Every once in a while, the members of the U.S. Congress get mad at the Internal Revenue Service. Reacting to some bureaucratic bungle, real or imagined, the senators and representatives launch a round of angry speeches in their respective chambers. Then they order IRS officials to appear at a hearing before one of the congressional oversight committees—a session that is generally marked by scorching rhetoric, hostile questions, and furious accusations, as long as the TV cameras are on. Finally, the members put out a fiery report denouncing the tax code and the IRS staffers who administer it. Then they move on to the next target.
There’s a strong kill-the-messenger flavor to these periodic outbursts of manufactured rage. Members of Congress love to harangue the IRS bureaucrats about lengthy tax forms and unfair rules and complex instructions—but of course the IRS isn’t responsible for the length, the fairness, or the complexity of our tax code. It is Congress that writes the tax laws. It’s Congress that adds hundreds of new exemptions, allowances, credits, and calculations to the tax code every year. It was Congress that decided to give the IRS responsibility for managing the health insurance subsidies flowing to millions of Americans under the Affordable Care Act (ObamaCare)—and then cut the agency’s staff after assigning it this major new task. It was Congress that assigned to the IRS the management of the earned income tax credit (EITC), which has become one of the nation’s largest support programs for low-income Americans. It was Congress that crafted the much-hated alternative minimum tax, which spawned whole new dimensions of complexity, and hours of additional work, for millions of families. And yet congressmen and senators can’t seem to resist pointing angry fingers at the IRS, as if somebody else had created the legislative monster that is the U.S. tax code.
This form of political showmanship reached its zenith in the spring of 2016, when a group of Republican backbenchers mounted a quixotic effort to impeach the commissioner of the IRS, John Koskinen. This idea—the first time Congress had ever tried such a thing—was doomed from the start, because the leadership in both houses opposed it, viewing the whole exercise as an empty gesture. But the critics were determined to proceed, in large part because Koskinen—who came out of retirement in his seventies to run the agency and thus had no fear of snippy young congressmen—had never treated the august members of Congress with the respect and deference they had come to expect from bureaucrats. Indeed, Koskinen generally displayed thinly veiled contempt for committee members when he was hauled into a congressional hearing. Whenever the members starting griping about the complexity of the tax system, Koskinen would shake his head and steer the complaint right back at them. “I didn’t write the tax laws, Congressman,” he would say. “You did that.” When Congress scheduled a hearing in mid-2016 on the impeachment resolutions, Koskinen rather blatantly thumbed his nose: the IRS sent word that the commissioner was too busy to make the one-and-a-half-mile ride to Capitol Hill to testify. The impeachment resolutions didn’t come to a vote in either chamber.
Generally, a congressional inquisition of the IRS leads to nothing more than a fleeting moment on the evening news and a committee report that is put on a shelf and forgotten. But occasionally, this burst of congressional rancor prompts new legislation designed to deal with whatever problem sparked the anger in the first place. One such moment came in 1998, following a series of heated congressional hearings on the way IRS agents were treating (and sometimes mistreating) taxpayers who had run afoul of the code. The result was the IRS Restructuring and Reform Act of 1998, a voluminous and hugely complex new law, which included the laughable “anti-complexity clause”—that is, Section 7803(c)(2)(B)(ii)(IX). Another part of that same law—to wit, Section 7803(c)(I)(B)(i)—created a new office within the Internal Revenue Service, to be known as the Office of the Taxpayer Advocate. The national taxpayer advocate was based on a position found in the national tax agencies of several foreign countries: the ombudsman. The taxpayer advocate’s main job is to be a helping hand for harried taxpayers facing an audit or a penalty fee or a levy from the IRS. This ombudsman is to work within the IRS but not under the control of the commissioner; the advocate is appointed by the secretary of the Treasury to an unlimited term and can be removed only by the secretary. Congress did not stint on resources, either; the taxpayer advocate has a staff of two thousand people, with offices in every state, who are empowered to jump in whenever a taxpayer complains of being mistreated.
