and some loans for these people and other loans for these people make sense. Like think tanks love this. I have read so many simplifying our financial aid white papers over the course of my career. But the way our system of governance is set up just doesn't incentivize that kind of like, step back, clean the whole house, take everything out of the closets and put it on the table and decide what we want to keep approach. The Marie Kondo approach to financial aid.
The other thing that that I think about you know thinking about tax reform is this is really doing this kind of volunteer work has really illustrated to me Where and for whom taxes are complicated so my own taxes This is the this is the first year because I purchased a home. I'm getting married next year Or that my taxes could at all. Getting married this month. I'm getting married for next tax year. I'm getting married, like these two years are the first time that my taxes could have been spent. - Yeah, I was gonna say, did I like send my suit to the cleaners for nothing? Okay, I'm gonna say that sentence over. Or I'll leave that in. I mean, if we're surprised, imagine how Alex feels. God, yeah. You should tell Alex you're planning on marrying him. This is the first year that my taxes are arguably at all complicated. When I was in my 20s, I had an income that was too high to claim the EITC, too low to deduct anything and have it
be meaningful to me at all. And I kind of was like, I don't really get what the big fuss is about taxes. I didn't mind my hand, I didn't even use TurboTax some years. If you're making half of what I made as a 24-year-old and you're supporting three kids, which is a lot of the situation of people I see, the tax system that you're dealing with and the resources that you have to deal with said tax system are so on a different planet it's almost like doing an entirely different task. And I think that is something that a lot of people who start out reading and writing about tax policy maybe don't get on a visceral level. Or if they do get it, they get it when it's later in life and they have a mortgage and they have kids that they also have, you know, if you're a professional policy person in DC, usually an income that allows you to sustain having those things without a ton of obvious and direct government support. - We can talk about the mortgage interest deduction, but. - Two, yeah. - I actually do have a question, this is a basic question that I have, because I. I...
One hand I'm aware of the concept that there's a lot of middle class social safety net stuff through the tax code and often done in a way that prevents people from thinking of it as like social safety net. Like the mortgage interest deduction. On the other hand, I am aware from having spoken to you guys and other people who know things about tax policy that like it's also complicated at the lower end of the income spectrum. Is it more complicated or is it just that there are equal that there's like
of complexity for working class families and a level of complexity for middle class to upper middle class families, but the latter group has the resources to be able to pay somebody else to do their taxes and the former group does not. I think it's mostly that. I think taxes are complicated for a lot of people in a lot of different ways. And I think there are a few factors that occur across income groups and across social groups that make them more complicated. One is if there's any kind of child custody arrangement or any kind of situation that isn't two parents married to one another filing as a married couple who are taking care of the kids that they have. Together and that obviously occurs across social groups and across income classes. The other is like in general though, I think if you're frankly a wealthy person and your taxes are deeply complicated, they are complicated because of your investments. They are complicated because of, I don't know what this like.
Buying and selling crypto is a thing that we were asking low income people about in 2018 if they'd die. We're still asking about it. Has anyone bought crypto? I've had to explain Ethereum to so many women in their 70s. - Yeah, we're still asking about that. Literally no one has ever bought crypto. That kind of thing. You know, if you have really complex investments, if you're not just taking the mortgage interest deduction and like, you know, you're paying for your kids' college and taking something off of that, like that is a situation where you are going to have a professional person. To help you with taxes. - I think the other thing that's changing things at the bottom end that I've seen a lot more of this year is gig economy work. If you work for Uber, if you work for Lyft, if you work for DoorDash, none of those companies withhold because they're treating you like you're a private contractor or a small business. They expect you to keep track of your--
own expenses and to be putting aside your own money for income tax, self-employment tax because you also owe your own Social Security and Medicare taxes. And those are outrageously complicated returns and ones that people lower and lower on the income spectrum are doing as those kinds of jobs open up. Oh wow, yeah. And the threshold for having to pay self-employment taxes is... Just like absurdly low, right? So I'm not actually qualified to do those returns, because Dylan is a more qualified tax preparer than I am. And so that would be a situation where I would just send them off to somebody else immediately. And I can guess you're seeing a lot more of those. Consider yourself lucky if they're not. Fun. Next year, next year I'm getting certified advanced. We're going to take a quick break and then we're going to come back and talk about ways to improve this system. So stay with us.
