Filing Your Tax Return: Competition or Monopoly?

In America, an extremely heated public debate rages on about the role of the federal government in managing and paying for health care services. On one side of the argument, Republicans have rushed to the defense of House Representative Paul Ryan and his proposal to convert the Medicare system into a private sector voucher plan. And on the other side, the Democratic Governor of Vermont has taken the first concrete steps  towards implementing a Canadian-style single payor government system for an entire American state.

Interestingly, though, similar debates are also taking place about other sectors of the economy. For instance, let’s consider the Do-It-Yourself (DIY) income tax electronic form preparation and filing industry. Although many states have developed their own internet-based government systems for citizens to file their income tax returns, the Internal Revenue Service of the federal government has instead opted to encourage private corporations to compete with each other to provide this service to taxpayers.

Last week, however, the United States Department of Justice (DoJ) filed a lawsuit to block a corporate acquisition that would utterly transform the competitive market for such tax return preparation services. Was it an example of an unwarranted government intrusion into a private sector market place? Or, alternatively, did it represent an appropriate case of government oversight and regulation?

Seventeen Competitors … Or Only Three?

At first glance, the market for DIY income tax preparation services appears to be a highly competitive one. After all, the Internal Revenue Service promotes seventeen organizations that offer tax filing services to the public … and those are only the firms that are willing to provide free assistance to citizens with relatively low Adjusted Gross Incomes! Many other firms across the nation sell competitive services as well, although they decline to provide any free filings.

It is indeed a broadly diverse list, ranging from the national for-profit industry giant HR Block to the tiny start-up I-CAN! program of the nonprofit Legal Aid Society of Orange County, California. Nevertheless, it is important to note that 90% of all electronic tax filers across the nation have opted to utilize the services of only three organizations: Intuit, HR Block, and 2nd Story Software.

Intuit, of course, is a $3.5 billion global technology company. And HR Block prepares one out of every seven tax returns that are filed in the United States. 2nd Story, though, is a relatively small, privately owned firm that has made its mark by being a “maverick” on service pricing.

In October 2010, HR Block announced a plan to acquire 2nd Story and its TaxACT filing service, a move that would effectively consolidate 90% of the federal income tax filing market into the hands of a pair of industry giants. After studying the merger for more than seven months, the DoJ filed a lawsuit last week to block the transaction in order to preserve private market competition.

Broader Ramifications

The questions raised by the DoJ’s action, of course, extend far beyond the DIY income tax filing industry. Does the federal government possess the right to prevent private corporate mergers in the name of preserving competition, even for industries that actually support a large and diverse collection of competitive service organizations? Can it justify taking such actions by noting that the largest competitors in the industry have amassed significant shares of the total market?

These broad questions are relevant to regulatory policy in many economic sectors, including — perhaps most importantly, considering the current debate over federal policy regarding Medicare — the health insurance industry. After all, in many population centers across the United States, the market share of the two or three largest private health insurers now exceeds 90%. The entire state of Rhode Island, for instance, is only served by three commercial insurance companies, with Blue Cross Blue Shield serving 70% to 80% of the self-insured large group and fully insured markets, and with the national industry giant United Health serving another 10% to 20% of these clients.

While the debate over national health care policy raged through Congress last year, many Democratic proponents of a “government option” supported a proposal to trigger such an option where ever private insurance markets are non-competitive as a result of insurer consolidation. If the DoJ succeeds in establishing that a large market share in the hands of a duopoly of tax return preparation providers is in fact non-competitive, could it then reassert the need for a “government option” health insurance plan in states like Rhode Island by utilizing the same rationale?

Similar questions can be asked about the federal government’s sponsorship of Amtrak in the public transportation industry, of the U.S. Postal Service in the package delivery industry, and of many other government programs and services as well. To prevent free-for-all disputes from flaring up in each of these ostensibly unique industries, it may be helpful to begin such debates by achieving some level of consensus about the appropriate role of government in maintaining market competition.