Preliminary Evidence from a New Survey1

The United States Federal income tax code has an enormous potential to shape the economic and financial decisions of taxpaying households. Tax rates, compliance laws, and the withholding system create incentives, as do the methods by which the Treasury collects tax receipts and disburses tax refunds. The role of third party service providers in this incentive structure is less well understood, even though tax preparation firms play important roles in our tax system. Nationally, more than half of taxpayers use paid preparers to submit their tax returns. Low- and moderate-income (LMI) households are among those who use the paid tax preparation system. In fact, among those who file, more than two-thirds of low-income households use paid tax prepara-tion services. Thus, understanding the role of third party providers in the tax system is critical to understanding how our tax system functions. Tax preparation service providers can potentially both increase and de-crease social welfare. On the positive side, tax preparation firms may increase the likelihood that taxpayers will hear about and take advantage of tax incentives designed to reach them. For example, over 20 million low- and moderate-income households file for approximately $35 billion in refunds and reduced tax liability under the Earned Income Tax Credit (EITC), designed to reward work for low-income working families. On the negative side, tax preparation firms can add to the costs of the tax system and reduce the effectiveness of the EITC and other tax incentives. Tax preparation is costly in itself to tax filers, and low-income households often face additional costs associated with filing. For example, many low-income households lack bank accounts and receive a paper check by mail from the IRS; they thus must wait longer for their re-fund checks than banked households using direct deposit. Those unbanked households receiving a check must also pay a significant fee to cash thei