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The wireless company with nothing to hide. Seriously, hidden fees? We don't have them. Annual contracts? Great wireless on just one line? Now that's more like it. Get unlimited 5G data powered by Verizon for just $25 a month, taxes and fees included. That's right, 25 a month, every month. Sorry, hidden fees, we're just not that into you. Is just visible. Switch today at visible.com. Rate with service on the Visible plan. For additional terms and network management practices, see visible.com. And we're back. Okay, so... The American taxes are really complicated and so almost any simplification would be better. Things are a lot better since things got simplified in 2017.
In reading about how other countries do things, there's sort of two broad schools of thought that other countries use to make taxes dramatically simpler. They often sort of coexist and reinforce each other. So don't think of these as either or. It can be both and. So the first is prefilled returns. And this is something where the government, most governments, including the US government, including the IRS, get notices from businesses and other places about how much money different people are making from different ventures. And so under a pre-filled returns, the. The tax authority puts those together, sort of fills out a return for you, and either it can be opt out or opt in. So, either they send you the return and you sign it and send it in and your taxes are done or in lieu of any... Action by you that is treated as your return and you don't have to do anything. And my underst--
is that that's something that, at least for a significant portion of Americans, could be done fairly easily. That a very large share of Americans have a canonical easy return, which is you have one or two W-2s showing your wages, you take the standard deduction, your taxes take a single page, and then the government can just send you your refund automatically. Those are super easy. There's some slightly harder cases, like if you might qualify for the earned income. Income credit, if you have dependents, that you're not getting benefits from, if you have mortgage interest or charitable. But even those, like a lot of mortgage companies send in forms to the IRS saying how much people have paid in interest. Like the IRS knows about that already. They could incorporate that if they want to. I don't have to collate these three different letters from my mortgage being sold like three times in the first year I had it. This is wonderful news.
The other one, which I'm really excited about but is also a lot harder, is called various things. Holding in Japan, the UK calls it pay as you earn. And the idea there is just-- Like you get really, really good at withholding. The government has since the 1940s, when a young treasury official named Milton Friedman invented the system of tax withholding we currently use to make money for the treasury during World War II, something he would later say was his deepest regret in life. Like, the government takes money out of your paycheck. You do not have to have some giant savings account and send them thousands of dollars at the end of the year, typically, unless you work for DoorDash. And different countries do this different ways. The UK tries to be very precise on each paycheck. And so they're constantly adjusting and readjusting how much they're withholding. and...
Japan and Germany have a system where on your last paycheck, they change really dramatically to make sure that they've actually withheld the exact amount you owe. And in this one, it's preferable to prefilled returns in some ways in that it's much less action on your part. You don't have to wait for a giant refund or you're less likely to owe a big chunk of money at the end of it. But my understanding is that to do this in the U.S., you just need to dramatically simplify the tax code. Like the nice thing about pre-filled returns is that like the content of the tax code does not need to change that much. It might have to change so that more people can benefit from pre-filled returns, but with Withholding, it really does. Like, you can't really do that if you have a million tax credits and tax deductions. And so you would either want to rename those things and make them not tax provisions. Like maybe there's an agency for earned income and you--
an application to them that is not part of your tax return. And so you don't have to pay taxes, but if you want that, you do have to file something. And so maybe Libby and my volunteer work is helping people file that. But you would have to break it out kind of like that. And also, some of these systems are just less progressive because brackets make this more complicated. I think the UK only has like two or three income tax brackets. It's a much flatter tax code than the US has. And that really simplifies precision withholding. It also has downsides, it's a less progressive income tax system overall, I think, than the US. I mean, in some ways, and I think in interesting ways, the US is getting closer to something like prefilled forms for people with very simple tax returns. I boycotted TurboTax for several years for reasons that will become clear in a second. But nowadays, because I'm busy, I log in.
