Automatic Tax Filing: A Challenging Idea for Canada

In Canada, most government cash benefit payments require recipients to file a tax return. Individuals who fail to participate in the tax system, often the most vulnerable in society, may forgo important government benefits (or even entitlements to government services when such services are tied to tax return information). The September 2020 Speech from the Throne committed the federal government to “work to introduce free, automatic tax filing for simple returns to ensure citizens receive the benefits they need.”This Commentary first describes various levels of possible filing automation. First of all, some countries do not require tax filing at all for people in simple tax situations, particularly employees for whom tax withheld at source by the employer and remitted to the tax authority is adjusted throughout the year such that the total amount withheld at the end of the year corresponds to the exact tax liability. Individuals facing a more complicated tax situation, or eligible for additional tax relief, must often file a tax return. In other countries, particularly in Scandinavia, tax filing is quasi-automatic: eligible taxpayers with basic sources of income receive prepopulated tax forms with their tax liabilities already computed by the tax authority; taxpayers need only verify the prefilled information for accuracy.The completeness of prepopulated tax forms and the accuracy of computations prefilled by the tax authorities depend on the complexity of filers’ tax situations. The greater the number of taxpayers with basic tax returns, the more practical it would be to fully automate tax filing. Provided the Canada Revenue Agency obtains reliable basic personal information on tax filers, we estimate that only one in three potential tax filers would have a “basic” tax return – i.e., a tax return for which the CRA would already receive sufficient information from third parties to accurately compute taxes and benefits.Therefore, we argue that the Canadian tax code contains too many deductions and credits recognizing specific personal circumstances, expenses, or activities to make a widely available, fully automatic filing system practical. On balance, the current self-assessment with Auto-Fill by the CRA is well adapted to Canada’s complex tax system, and making it more automatic would require a fundamental simplification of the underlying tax system.The Commentary concludes that fully automatic filing for all is a blunt instrument to get to the narrower problem of non-filing eligible benefit recipients. We estimate that about 4.2 percent of potential tax filers – or more than 1 million people – do not participate in the tax system, but likely should. More targeted strategies to reach these people are preferable, such as decoupling the requirement to file a tax return from eligibility to receive benefits. Despite practical challenges, establishing a new body specifically tasked with delivering income-tested benefits to Canadians could make this possible, better serving the poverty-reduction objectives of government support programs that are now tied to tax filing.Canada’s federal and provincial governments increasingly use cash benefits to families as a mean to achieve their redistribution goals, including poverty reduction.Many benefits require recipients to file a tax return to be eligible – the cash transfer system is intertwined with the tax system. Individuals who do not participate in the tax system, often the most vulnerable in society, could forgo important government benefits or entitlements to government services.The September 2020 Speech from the Throne committed the federal government to “work to introduce free, automatic tax filing for simple returns to ensure citizens receive the benefits they need.” It is not clear what automatic filing actually would mean in practice, although it seems to imply an automated process through which taxpayers would have their tax return filled and filed by the Canada Revenue Agency (CRA) in the case of federal and provincial/territorial personal income taxes, except in Quebec, where provincial taxes are administered by Revenu Québec. For many taxpayers, having the tax authority’s automated systems fill out their tax return and compute their tax liabilities on their behalf for free is certainly an appealing idea.In this Commentary, we review Canada’s current tax-filing practices and look at various tax-filing systems around the world. Based on this review, we suggest what automatic tax filing might look like in Canada, and examine potential rewards and challenges.We present an estimate of the number of people who do not participate in the tax system but likely should, and sketch some of the factors and difficulties explaining their non-filing behaviour. We also discuss the complexity of the tax code, and estimate how many taxpayers truly have a basic federal tax return that easily could be fully automated.We argue that making fully automated and automatic tax filing broadly available in Canada is challenged by the complexity of the tax code. The tax system is widely used to achieve social and economic goals, and a number of provisions would be difficult to automate. Governments’ appetites to use new tax concessions for their redistributive goals are on the rise, making fundamental tax reform aimed at tax simplification unlikely. We conclude that automatic filing for all would be a sweeping solution to the narrower problem of getting benefits to eligible recipients who do not file a tax return. More targeted strategies to reach these people are preferable. We propose that decoupling the requirement to file a tax return from eligibility to receive benefits is worth serious consideration. Despite practical challenges, establishing a new body specifically tasked with delivering income-tested benefits to Canadians could make this possible, better serving the poverty-reduction objectives of government-support programs that are now tied to tax filing.