What a country that could manage without tax withholding would be like

Let's imagine a country in which it would be practical to replace tax withholding on wages with universal quarterly payments sent in by taxpayers, as Charles Murray proposes in today's Wall Street Journal.

In such a country:

1) Everyone would have checking accounts, so everyone would have a low-cost alternative to using money orders to pay their taxes.

Which in turn would mean that everyone in that country trusts banks, and everyone in that country has the organizational skills, arithmetic skills, and self-discipline to manage their bank accounts in a way that will make it worthwhile for banks to offer them checking accounts.

[Reality check: In 2004, the Federal Reserve estimated that 10 million "unbanked" or "underbanked" Americans lack checking accounts. Some people can't get checking accounts because they've had trouble managing checking accounts in the past. In some cases, their troubles were not entirely of their own making, but due to an irresponsible spouse or other relative with whom they had a joint account. In other cases, the problem was due to depositing a check written by another person which they thought was good, but which was, in fact, not good. In other cases, the problem was due to misunderstanding of the bank's policies on fees and holds placed on certain types of checks deposited in their account.]

2) Everyone in that country has the capability to make reasonably accurate projections of their accrued tax liability each quarter without spending inordinate amounts of time figuring it out.

Which in turn would mean that: the tax system in the country is much simpler than the one we currently have, and everyone has a reasonable amount of number sense and fluency with arithmetic computations.

[Reality check: the National Taxpayer Advocate announced in January that individuals and businesses spend 7.6 billion hours a year complying with tax filing requirements under our convoluted and complex current law. And far too many Americans are innumerate.]

3) Everyone in that country has the budgeting skills to manage their cash flow so they'll have the money available when the quarterly tax payments are due.

Which in turn would mean, again, that everyone has a reasonable amount of number sense and fluency with arithmetic computations, as well as organizational skills and self-discipline.

[Reality check: even a veteran New York Times economics reporter can't manage his financial affairs responsibly. He writes that he repeatedly overdrew his checking account, and he ran up clearly unsustainable and pyramiding mortgage obligations.]

A good friend of mine is an amazingly awesome fifth-grade teacher in an inner-city school, where 85% of the children come from families with incomes qualifying for free lunch. She has a system in which every student has a classroom job, and gets paid in a classroom "currency". They can earn extra currency for various positive acts (and lose it for negative ones.) They have to pay "rent" for their seats in the classroom. Students who build up significant positive balances can actually "buy" other students' seats, in which case they become the landlords and collect the rent from those classmates whose seats they own. They also pay "taxes" in their classroom currency. They can use their currency to pay for various classroom privileges, and there is a monthly auction in which students can use their accumulated balance to bid on items the teacher has managed to collect.

I am in awe of this teacher--she walks on water, as far as I am concerned. She also has her fifth grade students eager to tackle Shakespeare. By the way, half her students come from Spanish-speaking homes and the other half come from English-speaking homes, so she teaches in a special immersion program where both groups of students develop mastery of both languages. She teaches all subjects in English and Spanish on alternating days (all English one day/all Spanish the following day.) And she runs marathons. And she and her husband are working on climbing all the Adirondack high peaks with their own three children (a great way to learn about goal-setting, problem-solving, and tenacity!)

But I digress--in my ideal country, all children would grow up with parents and teachers who would give them the tools they need to manage checking accounts and budgets responsibly, and pay their tax bills themselves, without the need for withholding.

In such a world, it would be practical to replace our current system of withholding with quarterly tax payments made directly by taxpayers, as Charles Murray proposes.

Is tax withholding bad for democracy?

Charles Murray thinks the answer is yes.

In his Wall Street Journal op ed, Charles Murray proposes that our democracy would be better off if everyone just wrote checks four times a year for estimated taxes, instead of having taxes withheld from their wages. He'd also eliminate payroll taxes earmarked for Social Security and Medicare and fold them into the income tax.

The article begins: "Tax Withholding Is Bad for Democracy
So is the payroll tax. End them both and voters will have a healthier understanding of the government burden."

Murray spells out how his proposal would work as follows:

Fold payroll taxes into the personal tax code, adjusting the rules so that everyone still pays the same total, but the tax bill shows up on the 1040. Doing so will tell everyone the truth: Their payroll taxes are being used to pay whatever bills the federal government brings upon itself, among which are the costs of Social Security and Medicare.

The finishing touch is to make sure that people understand how much they are paying, which is presently obscured by withholding at the workplace. End withholding, and require everybody to do what millions of Americans already do: write checks for estimated taxes four times a year.

Both of those simple changes scare politicians. Payroll taxes are politically useful because low-income and middle-income taxpayers don't complain about what they believe are contributions to their retirement and they think, wrongly, that they aren't paying much for anything else. Tax withholding has a wonderfully anesthetizing effect on people whose only income is a paycheck, leaving many of them actually feeling grateful for their tax refund check every year, not noticing how much the government has taken from them.

But the politicians' fear of being honest about taxes doesn't change the urgent need to be honest. The average taxpayer is wrong if he believes the affluent aren't paying their fair share—the top income earners carry an extraordinary proportion of the tax burden. High-income earners are wrong, too, about being exploited: Take account of payroll taxes, and low-income people also bear a heavy tax load.

The behavioral economics research on tax salience suggests that he's right that people would have a greater realization of their true tax burden if they wrote quarterly tax checks rather than just having the tax money disappear from their paychecks before it ever even got to them.

I can tell you for sure that most people I encounter, whether friends, relatives, co-workers, or our VITA site clients, do not fully realize the magnitude of the taxes they pay.

When April 15 looms, they mostly focus on the refund or the balance due, with little awareness of the total amount of taxes they've paid through withholding. (That goes especially for their employer's share of payroll taxes for Social Security and Medicare, a cost which is invisible to many people, but which most economists believe is ultimately borne by the workers in the form of wages that are lower than they would otherwise be.)

I have a lot of concerns about the practicality of having everyone pay estimated taxes instead of withholding. For example, there are many taxpayers who are among the "unbanked" or the "underbanked," who do not have checking accounts. Some use money orders to pay their bills and sending four quarterly payments would be an added expense for them. Managing their budgets to accumulate the money needed for quarterly payments would be a challenge for many, especially those without bank accounts. Given how complicated our tax system is, many taxpayers would also have trouble computing even a ballpark figure for their quarterly estimated payments, and a number of them would probably wind up paying added fees to a tax pro to help them figure their estimated taxes correctly.

On the other hand, the withholding formulas built into the current system don't work all that well either, especially for people with multiple jobs or certain kinds of widely varying income streams, not to mention the AMT and the kiddie tax.

Of course, tax simplification could go a long way to simplify both the withholding system and the estimated tax computations!

But the Murray proposal doesn't address the simplification question at all. In fact, he seems to want to preserve the complexity of the current system, since he writes that the 1040 should be revised so that everyone would still pay the same total of income tax and payroll tax that they currently pay.

Postscript: Charles Murray doesn't mention, but presumably knows, that a famous conservative economist (someone I imagine he greatly admires) ironically played a major role in introducing withholding in the first place. See comments for more details.