Technology's Role in Comprehensive Tax Reform

The U.S. tax code is far from a static document. To the contrary: the set of rules outlining tax policy for all Americans, be they individuals, families, corporations, or other taxpaying entities, averaged one change per day, every day, each year since 2001 [1].

These changes, by and large, have a narrow focus and impact; sometimes changes reflect an effort on the part of Congress or the IRS to make tax filing quicker and easier for individuals [1]. Other times, changes are made to reflect new laws, such as 2008’s Affordable Care Act, which created the Individual Mandate for purchasing health insurance. Whatever the cause, however, these changes have added to the length and complexity of the tax code, and created a common cause among politicians from both major parties: comprehensive tax reform [2].

What is Comprehensive Tax Reform?

What constitutes “comprehensive” tax reform is somewhat subjective, but generally is referred to as any bipartisan Congressional effort to rewrite or even eliminate large portions of the current tax code, with special attention paid to exemptions, tax rates, and broadly defined “loopholes” which allow payers to reduce or eliminate their tax burdens. For many, the point is to make the tax code shorter, simpler, and easier to understand, rather than continuing the trend of making it longer and more nuanced year after year [1].

The last major overhaul to the U.S. tax code was in 1986, when the Tax Reform Act was passed [2]. For perspective, that is eight years before the Internet became a fixture in the average household or business [3]; 25 years before cash registers equipped with NFC readers began accepting mobile pay, setting the stage for mobile phones to function as digital wallets [4]; 27 years before online retail revenue overtook that of traditional brick-and-mortar stores during the holiday shopping season [5]. There is still debate over the future of ecommerce with respect to sales tax, taxing authority, and even whether the nature of online retail necessitates a federal sales tax or similar instrument [6].

Technology since the turn of the century has not only revolutionized the marketplace, it has continued to evolve and disrupt economies around the world. Tax policy, by contrast, despite thousands of changes and additions, has not kept up with this rate of transformation, nor been updated to reflect the new realities of ecommerce, digitization, or the global appetite for automation — not to mention the need for cybersecurity solutions and some measure of privacy [7].

Much of the need for comprehensive tax reform, in fact, is to better update the federal tax code to reflect contemporary realities brought on by technological change [8]. From global competition and marketplaces, to new financial instruments for moving, transacting, investing, and earning money, the tax system lags behind the realities of the economy and the world. While arguments over what reform should look like is often dominated by ideology and partisanship, technology has become a key variable both in how money is made, how taxes are paid, and how accounting functions are performed [8].

The Cost of Filing and Collecting Taxes

The IRS operates on a budget of more than $11 billion each year [9]. Meanwhile, the cost to individual taxpayers (excluding those with self-employment income), was over $40 billion in 2016 alone [10]. Businesses spend four to six billion dollars on tax compliance each year. On top of the dollar cost of tax preparation, taxpayers spend a collective six billion hours preparing their taxes each year [1].

Many ideological contests surrounding tax policy, and proposals for comprehensive tax reform, debate notions of fairness. Yet there is also a significant conversation over who should pay the costs of submitting tax returns (on the payer side) as well as controlling the costs of processing these returns (on the government side) [10]. Ultimately, of course, taxpayers are responsible for both sets of costs, as the revenues generated by their taxes provide the budget for the IRS.

This is one of the key areas where the potential of technology is having an influence on the future of tax reform. Paradoxically, however, bringing certain types of technology into the mix with an eye to simplifying the filing process is sometimes seen as a conflict of interest.

Historically, third-party software or professionals take on the task of planning for and filing taxes for the majority of taxpayers [11]. Their industry knowledge and/or proprietary programming bridge the gap between payers and the IRS every year. Under many reform proposals to create a more streamlined pathway for technology-augmented tax filing, the government would, in effect, displace these third-party preparers (though not the need for tax planning assistance), and let taxpayers share data directly to quickly and accurately pay taxes [11]. In fact, a universal pro forma return system would allow the government to estimate taxes for the majority of payers in advance, based on third-party data culled from employment records and similar resources, effectively automating the filing process so that refunds and bills are the only interaction most people have with the IRS at all [10].

The problem, according to critics, is that this puts the IRS itself in charge of both preparing and then processing returns [11]. The incentive under such a plan for tax reform could be to err on the side of the government to maximize revenues [10]. There is little question that such automation would reduce the time, energy, and expense of filing, but critics sometimes fear that it wouldn’t necessarily mean maximum savings to taxpayers [11]. In this case, the intersection of tax law and technology shows potential for savings, but risks disguising the costs to taxpayers; the extent to which the IRS can even take advantage of automation or other digital filing solutions remains an open question among lawmakers and tax lawyers [10].

Automating Tax Law Compliance

Tax law is not just preoccupied with accounting, but with enforcement and compliance. As technology changes how returns are submitted and processed, it also changes how errors — malicious or otherwise — are detected, reported, and corrected.

Consider the following common scenario [12]:

A married adult couple — husband and wife — use free online software, approved by the IRS, to prepare their joint tax return. Shortly after attempting to E-file online, their return has been rejected. It turns out that their son, who they claimed as a dependent, filed his own return in which he claimed he was no longer a dependent of his parents. His social security number was flagged on his parents’ return, automatically getting it rejected by the IRS until the duplicate claim issue is resolved.

This is just the tip of the iceberg of tax filing automation, but it illustrates how minor compliance issues — which traditionally would take countless man hours and manual oversight — can be almost instantaneously caught and triaged through an automatic, digital corrections process. Not only does this save money on the government side, it lets taxpayers know more quickly when there is an issue with their returns, and gives them an opportunity to correct known issues.

The conflict of dependent status in the above example could be the result of innocent miscommunication; the son may be filing taxes on his own for the first time, and thus not realize his parents are still claiming him. Alternatively, this could be intentional: both parties, in an attempt to maximize their deductions and credits, are both trying to use what seems to be the most advantageous status on their returns. In any case, the burden of enforcing compliance is shifted, expedited, and automated by the IRS utilizing digital solutions [12].

Analytics: Revenue, Law, and Transparency

Digital accounting software has proven its value to businesses and individuals. From budgeting and tax planning to gaining insight into spending patterns, controllable expenses, and increased security, the power of digital financial records is established. That power comes in part from making data-management easier, while at the same time making data more portable, organized, and easier to analyze [8].

Where corporate taxpayers are concerned, there has been a broad shift in priorities toward transparency, driven in part by globalization [8]. This means businesses are moving to bring more data and accounting functions into the digital age, to increase the mobility and visibility of tax issues among relevant parties internally. The need to comply with multiple jurisdictions and local taxation authorities — cities, counties, states, across the country and around the world — means global businesses are turning to technology like never before [8]. Many legislators are looking for ways to reform the U.S. tax code not only to support these compliance efforts, but to incentivize corporations to share more data and thereby give government more insight into the challenges, trends, and opportunities to support the growth of private business [2].

The power of digital analytics is beginning to have an impact among taxing authorities as well. Taking the same basic approach as big businesses, state and local tax jurisdictions are using digital tax data to extrapolate everything from population and demographic information to reassessing the value and effectiveness of public spending initiatives [13].

This use of data, beyond providing insights into populations and socio-economic trends, is informing the future of tax law, and the filing process itself. Big data has been a buzzword in the private sector for years; accountants, tax lawyers, the IRS, and Congress all have an interest in seeing the promise of big data realized with respect to America’s tax system as well [13].

Comprehensive tax reform, no matter what form it takes, will have to accommodate new technology. By earning your Masters of Taxation or LLM in Taxation from Villanova University online, you can be a part of bringing the practice and rule of U.S. taxes into this digital future.