Lawrence Summers, who was the last Treasury secretary of the Clinton administration, made an inspired choice when he named the first national taxpayer advocate in 2000. He picked Nina Olson, a tough, feisty tax lawyer and single mom who had spent the bulk of her career as an accountant, doing the books for a series of one-person or mom-and-pop businesses. Seeing all the trouble her clients had in filing their taxes, Olson went to law school at night and then earned a master’s degree in tax law at Georgetown University. She was perhaps the only graduate of that elite program who did not use her degree to represent an upper-bracket clientele. Instead, she opened a clinic in Richmond, Virginia, to help low-income people who had tax problems but nowhere near enough money to hire a tax lawyer.
Having spent years watching her clients fall into despair as they struggled with endless IRS forms and incomprehensible IRS instructions, Nina Olson was ready, willing, and able to take on the agency from the inside when she was asked to become the taxpayer advocate. “The thing is, they had to listen to me, and they couldn’t fire me, no matter how mad they got,” Olson told me one day in her impossibly cluttered office at IRS headquarters. As of the publication of this book, Nina Olson is still the national taxpayer advocate—the only person ever to hold the job.
In addition to standing up for harried taxpayers, the taxpayer advocate was given a series of further responsibilities by the IRS Restructuring and Reform Act of 1998. Among other things, the law—this would be Section 7803(c)(2)(B)(ii)(III)—requires that she report to Congress regularly on “at least 20 of the most serious problems encountered by taxpayers.” This she has done every year, and nearly every year she has listed the same issue as the number one most serious problem facing American taxpayers. That problem is the complexity of the tax code.
“Every year, I tell them that the tax system is just too complicated—that people have to pour all sorts of time and money into the task of filing their taxes,” Olson told me. “And of course that makes people hate the system, and hate the IRS, and feel that the other guy is cheating while they have to pay full freight. I mean, it undermines the whole idea of voluntary compliance with the tax code!
“So every year I tell them about this problem, and every year they make the problem worse. Why did they ask me to file a report on serious problems facing taxpayers, if they just go on doing the same thing? Sometimes I feel like Cassandra.”1
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NINA OLSON KEEPS WARNING CONGRESS that the steady stream of revisions and additions to the tax code can only exacerbate the problem of complexity. But Congress doesn’t listen. Commerce Clearing House, a publisher that tracks developments in the tax laws, has estimated that there are about 420 significant changes to the tax code every year, many of which require new forms, new rules, and whole books of instructions for taxpayers to follow.
“One of the most surprising, most disappointing things I found when I got this job,” said John Koskinen, who was named commissioner of the IRS in 2013, “is the way Congress just changes the tax code willy-nilly, without ever thinking about it. People keep adding stuff without ever thinking, is this going to be easy to deal with? Is this going to make taxes more complicated? Because they are way too complicated already.”
The national taxpayer advocate set forth the familiar complaint in significant detail in her annual report to Congress for the year 2012. “The most serious problem facing taxpayers—and the IRS—is the complexity of the Internal Revenue Code,” Olson reported. She went on to list some of the implications of this complexity. The tax code, she wrote,
The U.S. tax code has grown so huge that nobody really knows how long it is. During the 2016 presidential campaign, candidates routinely cited a figure of seventy-three thousand pages—a number that seems to include about thirty-five hundred pages of the law itself, plus another seventy thousand pages of regulations. The Republican candidate Carly Fiorina said she could reduce that “down to about three pages,” although the proposal she made for tax simplification would have replaced only Subtitle A of the code (there are ten more sections, Subtitles B through K, that presumably would have remained intact under the Fiorina plan).
When Nina Olson’s staff copied the entire Title 26 of the U.S. Code (that’s the Internal Revenue Code) into a Microsoft Word document, the program’s “Word Count” feature found a total just under four million words.
The IRS likes to boast that it is a highly efficient government agency, and this is accurate, in a sense. In fiscal year 2015, the agency spent $11.4 billion and brought in revenues of $3.3 trillion; that is, the service spends just thirty-five cents for every $100 it brings in. Another measure of efficiency is revenue per employee. The agency has a staff of about seventy-six thousand to raise that $3.3 trillion, which means the average IRS employee takes in more than four hundred times her government salary.2 On both measures—cost of collection and revenue per employee—America’s IRS ranks at or near the top for sheer efficiency among the taxing agencies of the world’s rich countries.
