by T. R. Reid
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,
“Makes compliance difficult, requiring taxpayers to devote excessive time to preparing and filing their returns;
“Requires the significant majority of taxpayers to bear monetary costs to comply, as most taxpayers hire preparers and many other taxpayers purchase tax preparation software;
“Obscures comprehension, leaving many taxpayers unaware of how their taxes are computed and what rate of tax they pay;
“Facilitates tax avoidance by enabling sophisticated taxpayers to reduce their tax liabilities and by providing criminals with opportunities to commit tax fraud;
“Undermines trust in the system by creating an impression that many taxpayers are not compliant, thereby reducing the incentives that honest taxpayers feel to comply; and
“Generates tens of millions of phone calls to the IRS each year, overburdening the agency and compromising its ability to provide high-quality taxpayer service.”
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 differ
ent 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:
“If you are a single-member LLC that is disregarded as an entity separate from its owner (see Limited Liability Company (LLC) on this page), enter the owner’s SSN (or EIN, if the owner has one). Do not enter the disregarded entity’s EIN. If the LLC is classified as a corporation or partnership, enter the entity’s EIN.”3
“If you are considered the owner under the grantor trust rules of any part of a domestic liquidating trust under Regulations §301.7701-4(d) that is created under chapter 7 or chapter 11 of the Bankruptcy Code, you do not have to report any specified foreign financial asset held by the part of the trust you are considered to own.”4
“Enter 6% (.06) of the smaller of line 40 or the value of your Archer MSAs on December 31, 2015 (including 2015 contributions made in 2016). Include this amount on Form 1040, line 58, or Form 1040NR, line 56.”5
“The recapture amount that you must include on line 1 will not exceed the amount of your early distribution; and, for purposes of determining this recapture amount, a rollover amount (or portion of a rollover) will only be allocated to an early distribution once.”6
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 Estonian
s 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.
