Imagine it’s tax filing season. You’re dreading figuring out your tax liability this year, because in the last few years you’ve been earning sporadic capital gains and dividends that sometimes have led to a surprise tax bill at year-end. This year, though, is the first year that pay-as-you-earn (PAYE) tax collection has been expanded beyond wage income to cover additional types of earnings, causing your capital gains and dividends to be withheld at source, as well as some key deductions and credits, so that you don’t have to retrospectively reconcile your income, withholding, and deductions—all you need to do is fill out and file your Form 1040. There is no big bill, because withholding at source was applied on all of your income, and because it accounted in advance for the standard deduction and for the deduction you knew you would claim for student loan interest.
This hypothetical scenario is a reality in some other countries, such as the U.K., which have embraced advances in technology to improve the accuracy and breadth of their tax withholding systems. For example, the U.K. utilizes real-time reporting technology to exchange information with employers and has made a variety of changes in its tax system, in part to more effectively facilitate its expanded PAYE system. Among other things, the U.K. relies on a single unit of taxation (the individual), doesn’t tax capital gains and dividends below a certain threshold, and administers certain entitlement programs outside of the tax system. These structural adjustments enable two-thirds of U.K taxpayers to fully and accurately satisfy their tax liabilities by year-end.
Other countries, including New Zealand, Spain, Australia, and France, have implemented, or are in the process of implementing, similar approaches to provide a more expansive, user-friendly tax system. While they differ in scope and particulars, they are similar in that, insofar as possible, they seek the broadest PAYE coverage for the greatest number of taxpayers. Additionally, the U.K. has made strides toward a return-free filing option, under which taxpayers who neither owe nor are owed payments at year-end are allowed to forego the formality of filing a tax return. Other countries also may incorporate return-free filing as the breadth and accuracy of their PAYE systems make this option feasible.
Whether or not the U.S. would want to take such steps and would be willing to implement changes to the tax system such that a comprehensive PAYE system would be possible remain open questions. Nevertheless, the potential benefits flowing from an expanded PAYE system prompted TAS to examine what other countries are doing in this area and to analyze how such a system might be applied in the U.S. A link to our study is here. For example, we determined that a PAYE system that withheld taxes from the four most common types of income (wages, interest, pensions, and dividends) and that accommodated the standard deduction would allow accurate PAYE coverage for 26 percent of U.S. tax returns (38 million). If that system were expanded to cover seven of the common types of income and the seven most common deductions and credits, it would cover 51 percent of tax returns (75 million), as illustrated in the figure below.