As tax season wraps up for tax year 2023, the IRS is eager to tout the supposed success of its new Direct File pilot program that debuted this season. However, a recently released report from the Government Accountability Office (GAO) shows that the IRS hasn’t appropriately measured the true costs – or benefits – of the pilot, raising questions about its future.
In 2022, the IRS received $15 million within the $80 billion Inflation Reduction Act (IRA) to establish a task force to study its ability to offer a Direct File program that would offer free tax filing services to qualified taxpayers, a service that is already offered through the IRS’s Free File program in partnership with commercial providers. The IRS instead overstepped its mandate, going well beyond simply studying Direct File and instead rolling out a pilot program for this tax year.
In its Strategic Operating Plan (SOP) outlining the use of IRA funding, the IRS promised to conduct a study to “ensure any direct file service is feasible, cost-effective, secure, and meets the needs of taxpayers.” In May 2023, the IRS released one of two reports required by the IRA outlining taxpayer sentiments towards a direct filing system and the potential cost. The report estimated that it could cost taxpayers between $64 million and $249 million annually, depending on the number of filers who would be able to use it. The second report was required to be prepared by an independent third party, which ended up being a left-leaning think tank that has previously advocated for government-run tax filing. They used the same cost factors as the IRS and came up with a similar estimate.
GAO’s report confirms that not only did the IRS fail to properly account for costs in its report prior to rolling out its pilot program, it is still unable to determine whether Direct File is cost-effective even as tax season comes to an end. GAO found significant methodological weaknesses in both the IRS report to Congress on Direct File from May 2023 and the IRS cost estimation practices during the pilot.
GAO found that IRS is insufficiently collecting data to measure costs in the following areas:
Customer Service: There is no methodology to estimate the cost of 400 employees’ time spent on Direct File customer service, the cost of training those employees, and the potential future cost of customer service if Direct File continues.
Technology: Pilot evaluation plans do not account for the cost of frequent updates that would be required due to tax law changes or taxpayer feedback.
State Tax Integration: IRS officials are unsure how to calculate the cost of transferring data to state tax returns and have no metric for doing so, despite the fact that the pilot program is already doing this for Arizona, Massachusetts, and New York. Of the twelve states participating in the pilot program, only four have an income tax. California opted not to integrate its returns with Direct File.
Other Taxpayer Needs: There is no plan for estimating the cost of scaling up Direct File capabilities beyond its current scope, which only allows taxpayers to claim limited deductions and credits. GAO notes that even this limited scope required significant work from the IRS as it drafted questions to collect taxpayer information, tested them, and put them through legal review.
Additional Labor: IRS did not account for the cost of 29 U.S. Digital Service (USDS) employees currently working to build and run the pilot program until September 2024. While the IRS is not required to reimburse USDS for their work, the cost of their labor should still be included in a genuine cost estimate as their labor is still paid with taxpayer funds.
Given this inability to demonstrate whether Direct File is truly cost-effective, the IRS will have to rely on other measures to back any claims of the program’s value to taxpayers. Unfortunately, GAO has also identified severe weaknesses in the IRS’s calculation of its supposed benefits. The IRS did not have metrics to determine if their program leads eligible taxpayers to claim more credits and deductions and did not have metrics to determine if Direct File will reduce paper returns and errors.
Furthermore, taxpayers already benefit from IRS Free File, a decades-long public-private partnership between the IRS and a coalition of commercial providers called the Free File Alliance. Free File provides free tax filing options for taxpayers with annual adjusted gross income below $79,000 and has served over 71 million taxpayers since the program began in 2003. In GAO’s report, the IRS concedes that taxpayers would spend a similar amount of time filing their taxes through Direct File as they would with Free File. In a Senate Finance Committee hearing, Senator Mike Crapo (R-ID) pointed out that the IRS spends less than $5 million per year on Free File compared to the $114 million it has budgeted for Direct File in FY2024.
In search of reasons to continue the program, the IRS plans to conduct a study soon to compare the burden to taxpayers between their new offering and the filing options already available. Until then, the IRS continues to rely on informal user reviews to demonstrate its value. Notably, the most widely reported positive review came from an IRS employee who was promoted in the press as the first Direct File user.
Outside of the IRS, the public is increasingly taking notice of the pilot program’s serious flaws. Just a few weeks prior to the end of tax season, only 50,000 people had used Direct File. States have raised serious concerns about the pilot with 13 state Attorneys General and 21 leading state fiscal officials sending letters to the Department of the Treasury about the program’s potential negative consequences for taxpayers. IRS Commissioner Daniel Werfel has been asked about the necessity of the program and its cost several times by both chambers of Congress within the past year.
The work on Direct File was clearly taken too far too fast, and the IRS could further balloon the program if left to its own discretion. While Commissioner Werfel has repeatedly emphasized that Direct File is just one option for taxpayers, it is easy to imagine a scenario where the IRS actively undermines services offered with the Free File Alliance, instead directing users to its own service. In the future, the IRS could try to do as some groups have already requested and pre-fill returns with taxpayer information using Direct File, letting the proverbial fox into the henhouse as the IRS has no incentive whatsoever to ensure that taxpayers receive every credit and deduction they are entitled to. It could also open the floodgates for severe breaches of taxpayer privacy as the IRS consistently fails to protect the data it already has. Government-run filing has also already been studied by authors from the Department of the Treasury and Federal Reserve.
GAO’s report ends with three simple recommendations: to estimate and document the full cost of Direct File, to estimate and document the potential benefits of Direct File, and to use that data to inform decisions about the program’s future. Taxpayers need to know whether this program is a costly and duplicative waste of resources, and the IRS cannot responsibly continue it if so.
Instead of pouring hundreds of millions into Direct File, the IRS should do more to leverage Free File, leading to government savings. Lawmakers can also do their part to simplify the tax code to prevent taxpayers from spending 6.5 billion hours annually complying with tax laws.