A Fine Mess

by T. R. Reid

  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 m
illions of dollars fighting the “tax simplification reform” of pre-filled forms.

  —

  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.

  12.

  THE MONEY MACHINE

  As a boy growing up on his father’s coffee plantation outside Saigon—in a country known then as French Indochina—Maurice Lauré liked to spend his evenings in the community library. The volume that young Maurice liked best was an oversized picture book showing the uniforms of French government officials. As a country that reveres its civil servants, France provided impressive uniforms not only for the military, police, and firefighters but also for customs agents, bank inspectors, drain commissioners, public health officers, mayors, municipal band leaders, and others.

  The outfit that made the greatest impression on young Maurice Lauré was the uniform of the inspecteur des finances, or tax collector. Going back to the eighteenth century, agents of the French national tax authority wore an impressive blue suit with a yellow stripe down each leg and a golden epaulet on the right shoulder. “It seemed to me to be a terribly important corps with influence in all things,” Lauré recalled in an interview some fifty years later. “So I told my mother I would like to be an inspecteur des finances. She thought it was an excellent idea.”1

  After a detour into the army’s engineering corps during World War II, Lauré did, in fact, join La Direction Générale des Impôts, the French equivalent of the IRS; sadly, that “very fine” uniform had been retired by the time he arrived. By the early 1950s, he was co-director of the agency, and one of the major problems he addressed was noncompliance by business taxpayers. France at the time imposed a tax on commercial activities of the type known as a turnover tax or a gross receipts tax. It was a complex edifice and fairly easy for businesses to avoid, which they regularly did. So Lauré, the engineer turned tax man, rolled up his sleeves and designed a new kind of tax, a levy that applied to virtually every business transaction but that was easy for tax collectors to track and thus hard for taxpayers to duck. In 1953, he published his seminal book, La taxe sur la valeur ajoutée (The tax on added value).

  Drawing on earlier work by the German economist Wilhelm von Siemens and the American Carl S. Shoup (who had proposed a value-added tax for Japan during the American occupation after World War II), Lauré’s new tax on commercial transactions worked so well that it began to spread to other countries; Europe’s nascent Common Market (which became the European Union) made the value-added tax mandatory for all its member nations in 1967, on the theory that a unified market should have a unified tax structure. Fairly quickly, the idea was taken up in South America and Africa, in the fast-growing “Tiger economies” of East Asia, and then, somewhat later, in former British colonies like Australia, New Zealand, and Canada. By 2016, some 175 of the planet’s 200 countries had a value-added tax or a goods and services tax, which is another name for the same thing. This form of taxation brings in about 20% of all the government revenue in the world; among the members of the OECD, the club of rich nations, VAT payments constitute 33% of all tax revenue. For many countries, the VAT has become the most important single tax; in France, Lauré’s invention generates about 40% of revenues.

  “The rise of the value-added tax,” observed the economic historian Liam Ebrill, “was the most dramatic—and probably most important—development in taxation in the last half of the twentieth century.” The law professors Alan Schenk and Oliver Oldman noted that “the VAT has spread more quickly than any other new tax in modern history.”2 The International Fiscal Association, a global think tank on government finance, has created the Maurice Lauré Prize to recognize the most innovative proposal put forth each year to improve tax collection. “If you look at the economic history of the last half century or so,” said Professor Richard Bird of the University of Toronto, “the VAT is one of the world’s biggest fiscal stories.” Professor Bird, who has helped design tax regimes for numerous countries, told me that “a VAT, or its twin, a GST, is an absolutely essential element of any tax structure today. To set up a tax system anywhere that didn’t include a VAT would be malpractice; it would be like creating a health-care system without hospitals. That’s why every responsible Finance Ministry has used it.”

  Professor Bird’s comment is a backhanded slam at the United States, because our country is the only developed nation that has missed the boat on this successful new innovation. Almost all economists who’ve looked at the U.S. tax code, almost every blue-ribbon study commission, almost all presidential candidates who bother to propose a program of tax reform, agree that some version of the value-added tax could increase the fairness and efficiency of our tax system and reduce its mind-boggling complexity. And yet the United States stands alone among the world’s rich nations in refusing to implement this common levy.

  It’s one of the curious manifestations of the concept of “American exceptionalism,” the idea that there’s no country like the United States of America. Of course we’re proud of the freedom and opportunity the United States offers its citizens and its immigrants. There may not be another country where the son of a visiting student from Kenya, raised by a single mother in modest circumstances, could grow up to be elected the head of state; there may not be another country where the son of an immigrant restaurant worker from Syria could create the company called Apple. There are unique aspects of the American way that make these success stories common, and nobody wants to lose the things that make our country exceptional. The problem comes when U.S. politicians are so determined to be exceptional, to do things our own way, that they refuse to implement a valuable idea that almost every other country on the planet has embraced to its benefit. This makes us exceptional, but not in a way that any other country would choose.

  —

  THE VALUE-ADDED TAX IS essentially a sales tax—like the retail sales tax most Americans pay at the store every day—but one that is applied to every stage of commerce, not just to the final sale at the retail store. To see the difference, let’s imagine an American, whom we’ll call Mrs. Buyer, purchasing a dining-room table—a handsome mahogany table, stained a dark reddish brown—at a local emporium called the Acme Furniture Store.

  Under the retail sales tax that is familiar to Americans, the transaction works like this: The retail price of the table is $600. But the customer, of course, has to pay more than that. If the local sales tax is 8%, Mrs. Buyer has to pay $648 for the table—the retail price, plus the 8% tax. The customer pays the tax; the furniture store plays the role of tax collector, taking in the $48 and sending it on to the local department of revenue. It’s important to note here that Mrs. Buyer doesn’t know whether the furniture store actually remits the tax payment to the government and doesn’t much care, either. It makes no difference to her.

  Under a VAT regime, the government receives the same amount of revenue as the retail sales tax, but the collection process is different.

  It starts when the owner of Mahogany Forests Inc. sells the raw timber to a wood-finishing company that we’ll call Elite Wood Products. Elite pays the forest company $150 for the timber, plus a value-added tax of 8%, or $12; the forest company is required to remit this tax to the government.

  Elite Wood Products cleans and sands the wood and applies that dark reddish-brown stain. Elite then sells the finished pieces of wood to a furniture maker that we’ll call Distinguished Tabl
es Inc. The price is $250, plus a value-added tax of 8%, or $20; Elite is obliged to remit the tax it collected to the government. But it can take a credit for the amount of tax it previously paid—that is, the $12 in tax it paid to the forest company—so that Elite’s actual tax payment to the government is $8.

  The skilled workers at Distinguished Tables use the dark-stained wood purchased from Elite to build a beautiful table, with carefully finished corners and striking carved legs. Distinguished, the table maker, then sells the table to a wholesaler, an outfit that we’ll call Wholesale Furniture Trading Inc. The wholesale company pays $400 for the finished table, plus a value-added tax of 8%, or $32. Distinguished Tables is required to remit this tax payment to the government, but it gets a credit for the amount of tax it previously paid—that is, the $20 in tax it paid to Elite Wood Products. So Distinguished, the table maker, actually pays the government $12 in tax.

  Wholesale Furniture Trading sells the table to the retail store, the Acme Furniture Store. The price is $450, plus a value-added tax of 8%, or $36. The wholesaler is obliged to remit this tax to the government, but it can take a credit for the tax it paid—that is, $32—to the table maker. So Wholesale Furniture Trading pays the government $4 in tax.