An exact-withholding system has the potential to reduce tax compliance burden for taxpayers. Filing tax returns can be a drain on taxpayers’ time and resources, emotions, and, for those who hire a tax preparer, wallets. Thus, even if most taxpayers can complete their returns with relatively little effort, a return-free system could still provide them significant benefits.

However, many taxpayers would not be able to rely on exact withholding to accurately compute the amount of taxes they owe or the refunds to which they be entitled. Precision in withholding is already challenging for married couples or taxpayers with more than one job. Further, there is no mechanism for withholding taxes on certain types of taxable income, such as self-employment income and many types of capital gains. Complicated eligibility rules for deductions and credits would also restrict the use of exact withholding. Some of those challenges could be alleviated with fundamental reforms to the income tax, but the impact of those changes on tax liabilities could vary among taxpayers.

Moreover, if states with income taxes failed to shift to an exact-withholding system, the reduction in taxpayers’ filing costs would be modest. And if states do not follow the federal government’s lead on tax simplification, the overall benefits of a federal exact-withholding system would further decline.

Exact withholding could lower the administrative burden on the Internal Revenue Service and decrease federal expenditure for tax collection. But the drawbacks to a return-free system include a potentially heavier administrative burden on employers and other businesses charged with withholding income tax.

In addition, taxpayers and opponents have expressed concern that a return-free plan would allow the government to decide how much tax was owed, limiting taxpayers’ independence and constraining their ability to appeal tax agencies’ decisions.

Under the current system, taxpayers appear to like overpaying tax through withholding and then receiving refunds. Moving to a cumulative exact-withholding system would eliminate refunds for those taxpayers whose taxes can be accurately withheld during the year. But eliminating those refunds has certain advantages. Some taxpayers may view refunds as a form of forced saving, but an exact-withholding system could encourage them to adopt new financial strategies and begin earning returns on their income during the course of the year instead of waiting for a refund the next year. Others may overpay during the year to avoid a large tax bill when they file their tax return; a successful exact withholding system would alleviate that stress.

Some argue a “visible” tax system is important, on the principle that citizens who know what they pay can make better economic and political choices. In an exact-withholding system, taxpayers might not be fully informed about how they are being taxed and thus less aware of the tax consequences of their actions. However, the visibility of the tax system may already have been diminished as more taxpayers rely on paid preparers and tax preparation software.

Updated January 2024