And they say, Do you still have the same job you had last year? And I say, Yes. And they say, We can find your W-2 somewhere in the back end of our system with the IRS. Wait a second. And I think this year it actually did successfully pull it forward and successfully pulled forward a lot of my stuff. And it was basically like looking at the paper version I had, making sure that nothing had Wrong, I don't know why it would have since obviously it all came from the same source, and going forward. Interesting thing to me about that is I have to go through the interface of TurboTax, which I feel like is-- Good entree into how our tax system is built around some very specific pieces of software owned by private companies, and how those companies are sort of a bigger barrier. You would think it sounds like a joke to be like, Oh, big TurboTax is the reason that we don't have a better tax system.
It's actually part of what is going on here. - Yeah, so, Intuit. So the idea of prefilled forms, as Libby was saying, is not like a totally new idea. And in fact, the Bush administration proposed it in 2002, and they were going to do it. And tax preparation companies, in particular H&R Block and Intuit, which makes TurboTax, fought back extremely hard that they thought this was-- To his diar-esque quilting private business, which is insane. Like, these are services that only exist because of the public sector. But they succeeded. And so there was this deal called Free File and the deal was that the IRS would not create its own like not even would
Do its own prefilled forms, but wouldn't do an online tax filing system that you could do without going through a private company at all. And so that's why that doesn't exist. You can't just go to irs.gov and pay your taxes even if you want to fill it in there. Through some kind of private service or through something called free file fillable forms, - This may be the only room that has ever had two people in it at once who have used free file fillable forms. - No, I've used it for the last few years because my TurboTax hack is that I use TurboTax to optimize. And then I have enough confidence in my basic arithmetic that I go in and file through-- - This is also how I used to do it. - This is the life of kings, yeah. You use TurboTax as a fact checker. - We're such weirdos.
So this free file deal, and part of it was that low income people were going to be eligible for free services through TurboTax and all these other places. And this system didn't work from the get-go, so in 2019, 70% of Americans were eligible for free file through this program. 2.6% filed their taxes through it. 0.6%, 70% were eligible. And some of that was as Justin Elliott and Paul. At ProPublica have reported extensively these companies were like actively undermining free file and were trying to hide the free file websites from Google. They were trying to like upsell people in the free file program but being like you know this would be a lot easier if just like paid us to do your taxes. Um, and the scripts they gave their customer service workers were, are you sure? It's, it's like trying to cancel your cable, but worse.
But then eventually this grand deal fell apart. So H&R block left Intuit, left the Free File lines. There's still a few things like-- tax layer that are in the alliance, but it's all kind of falling apart. And I think that's kind of exciting in that, like, it means the deal's off. Like the deal was if these places do free returns for people, the IRS won't make its Us and now they're not offering these free returns and so like I've my understanding is that given enough budget, which is a big if, like the IRS could put out a request for proposals today and try to set up a system like this, and I have an article explaining But it's kind of an hour and every moment because the old regime is falling apart and we kind of need a new one. The old is dying and the new is struggling to be born? - Something like that. - So my question about the idea of prefiling or precision withholding.