But the IRS achieves this noteworthy status by imposing much of the cost of the tax system on taxpayers. In other rich countries, as we’ll see shortly, the tax collector shoulders much of the burden that is borne by individual and corporate taxpayers in the United States. The IRS, in contrast, pushes those costs onto us. While the tax agency spends $11.4 billion, American taxpayers end up paying vastly more just to file their annual returns. The Office of the Taxpayer Advocate says American families spend 3.16 billion hours each year getting their taxes done—gathering the data, keeping records, and filling out forms; businesses spend about 2.9 billion hours on the same tasks (a figure that does not include all the time required for the tax-avoidance gymnastics). At an average wage, those six billion hours devoted to filing tax returns represent about $400 billion per year of working time; six billion hours is the equivalent of 3.1 million people working forty hours per week, fifty weeks per year. In terms of time and cost, just paying our taxes has become one of the biggest industries in the United States.
Because the system is so complicated, hardly any Americans still fill out Form 1040 by themselves. Just two decades ago, pulling out the shoe box full of receipts and filling in the tax forms was a standard, if not particularly pleasant, rite of spring for most U.S. families. Today, barely 10% of Americans do their own tax returns. About 60% of all individual taxpayers hire tax-preparation agencies to do the work for them; another 30% buy tax-preparation software each year to get them through the process. The IRS says an average family at the median income shells out about $260 per year for tax-preparation services; those with higher incomes can easily pay ten times as much. Including the hours needed just to gather the records, Americans spend about three times the IRS budget just to file their returns. “The current tax code imposes huge compliance burdens on individual taxpayers and businesses,” the Office of the Taxpayer Advocate says.
Filling out a tax return in the United States can resemble solving an absurdly difficult word puzzle. The hundreds of different IRS forms are studded with thousands of instructions and precautions that people have to read two or three times to figure out. When I was writing the first chapter of this book, I asked Nina Olson to help me find a standard IRS instruction that is so complicated it would seem ludicrous. She replied, “But there are so many of those!” Eventually, we settled on the instruction found in chapter 1 of this book: “Go to Part IV of Schedule I to figure line 52 if the estate or trust has qualified dividends or has a gain on lines 18a and 19 of column (2) of Schedule D (Form 1041) (as refigured for the AMT, if necessary).”
That one comes from IRS Form 1041, but Nina was right. There are countless instructions and directions that could give you a good laugh—if you didn’t have to figure out what they mean:
Among tax experts and aficionados, there is a friendly competition going on to come up with a nutty but fictitious instruction that sounds so authentically convoluted that it is hard to differentiate the phony from the real thing. One professor of tax policy gave his students the following quiz:
Which of the following is NOT a genuine IRS instruction?
a. Combine Lines 1 through 17. Enter here and on Schedule M-3, Part II, Line 27, reporting positive amounts as negative and negative amounts as positive.
b. Enter the number of vehicles for categories A–V in the applicable column. Add the number of vehicles in columns (3a) and (3b), categories A–V. For category W, enter the number of suspended vehicles in the applicable columns.
c. Enter 18.2% (.182) of line 37(b) or the total of your monthly electric bills for the tax year (excluding December, January, and February), whichever is greater.
d. If you received a Form 1099-INT that reflects accrued interest paid on a bond you bought between interest payment dates, include the full amount shown as interest on the Form 1099-INT on Schedule B (Form 1040A or 1040), Part I, line 1.*
One of the more pernicious aspects of the complexity problem is that some of the most opaque provisions of the tax code apply to people in the lowest income brackets—the taxpayers least able to afford a tax accountant to help them navigate this regulatory swamp. For example, the earned income tax credit is a reverse income tax through which the federal government gives money to working people whose income is below the median (the cutoff is about $15,000 per year for single people and $50,000 per year for a family of four). The instruction book for low-income taxpayers hoping to get this benefit (Publication 596) is fifty-nine pages long. The book lists fifteen separate conditions, spread over three chapters, that you have to meet to claim the credit. “If you meet all seven rules in this chapter,” states the introduction to chapter 1, “then read either chapter 2 or chapter 3 (whichever applies) for more rules you must meet.” And even that warning is incomplete, because the first sentence of chapter 4 reads, “You must meet one more rule to claim the EIC.” The whole thing is so complicated that the error rate is 27%, which means one out of four filers, and the IRS, have to spend even more time trying to get it right. This has prompted a mini-industry of tax fraud, with shysters going door-to-door in low-rent neighborhoods offering to fill out the EITC forms (for a fee, of course) whether the client actually qualifies or not. Similarly, the tax credits for people buying health insurance on the ObamaCare exchanges are generally aimed at low-income taxpayers and are also ridiculously complicated.
