5/2/2001 12:00:00 AM - Bruce Bartlett
Congress's Joint Committee on Taxation has just released a massive new study of tax simplification. It is a measure of the increasing complexity of the tax system that a 1977 study by the JCT on this subject was just 129 pages long. This time, the committee needed three thick volumes and 1,300 pages to adequately cover it.
Republicans and Democrats, liberals and conservatives, disagree on just about everything in Washington. But on the issue of tax complexity, they are as one. All denounce the problem in words not fit for a family newspaper. Yet, the problem only gets worse with every tax bill passed by Congress. Indeed, all major tax bills carry the de facto title, "Lawyers and Accountants Employment Act of (fill in year)."
Of course, Congress is not solely responsible for creating tax complexity. Treasury and Internal Revenue Service regulation writers often add to complexity by taking clear legislative language and turning it into gobbledegook. And the courts also play a critical role, by adding multiple layers of decisions and interpretations to the existing maze of law and regulation.
The JCT study identifies the magnitude of the complexity problem with some interesting statistics. Following are a few:
-- The Internal Revenue Code has 1,395,000 words. It has 693 sections applicable to individuals, 1,501 sections affecting businesses, and 445 sections dealing with tax-exempt organizations, employee plans and governments.
-- As of June 2000, the Treasury Department had issued 20,000 pages of tax regulations, containing over 8 million words. Last year alone, the IRS published 58 revenue rulings, 49 revenue procedures, 64 notices, 100 announcements, at least 2,400 private letter rulings and technical advice memoranda, 19 actions on decision, and 240 field service advice documents.
-- There are 649 different IRS forms, schedules and instructions totaling more than 16,000 lines; 159 worksheets contained in the IRS instructions; and 340 different IRS publications totaling more than 13,000 pages. The 1040 form alone has 79 lines, 144 pages of instructions, 11 schedules totaling 443 lines and 19 separate worksheets.
No wonder, then, that taxpayers contacted the IRS 117 million times in 1999 for advice and clarification -- getting a wrong answer 47 percent of the time to boot, according to the General Accounting Office. Others turned to accountants and lawyers for assistance. Some 55 percent of tax returns now indicate that a professional tax preparation service was employed. This is up from 48 percent in 1990. According to a recent Harris Poll, 51 percent of those paying a tax-preparer could have done their own taxes but weren't sure and didn't want to take chances. But a third said that their taxes are just too complicated to do by themselves.
A consequence of this is that a majority of taxpayers are now paying a substantial "tax," over and above the direct taxes they pay, in compliance costs. When a taxpayer has to pay several hundred dollars to an accountant each year to prepare his tax return, this is really part of his tax burden. It means that many taxpayers would be better off under a simplified tax system that allowed them to prepare their own returns, even if they ended up paying a bit more taxes in the process.
Another way complexity raises the tax burden is by making it harder for taxpayers to claim deductions to which they are entitled. According to a new report from the GAO, in 1998 more than 500,000 taxpayers overpaid their taxes by taking the standard deduction, even though they paid enough mortgage interest alone to come out ahead by itemizing their deductions. Collectively, they paid $311 million more than they had to. Amazingly, 6,000 of these taxpayers overpaid by more than $5,000 each.
Of course, this is just the tip of the iceberg. According to the American Institute for Certified Public Accountants, another major source of tax overpayments results from taxpayers failing to deduct all their state income taxes. Many only deduct the amount they send to the state when they have had underwithholding. But in fact, their total state income tax liability is deductible, including the portion that was withheld. The result, says the AICPA, is that many people pay more federal income taxes than they should.
It is not known how much of this goes on. I know from my own personal experience that there are deductions I would not have taken without an accountant's assistance and assurance. If I did my taxes myself, therefore, I would undoubtedly overpay.
Although the federal government benefits from tax complexity to the extent that people overpay their taxes, it suffers as well. According to economists Bill Gale of the Brookings Institution and Leonard Burman of the Urban Institute, tax complexity reduces compliance. Some taxpayers, they say, may be encouraged to cheat on their taxes because they believe others are paying less, due to their superior ability to exploit loopholes buried in the tax code.
The JCT has made a number of specific recommendations for simplifying the tax code and reducing complexity. Hopefully, Congress will make an effort to incorporate some of these changes in future tax legislation. Unfortunately, in the meantime, it is a virtual certainty that taxpayers will find their taxes more complicated after Congress finishes work on a tax bill this year. For example, many more will find themselves affected by the Alternative Minimum Tax, because the tax cut will lower their income tax liability below the threshold triggering an AMT liability.
Complexity will also be increased if George W. Bush gets his wish and taxpayers who do not itemize will, nevertheless, be allowed to deduct charitable contributions. In my opinion, this establishes a very bad precedent. The standard deduction exists precisely to compensate those who make such contributions but do not itemize. In effect, we are now going to give them a double deduction on the same contributions. Good for charities, maybe, but definitely a contributor to complexity.
To paraphrase, the road to tax complexity is often paved with the best of intentions.