Is that like if we were talking earlier about the kind of curve of tax complexity where it's like. High, low, medium, high, or high, low, high, very high, or whatever. It seems like both of these are targeting the things that are already low complexity and taking them to zero complexity. Like, I, you know, obviously the DoorDash contractor thing is not something that can be solved just by having the government get everybody's W-2s. The custody arrangements, Libby, that you were talking about don't seem like a thing that is going to be solved by precision withholding because the government doesn't have the information. So, and you know, obviously, Dylan, you clarified that these can be regressive in terms of bracketing. But it also seems like there's a certain extent to which the needability gap on tax filing that like
To help isn't something that is necessarily going to be super well addressed by reducing the complexity for the least complex tax returns. I think that's basically right. I think when we talk about tax complexity, we're really talking about at least two things and arguably three. And one is just kind of the annoying process for everybody, even if you have one job and rent and make too much money. To earn the EITC of just like, you have to get all your papers together and you have to sit down and you have to put the stuff into the forms and somehow TurboTax wants to charge you like at least $60 so they can do your state taxes too. You know, that's like, that is the situation that could be solved by this of like, there could be a better way to do that. I think for people who are reliant on a lot of the tax benefits, and I should say, I guess I should tease out what I mean when I say reliant, because obviously a lot of middle class people also get the mortgage interest deduction or some of these higher education
But, you know, if you are making, if you are a single parent or married parents of a large family making, you know, not that much, the Earned Income Tax Credit is like vitally important to you and it is vitally. Important that you get that in a way that like, are you able to claim the mortgage interest deduction as like a lawyer, you know, in a medium income area making a good amount of money is like that's still important to your personal finances, but it's not like, are you going to be able to like buy school supplies for the kids, you know, in the fall this year if you don't get it level important. So I think like, as long as people are dependent on tax credits as like a really sizable chunk of your income.
I learned actually doing people's taxes is like, for me, usually the amount that I would get back or very occasionally owe would be in the two or three digits. And if it was a high three-digit number, it's like, Oh, well, that's a nice amount of money that I'm getting in the mail. But it's not like a massive percentage of my overall annual income. When I started doing other people's taxes was the first time I had seen four-figure refunds coming back with any kind of regularity. And especially if you're not making very much money, that's a really significant thing. And so it's actually really important to figure out if we're not doing that, what else are we doing? At the same time, I've done through VITA still a lot of tax returns that were one per. With a W-2 job and maybe they claimed the EITC, but it was still pretty straightforward.
It's not to say that everybody who makes under the median household income has these incredibly naughty and complicated taxes that you have to sit down and tease out every single definition. People all up and down the income spectrum really would be helped by a simpler system. And I think one paper I recently read suggested that for EITC returns, your refund average is about 12% of your income, which that's huge. That's an extra month. - Yeah, and that paper, in fact, is our white paper. - Hey, hey. - Boom, boom. - Which is a good segue to our second break, after which we're gonna be talking a bit about how the complexity of the tax system leads into refunds and their size, so stay with us. And I'm Ed Elson. And we're the hosts, the co-hosts. It's kind of unfair to call them.
Co-host. I'm really the host. He's my Robin Givens. Let's just be clear on what this is. But anyways, we're the hosts of Prodigy Markets, your go-to podcast for all things money. Every Monday, we provide brash, unfiltered analysis on market moving news, high flying... Stocks, growing sectors, stupid boardroom decisions, and master of the universe CEOs. And on Thursdays we speak with some of the world's greatest finance professors, Wall Street insiders, and industry experts to keep you informed without getting bored. - You wanna understand money and how you can get more of it, you have to talk about money and we're here to help you do that. Follow Profity Markets on YouTube or wherever you get your podcasts to automatically receive new episodes every Monday and every Thursday. - That's right, the good news is we know how to get your economic security, the bad news is the answer is.
We'll tell you how on Property Markets. White Paper is an oldie but a goodie. It's from about 10 years ago by Chicago economist Damon Jones, who's great, a wonderful labor economist, public finance economist, and it's on Inertia and over withholding explaining the prevalence of income tax refunds. So this gets at something... We were talking about before, where especially at the low end, tax credits make up a huge share of refunds. People tend to get really big refunds. And so Jones is trying to explain why that happens. And there were two kind of prevalent theories when he was writing this about why most people, about 80% in his numbers, were getting refunds.
