Sam Hodges
Our credit system runs on the power of data. A simple IT upgrade at the IRS would put more of this power in your hands.
When you apply for credit, such as a loan, credit card or mortgage, you essentially ask a lender to evaluate your financial picture to make an informed decision about your approval, rate and terms. Right now, the information that lenders use primarily comes from two sources: you (the applicant) and private credit bureaus that keep track of things like your payment record to your current and past creditors.
This system is imperfect for a variety of reasons. It frequently leaves lenders with gaps and distortions in assessing your creditworthiness. Critical information that could make the picture clearer can’t be accessed at the speed our modern economy moves. Notably, this includes detailed, verified, multi-year financial data from your tax return, which can prove facts such as the applicant’s steady income. It’s held back by outdated technology at the Internal Revenue Service.
New legislation would change this. The IRS Data Verification Modernization Act of 2017, recently introduced in Congress by Rep. Patrick McHenry (R-NC) and Sen. Cory Booker (D-NJ), would set up an application programming interface (API) at the IRS.
This API would turn a cumbersome, manual process into an automated one. An API would allow the agency to provide your transcripts the instant you give your authorization. Credit providers would then have more information to make better decisions about your approval and rate. This could cut financial fraud and improve credit prices, speed and access for everyone.
Here’s how it would work
Right now, you can file what’s called a 4506-T form with the IRS. This form gives the IRS permission to send summarized transcripts of your tax returns to a third party, like a lender. It might take weeks to provide the information. It can happen quicker, but often only if you can afford to pay a private expeditor to speed things up. Lenders use these transcripts to confirm the details of your application, but it’s usually too late to factor them into your approval or rate in the first place.
Current technology makes this unnecessary. An API is essentially a specification that allows one program to request data from another one, securely and in real time. If you’re reading this article, or if you’ve ever used Facebook or gotten directions on your phone, you can thank an API. They’re commonplace — already enjoying widespread adoption and usage across the internet and our financial system.
Setting up the API that the legislation calls for would have huge results. For example, you could get a better rate on a mortgage because your lender could have instant access to more information to price your loan more accurately. If you were teetering on the edge of a bad credit score, it could mean getting a loan when you otherwise wouldn’t.
Leveling the playing field would be especially helpful for small businesses. It’s common for entrepreneurs to run a large balance on personal credit cards to get their business going, leading to a lower credit score. If they seek a business loan to consolidate this debt or grow their companies, they have trouble getting anything but the worst terms. A 4506-T API would mean the credit provider could consider more comprehensive financial data. They could see, for instance, that an applicant has been growing steadily and maintaining a stable profit margin.
Similar models across the Atlantic
The API proposed by Rep. McHenry and Sen. Booker is just the start. Other places around the world are beginning to adopt more comprehensive initiatives that expand access to financial data through innovation.
For example, by early next year, the United Kingdom will implement its Open Banking measures, which will enable people and small businesses to share their transactional-level current account data securely between banks and third parties through an API. This will transform the borrowing process by making credit assessment faster and more efficient, and reduce the likelihood of fraud, among other benefits.
This is in addition to the business data already available through Companies House, which serves as a central national repository that anyone can access for business information, including financial statements. Today, credit providers rely on this information, along with other data, to assess applications. In fact, the U.K. has had a public register of companies since 1844, but we have nothing comparable in the United States on a national level.
The European Union is instituting its own data access framework with the revised Payment Services Directive (PSD2), which requires banks to open up APIs by 2018 to give third-party providers access to their customers’ accounts. The directive aims to drive increased innovation, transparency and competition in payments and other financial services.
Like the U.K. and the EU, the United States is seeing a digital transformation across its financial services industry. People and businesses are seeking new options, enabled by technology, for making payments, getting loans, managing their budgets and more. But unlike our neighbors, we have no plan for getting our financial data, which these new services depend on, out of its current chokehold.
Setting up a 4506-T API at the IRS does not require legislation. But the IRS has been unable or unwilling to make it a priority to date, and, in fact, a similar measure in the previous Congress failed to garner enough support to pass.
It’s encouraging to see the bipartisan support this current bill has received so far in both houses of Congress. As our economy speeds ahead, we must ensure that this important tech update does not get left by the wayside.
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