The Messy Tax Code

As we enter the final days before IRS filing is due, many are considering the mind-numbing complexity of the U.S. tax code.  It is estimated that taxpayers and firms spend over 6 billion hours per year attempting to correctly file tax returns.  Not only does this figure represent the equivalent of millions of workers, but it also pulls billions of dollars out of more productive uses.  According to the IRS Taxpayer Advocates, who reported to Congress in 2010, the complexity of the U.S. tax code is driven, in part, by continual changes to the system as the federal government attempts to squeeze more and more out of taxpayers.  In the past decade there have been approximately 4,400 tax code changes resulting in 3.8 million words to document the American taxation system.  Since 1913, the tax code has ballooned from 400 to 72,536 pages in July 2011.  Worse yet, the blog Political Calculations expects that number to jump to 74,944 in 2012.

The irony of such an intricate tax system is that complexity is connected to compliance.  This is true both of honest taxpayers and evaders.  A recent report stated that IRS help centers provided wrong answers to taxpayer questions almost 30 % of the time.  Even the 90,000 plus IRS workers are unable to keep up with this ever-changing system.

The obvious question is why the complexity?  Why does the federal government try to increase revenue through such a complex set of rules?  The answer goes back to the fundamental role of government.  If the government wants more of something it subsidizes it, and if it wants less of something it taxes it.  A subsidy to the corn industry helps farmers grow more corn and more ethanol is produced.  A tax on imported sugar keeps sugar growers in America happy by keeping out global competition.  So, Congress uses the tax code to regulate the market in order incentivize specific behavior.  In other words, the complexity of the tax code is due to the unbridled desire for Congress to regulate.  The complexity is not a necessity to ensure Congress replenishes its coffers each year.

Congress loves to provide incentives to the tax code.  Any problem it wants to solve, use the tax code.  Any behavior it wants to change, use the tax code.  Any industry it wants to prop up or diminish, use the tax code.  President Obama’s stimulus package, which passed early in his presidency, added 300 pages to the tax code.  Manipulation of the tax code has simply become de facto government regulation.  This is not a new practice for Congress or the President.  Ever since the 16th Amendment, the federal government has increasingly used income taxes (on individuals and businesses) to regulate, but the ridiculous nature of this ever-increasing complexity is out of control.

Pursued by industry in order to impact individual incentives, federal tax deductions exist for children with an overbite who enroll in clarinet lessons and whaling captains can deduct ship repairs even though whaling in the U.S. is illegal.  The government also provides many additional deductions of impact healthy behavior from quitting smoking to doctor-ordered exercise.  While these may be a benefit to your health, is it prudent to add to the increasing complex system with additional changes, loopholes, and deductions?

Sadly, simplifying the tax code has become a partisan issue pitting those in favor of smaller government versus those who look to government to solve economic and social problems.  This is a mischaracterization of the issue.  Tax complexity is a massive waste of resources.  No matter if you are conservative or liberal, the billions of dollars invested in tax compliance are wholly unnecessary.  There may be differences on how to use the billions of dollars that would be saved with a simple system, such as a flat tax or a consumption tax, but all taxpayers should agree that 90,000 plus IRS workers and $430 billion spent each year on compliance is a colossal waste.  Now let’s convince Congress to change the system.

Is It Time to Make a Deal?

With the debate intensifying over raising the debt limit and cutting federal spending, all eyes are on the GOP.  Many conservatives are arguing that Republicans must give in to President Obama’s desire for elimination of tax loopholes on corporate taxpayers and other reforms that could raise taxes on the American people.  The mantra of the Republications is quite simple: spending is the problem and there is no need for revenue increases (read tax hikes).

Democrats on the other hand claim that certain programs are untouchable such as Medicare, Medicaid and Social Security.  Thus, the proposals outlined to cut $2-4 trillion from the Federal budget over the next decade must leave these entitlements alone.  These conflicting philosophical positions continue to arise: cutting spending and the size of government alone or continue the course by raising more revenue?  Should Congress agree to spending cuts AND tax increases in order to make a deal and act before the August 2 deadline to raise the debt ceiling?  David Brooks of the New York Times  recently wrote cutting a deal is the “mother of all no-brainers.”  Others are claiming that certainly the wealthiest Americans can afford tax increases (yet these increases are always couched as “allowing the Bush tax cuts expire”).  Consequently, the debate ensues and each side, Republicans and Democrats alike, are blaming each other for the pending default if a deal on the debt ceiling is not reached.

Again Americans are experiencing the tension between politics and economics that is as familiar as a thunderstorm on a hot summer evening.  The political process creates incentives for spending and compromise while the economics reflects an unsustainable budget shortfall that has implications that are not fully known.  The easy solution is to make a deal, raise the debt limit, and spend tax payer and borrowed dollars to oblivion.  Thus, the debate is one of principles that are on very different poles: limited government and incentives push to market participants versus government solutions to basic economic problems with little to discipline political actors.

The debt ceiling is the only tool left that provides for the possibility of fiscal discipline by politicians.  In the past, raising the debt ceiling has been a relatively simple policy option for a spendthrift Congress.  Yet, with the election of conservative Republicans in November 2010 there is a new push toward actually maintaining a principled position regardless of the political cost.  Many Republicans see this issue as that is, spending billions over budget, controlled by special interests, and taking control of the very market incentives that drive economic growth.  Why should high income earners pay higher tax rates (either via marginal rate increases or lost deductions) simply to fund programs that are inefficiently administered via the federal government?  Or to put it more clearly, why are Democrats set on maintaining or growing the current federal budget?

These are the questions that must be asked long before the question of “should the Republicans make a deal?”  According to those close to the debate, the big concern is that failing to raise the debt ceiling could likely lead to skyrocketing interest rates and a plummeting dollar.  Hence, the President and his party are characterizing the Republicans as willing to sacrifice economic stability for wealthy tax breaks.  Once again, this myopic view of the economy is endemic within the political process.  Obama is looking to the 2012 campaign and many in Congress are doing the same, yet the discussion of core principles must remain in this debate.  Any compromise at this point, as obvious as it may seem to some, is tantamount to once again throwing away all the economics for politics alone.  In congressional districts throughout the county, a majority of voters spoke loudly last November saying that they wanted a principled position on tax and spend policies to re-enter the political process.  Many Americans are tired of the bickering over billions when they have made significant cuts in their own budgets.  It is time for Congress to stop pandering to the few and start worrying about spending less for the entire country.