Is kind of like fear of punishment. People thought that if they owed money and were behind that like the IRS would clamp down on them. That doesn't make a huge amount of sense to me because like. You can owe money and just pay it on time. Maybe there's like a certain fear of authorities and things. If you're sort of low income or in a marginalized group. But it doesn't seem to really explain much of it. But the other is for savings that people like having a kind of mechanism to have a bunch of money all at once. That makes a little more sense to me. There was a good book called It's Not Like I'm Poor. By a group of sociologists, Sarah Halpern, Meeken, Kathy Eden, Laura Tosh, Jennifer Sykes, that talked to a lot of people getting EITC and sort of a lot of it was people liking the idea of a big lump sum, so that seems plausible. But Jones is testing another.
Theory, which is probably the one that makes the most sensitively to non-economists, which is just inertia, that people don't change how their income is withheld that much because it takes time and they have other stuff going on. And that might explain why people are consistently over withholding. And he tests this in a bunch of ways by seeing when EITC-- eligibility changes. He exploits a change during the George H.W. Bush administration where they increased withholding as a stimulus measure. He sort of tracks people over time and sees how they change withholding after they have sudden changes in tax burdens. People really don't change their withholding in response to that.
Any of these things, even though it would get them a lot more money a lot earlier. And it seems to suggest that inertia is a really powerful force pushing against people having their money on time and toward people giving an interest free loan to the government in the form of taking a tax refund. So I really like economics papers that are like the The basic non-econ way of understanding this is roughly correct. And this is really good evidence for this. But I think it has a lot of other implications for our tax code as well. So I was curious what you guys thought of it. I genuinely find the inertia argument and the risk aversion argument difficult to disassociate. From each other, right? Because like-- - I was gonna say the same thing about inertia and forced savings actually. Just like, I, if I have withheld-- I assume that level is being set by people who know more about the tax code and my likely tax liability than I do
I'm going to adjust that. I'm going to have to figure it out on my own. And then the risk that I am doing something somehow wrong and I'm going to have to pay money gets a lot more prevalent for me. Seems substantially more likely that if I am adjusting the withholding schedule, that I am going to make an error in the wrong direction and owe money than that whoever Or knows more about me with the tax code is doing that. So like, just from a common sense standpoint, like people are not going to want to take the extra effort to change. But part of the reason they're not going to want to take the extra effort to change things is because there are these two very powerful psychological drivers. I was gonna make the exact same point from the other other direction, which is if the quote-unquote problem is Oh, I just got 500, you know, 500, $500 back or $1000 back or however much people are getting back Versus the
problem of, Oh no, I owe the IRS $500. I do wonder if we didn't have such a refund. I'm not sure if that's the highest system if we would see people more willing to change withholding. Obviously, like one anecdote against a stream of data is not particularly valid. The one time I have gone to the actual trouble of like refi— and trying to remember how to fill it out and how I filled it out the last time, which is not easy to remember, and trying to-- Out what change would withhold a little more was when one year when I did owe a small amount and I was like, Well, this is an unacceptable situation. I need to fix this immediately. Other than that, I think it's hard to disentangle the factors at play here from the fact that it is nice to get a chunk of money. - Everything this makes me think of is the payroll tax holiday during the Great Recession and the discovery that people don't really notice a little bit more or a little bit less in their page. And personally, as an irrational, non-perfect economist invented human.
I would sometimes rather have a large chunk of money than that money divided by 24 over the course of the year because it's not as psychologically satisfying. And I think the paper has some interesting implications for EITC design from my point of view since the lowest finding that he has is on EITC and when certain changes in EITC payments do not lead to changes in withholding, people aren't really responsible. Bonding to the parameters there. And this gets at a big debate within Econ over the last few years about sort of how effective the EITC is at promoting work. This has always been one of the main appeals of the EITC to policymakers is that they want to incentivize low-income people working, bring people out of welfare into the labor force, and the EITC ramps up as you make more income from zero income to sort of $10,000 or so. And so it's meant to have that effect. The question has always been--
Do people understand this well enough for it to have that kind of incentive effect in practice? And Henrik Cleven at Princeton has a paper arguing, no, that outside of one instance in the 90s, changes in the ITC don't seem to change people's employment work habits that much. I think it's still kind of an open question within economics. There's a lot of literature disagreeing with Cleven. But I think that the Jones findings-- Like move me a little toward Cleven's direction, just in that if people aren't changing withholding in response to changes in the ITC, that's a pretty good evidence that they're not understanding the specific changes in it, and makes me less certain that they're going to be changing their actual employment habits in response if they aren't even changing their withholding, which is like one-fourth.