There’s another significant cost as well to all this complexity. A tax code so byzantine that people can’t understand how much they have to pay badly undermines the spirit of voluntary payment that is essential to a successful tax regime. Economists talk about a concept called “tax morale,” which means people’s willingness to pay for the services government provides. If the public services are popular, and if the tax code feels fair, then tax morale is high and people are willing to pay. But a tax code that nobody can understand reduces tax morale. Then people are not so willing to pay, and they look for ways to avoid paying what they owe.
“Complexity obscures understanding and creates a sense of distance between taxpayers and the government,” the taxpayer advocate says, “resulting in lower rates of voluntary tax compliance. . . . Taxpayers who believe they are unfairly paying more than others inevitably will feel more justified in ‘fudging’ to right the perceived wrong. . . . Simplifying the tax code so tax policy choices and computations are more transparent would go a long way toward reassuring taxpayers that the system is not rigged against them.”
For all these reasons, Nina Olson incessantly urges Congress to simplify the tax code with BBLR reforms.
Eliminating all those complex tax preferences will make the whole process of filing and paying taxes vastly easier, for both the taxpayer and the tax collector. Every deduction and exemption that is eliminated means one less line on the tax return, or one less form, and one less booklet of obscure instructions. Nina Olson concedes that following the path of simplification—of BBLR—might not be simple as a political matter. “In concept, most of us agree that the tax code is too complex, and that broadening the tax base by eliminating existing tax breaks in exchange for lower rates would improve the system,” she wrote in her 2012 report on the most serious issues facing taxpayers. “In practice . . . the threatened loss of existing tax breaks raises immediate concerns. And the lower we want tax rates to be, the more of these tax breaks we have to be willing to give up.”
It doesn’t have to be this way. Countless other countries like ours—advanced, high-tech, free-market democracies—have found ways to collect the tax revenues they need without imposing long hours of tedious labor and large tax-preparer fees on their citizens. Their parliaments and their tax collectors are no smarter than their counterparts in the United States. The difference is, those countries make a genuine commitment to simplification of the tax code. The U.S. Congress, in contrast, likes to talk about simplification but has shown no commitment to do anything about it (except once every thirty-two years). In many countries, the tax agency ombudsman—in essence, the equivalent of Nina Olson—has the power to order changes in the system, while Olson is stuck making endless futile pleas to Congress.
According to the Algemene Fiscale Politiek, the Netherlands’ counterpart of the IRS, the average time for a Dutch taxpayer to complete both federal and local returns is fifteen minutes. That’s partially because there’s really only one return. To make things easier for taxpayers, the Dutch have established a “unified” tax system such that the national and provincial governments use the same form to collect income taxes. But even the Netherlands is a piker in this field compared with Estonia, a former Soviet satellite that has leaped enthusiastically into the digital age. Estonia’s tax agency says the average time to complete its federal tax return is seven minutes. Estonia’s tax agency doesn’t want to waste any time reviewing tax returns on paper, so all returns must be filed online. The small cohort of Estonians who still don’t have a computer are invited to go to an office of the tax agency, where a helpful clerk will complete the online form for you.
