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IRS Bounces on Checks

Friday, December 2, 2011

How did the IRS fail to utilize modern payment technology that benefits taxpayers?

The IRS issued 119 million tax refunds worth $358 billion to individual tax filers last year; of those, 45 million refunds, totaling $166 billion, were issued by check. Moving that magnitude of money to that many households is no easy task. To lower the administrative cost for the government and the taxpayer, the Treasury Department operated a pilot program last year that distributed tax refunds to low- and middle-income taxpayers through prepaid debit cards hailed as convenient, safe, and cost-efficient.

Many expected the program to be a big hit, especially because it followed other government programs’ success in phasing out payments by check in favor of direct deposits or debit cards.

But Treasury’s initial enthusiasm about the pilot program did not translate into participation—of the 600,000 taxpayers given the option of receiving their tax refund on a prepaid card, only 2,000 chose to do so. Now, Treasury has suspended the program.

The program seemed not simply aimed at greater convenience and security for low-income taxpayers, but also at trying to 'establish ongoing bank accounts' for them.

Does low participation suggest that this is not a desired service by the IRS, or does it suggest that the government did a bad job at setting up the pilot? The latter seems more likely.

As part of a broader trend in payment technology, prepaid debit card usage has skyrocketed in recent years, alongside new innovations such as PayPal and Bill Me Later. In particular, these cards are popular among low- and middle-income individuals.

In general, government has been on board, too. State unemployment benefits are already distributed through debit cards and all other government benefits payments are moving quickly in this direction. Most impressive is the early government effort to move welfare benefits to debit cards beginning after welfare reform in the mid-1990s.

Debit cards allow the government to pay only 10 cents to provide a tax refund instead of the nearly $1 it costs to process and mail a refund check. And there are clear benefits to shifting tax refunds to debit cards for individuals who have no bank account for direct deposit, including safety, convenience, and the ability to avoid check-cashing fees.

Given all this, the low participation in the pilot program seems surprising. How could it be that the IRS failed in its effort to take such a simple step toward embracing modern payment technology that would yield both cost savings for the IRS and benefits to taxpayers?

Debit cards allow the government to pay only 10 cents to provide a tax refund instead of the nearly $1 it costs to process and mail a refund check.

The details and execution of the pilot program matter. House Ways and Means Committee Chairman Dave Camp (R-Michigan) and House Oversight Subcommittee Chairman Charles Boustany (R-Louisiana) wrote a letter to Treasury Secretary Tim Geithner expressing concern about the pilot. Because the debit cards can be reloaded and used for direct deposit, cash withdrawals, purchases, bill pay, and even saving, the congressmen noted that the program seemed not simply aimed at greater convenience and security for low-income taxpayers, but also at trying to “establish ongoing bank accounts” for them through the promotion of these cards. The letter questioned such involvement by the federal government in individuals' financial affairs. This timely and appropriate letter asked the Treasury Department about the nature and framework of the program, noting concern about high monthly fees on the cards—a contrast to most government-issued prepaid cards—and program oversight.

The IRS has indicated that they may reintroduce the program at some point in the future. This would be a sensible step, as it could be a great example of harnessing an innovation from the private sector to provide better public services at lower cost. If state welfare departments can make debit cards work, let's hope that the IRS, with a $12 billion annual budget and nearly 100,000 employees, can make it work, too.

Alex Brill is a research fellow at the American Enterprise Institute. He organized an event titled "Digital Money: Trends and Policy Challenges" that explored the growing role of electronic payments in our economy.

FURTHER READING: Brill also writes “Housing Finance: For Once, Please Leave It Alone” and “Please Actually Read My Research.” Todd Zywicki describes “Durbin’s Innovation Killer.” Nick Schulz says “Debit Card Surcharge Is a Free Market Reaction to Government Controls on Swipe Fees.”

Image by Darren Wamboldt | Bergman Group

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