As opposed to taking on more hours, giving you another job, that kind of thing. Yeah, I mean, I think I want to actually be very specific about what we're talking about when we're talking about adjusting your withholding, because it actually makes it sound like you can go to your HR office. Or whatever and there's a dial that you can turn that's like more taxes, less taxes. But it is a form that you fill out like basically to the best of your knowledge about like what your family structure is and what like you do and if you have another job.
And the relationship between that and what is taken out of your paycheck is frankly pretty opaque to me, a person who enjoys taxes and prepares other people's taxes. The time that I tried to adjust it, it was like not actually clear. It's like, okay, so I need to just like throw an exemption in here for the heck of it. This was, I think, pre-tax reform possibly. But it was like, it's not like you can just check a box that's like, oops, my refund was too big. Please fix it next year. And so there's a level of technical knowledge that kind of gets back to what we were talking about with the complexity of the system. The other note on the EITC being monthly versus lump sum that I think there's been a lot of really interesting sociological work on how families respond to it, what they do. There's a good amount of debt and borrowing that is then paid.
Off when the EITC comes out. And so it's definitely not that like, oh, everybody's perfectly logically saying like, well, I want to use this on a big item and I'm only going to buy those big items once a year. You know, there are some real in practice downsides to the way that like getting an extra month of income or more all at once, just the way that that affects people's budgets This is making me realize that I have actually a pretty elementary question about precision withholding, which like in theory would make this whole problem obsolete, right? When people say, Oh, over withholding, you're just giving an interest-free loan to the federal government, that the federal government actually makes use of in any meaningful way? And like, does that mean that going to precision withholding would, you know, force the federal government Meaningfully or is that money just kind of sitting there in a vault somewhere and so the fact that it's an interest-free loan to the federal government you know it's it's actually a deadweight law
Yeah, my understanding is that it would actually, the only way that affects government finances is in a debt ceiling situation where like they actually have to have a lot of like incoming revenue on hand at various moments. And so it might change the timeframe for those. Solution to that is to get rid of the Death Seal line. I don't think it's a specific problem to this. Individual refunds and like the overall sense of the US budget, I assume, are really not large enough to be changing anything. I think in the aggregate, changes in withholding probably affect that, just average over everyone's tax returns but... - But yeah. - Because the bias for over withholding is so strong? - Yeah, I mean 80% of people get tax returns. - Right. - Or get tax refunds rather. But when I say it's an-- interest-free loan, what I mean is that's money you could have gotten in your paycheck and stuck in a savings account. Right. Like it's money you're losing, even if it's not sort of
The government isn't putting it in a savings account, but you could be. Exactly. Also a meta- where it really depends on savings accounts having had interest rates, a thing that didn't really happen for-- Higher adult lifetime. - I don't know if NerdWallet is still a sponsor, but they have a great list of high interest checking and savings accounts. - I love my Ally account that was paying me like 1.75% last time I logged. Alright, now that we're blurring the line between ad and editorial, it's probably time to wrap up. Thank you so much. To Libby and Dara for joining the panel. Our producer is Sophie Lalonde. Libby Nelson is also and in addition to being here, our editorial advisor, Amber Halls, the deputy editorial director for talk podcasts. And I'm your host. In Matthews. Did you know we have a newsletter? We have a newsletter. We do.
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Transcript generated on 2024-05-30.