For Japanese wage earners, the task of paying income tax is even easier. Japan’s equivalent of the IRS, Kokuzeicho, gathers all the pertinent data for each worker—income, taxable benefits, number of personal exemptions, tax withheld, and so on—and then computes how much the worker owes in tax, down to the last yen. Because Japan uses a system known as “precision withholding,” with the amount changing whenever pay goes up or down, most people withhold the exact amount due. In early March, Kokuzeicho sends a postcard to every citizen that sets forth all this information: how much you earned, how much tax you owe, how much tax you’ve already paid through withholding. If you’ve paid in more tax than you owe, Kokuzeicho deposits the refund amount in your bank account; if you did not withhold enough, the agency takes the tax that’s due from your bank account. If the figures on the postcard from Kokuzeicho look about right, the taxpayer does nothing. The tax has been computed and paid already. If the numbers look wrong, you go into the local tax office and try to straighten things out. As a result, paying income tax is a totally automatic process for about 80% of Japanese households, requiring no more work than reading a postcard once a year. When I told my friend Togo Shigehiko that Americans spend hours or days gathering records each year and filling out the forms, he was incredulous. “Why would anybody want to do that?” he asked me.
Britain’s version of the IRS, Her Majesty’s Revenue and Customs, maintains a full-time bureau called the U.K. Office of Tax Simplification, or OTS.7 Its mission statement is similar to that of the Office of the Taxpayer Advocate at the IRS: “There is already evidence that simpler taxes encourage compliance: taxpayers find it easier to comply and have greater trust in the system. That implies reduced scope for avoidance.” But OTS has a track record that would make Nina Olson dark green with envy; the office has made some four hundred formal proposals to simplify either the tax code or the tax return forms, and 50% of them have been implemented, at least in part. The U.K. has established a system rather like Japan’s, with Her Majesty’s Revenue and Customs filling in the tax return with data it has received from employers, banks, brokerage houses, charitable recipients, and so on. The Brits also use a “precision withholding” system, called Pay as You Earn, or PAYE, which takes into account wages and benefits, Social Security and health-care deductions, student loan deductions, and various other adjustments to income. With that, most British wage earners find their yearly total of tax withholding just about equals the tax they owe; in 2014, according to the Office of Tax Simplification, only one in five Brits had to file a tax return.
There’s a pattern to the simplification of taxation in the Netherlands, Japan, Britain, and several other countries—including Denmark, Sweden, Spain, and Portugal—that have taken similar steps. In each case, the government does the work of filling out the tax return. The taxpayer just checks the numbers—sometimes with a beer in hand, as with my Dutch friend Michael—and confirms that the tax agency got things right. And if the agency got something wrong, there’s a mechanism for the taxpayer to make the correction. To make this work, the taxing authority has to know all the relevant information: wages, bonuses, benefits, bank and brokerage accounts, mortgage payments, charitable contributions, educational spending, and the like. As a rule, all payers and all recipients of money that might be deductible are required to report what they paid you, or received from you, to the government. In Britain, for example, charities report all contributions to Her Majesty’s Revenue and Customs, so the tax agency knows how much you gave and can compute the appropriate deduction for you.
The tax authorities refer to this type of system as “pre-filled forms” or “pre-populated returns.” (In the United States, it is sometimes called “return-free filing,” which is a misnomer, because there’s still a return. It’s just that the taxpayer doesn’t have to fill it out.) This approach is obviously simpler for the taxpayer. Beyond that, experience has shown that it leads to fewer errors; generally, the government’s computers don’t transpose digits when entering a number and don’t enter data on the wrong lines, as ordinary taxpayers sometimes do. Of course pre-filled forms work better when the tax system is simpler; if there’s no deduction for a home mortgage, for example, or no credit for buying a hybrid car, the tax agency doesn’t have to check with every mortgage company and every auto dealer to fill out the forms.
Could pre-filled forms work in the United States, with its convoluted rules on what constitutes “income” and its endless roster of credits, deductions, exemptions, and allowances? In a limited sense, it already does work here. California has launched what it calls an “experimental” program known as CalFile in which the revenue department will send you a state tax return that is already filled in; if the numbers look right, you sign it, and the work is done. If they don’t, you send back the return with your changes. The state has never spent much money to publicize this system, so it is poorly known and little used. But of the ninety thousand Californians who did file through this pre-filled form in 2012, 98% subsequently told pollsters that they loved it and would definitely use it again. When California asked users for comments on the system, the replies were downright ecstatic. “THIS IS THE BEST SERVICE I HAVE EVER SEEN BY THE GOVERNMENT,” one taxpayer said.
There are advocates, both in academia and in government, who would like to see a pre-filled form system for the federal income tax in the United States. It’s clear that the IRS already has much or all of the necessary data for a large number of American taxpayers. Anybody who has received a thick envelope in the mail from the IRS, raising questions about last year’s return, can see that the agency seems to have records on every payment (be it wages or self-employment income), every investment account, every bank account, and so on.
When I got such a letter—it was a CP2000 Notice, which is one step before an official audit—the document said, “The income and payment information we have on file from sources such as employers or financial institutions doesn’t match the information you reported on your tax return.” With some chagrin, I had to admit that the IRS was right, for the most part. I had received a fourteen-page year-end statement from my brokerage firm, full of different numbers for different investment accounts, some taxable and some not. I was supposed to figure out which data were relevant and where to enter them on my tax return. I got it wrong, which was why that CP2000 Notice showed up in the mail a few months later. And I thought, if the IRS has all this stuff in its computers, how come I had to dig through this fourteen-page statement to tell the IRS what it already knows? If I hire a tax preparer to do my tax return, why should I pay her to give the IRS information that it already has?
Questions like that have prompted several members of the U.S. Congress to champion pre-filled forms. Senators Ron Wyden (D-Ore.), Dan Coats (R-Ind.), and Elizabeth Warren (D-Mass.) and Representative Jim Cooper (D-Tenn.) are among the sponsors of legislation to create such a system. Given the current tax code, the IRS estimates that it has all the necessary information to prepare a completed Form 1040 for about 30% of American taxpayers; other estimates range as high as 40%. Over time, with stronger reporting requirements and a simpler tax code, that number could increase sharply, perhaps approaching Japan’s rate of 80% of taxpayers who simply get a postcard from the government each March. But even at the 30% rate that the IRS estimates, pre-filled forms could save American families one billion hours of work each year and $10 billion in tax-preparation costs.
If this system, already in place in many other advanced democracies, could save Americans such large amounts of time and money, why don’t we use it? The answer is pure politics. It turns out that the complexity of the U.S. tax system is a moneymaker for some large companies. So they have lobbied strenuously, and successfully, against all efforts to simplify the tax code. The “Tax Complexity Lobby,” as Forbes magazine called it, includes tax-preparation firms like H&R Block and Jackson Hewitt, as well as companies that make tax-preparation software.
The biggest spender in the anti-simplification camp is Intuit, the maker of TurboTax, the top-selling tax software program. The firm’s lobbying disclosure forms in Washington show that it has spent millions of dollars to persuade members of Congress to “oppose IRS government tax preparation.” (Intuit has also lobbied, without success, to shut down California’s pre-filled form system.)8 Intuit’s main argument seems to be that tax returns prepared by the IRS and then reviewed by the taxpayer would be less accurate than a return filled out by the taxpayer. “Relying on an actual withholding or government reconciliation tax system, eliminating or curtailing citizen participation in the taxation process, has far-reaching implications for accuracy in public tax expenditures, which are often targeted by policymakers to those lower and middle income citizens with the simplest returns,” the company says.
On Tax Day in 2016 (it was April 18 that year), Intuit placed a full-page ad in the New York Times headlined “Tax Simplification: A National Imperative.” “Simply put, our tax code is mind-numbingly complex,” the advertisement reads. “No one set out to create an incomprehensible tax code—it just happened, little by little, over a period of decades. . . . It will take a determined effort to tackle the resulting complexity and make common-sense tax simplification reform a reality.” Intuit’s advertisement did not mention that Intuit has spent millions of dollars fighting the “tax simplification reform” of pre-filled forms.
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IN ADDITION TO the familiar approaches to simplifying the tax code—things like BBLR and pre-filled forms—there is a school of thought which holds that the personal income tax can never really be simple, because the lobbyists and politicians will perennially add complex new provisions that benefit one interest group or another. Those who hold this view, accordingly, want to scrap the income tax altogether, or at least make it a much less important part of the government’s overall revenue-raising apparatus. To do that, these advocates propose a new form of tax that has been adopted, successfully, in some 175 countries around the world—but never tried in the United States.