Geithner and Our Incomprehensible Tax System

The tax woes of Treasury Secretary designate Timothy F. Geithner, whose confirmation hearings resume today, have made him the butt of jokes by late-night comedians. They have also spurred angry phone calls by ordinary Americans to their congressmen complaining about the man being contemplated to head the department which supervises the Internal Revenue Service, but who failed to pay certain taxes until he was audited.

But one thing that the debate about what Geithner knew, and when he knew it, hasn’t sparked is a discussion about the dense and increasingly obscure nature of our tax system. It’s an issue that we seem resolved not to tackle here in the U.S., even as the cause of tax simplification advances around the rest of the world. Indeed, we’ve just come through a presidential election in which taxation was a central concern, yet virtually everything proposed by both candidates would have made our knotty tax system even more complex.

The Treasury Department, which Geithner will head, reports that it now takes Americans 7 billion hours a year to comply with the tax code, including an estimated 3.55 billion hours of work by individual taxpayers, who also spend about $27 billion on tax software or outside tax preparation services. The proportion of households using professional tax preparation services has risen from 38 percent in 1980 to 90 percent today. It’s not hard to see why. The instruction booklet for form 1040, the most common form that individual taxpayers use, has increased in that time from about 40 pages to 155.

This is exactly the opposite of what is going on in most developed and developing countries. A two-year-old survey of tax reform among the 30 members of the Organisation for Economic Co-Operation and Development found that most countries have, since 2000 alone, implemented changes meant to simplify their tax systems and broaden their tax base. At the head of this reform movement were countries that had instituted some form of a flat tax, that is, a single tax rate that kicks in above a basic income level.

However, even countries that are not employing a flat tax are simplifying their systems by eliminating deductions and tax credits—which make it easier to determine your actual taxable income—and then lowering their tax rates to offset the disappearing deductions. With those kinds of changes going on elsewhere, no wonder that a study by PricewaterhouseCoopers for the World Bank ranked the United States 122nd out of 175 nations in terms of tax complexity.

Given the monster that our tax system has become, tax reform of this sort would seem to be a non-partisan no-brainer, a move that could save ordinary Americans hundreds of dollars without even cutting taxes. Since nine in 10 households spend money on tax preparation services, the savings would range along the income spectrum. Indeed, low-income filers are now just as likely to employ professional help, given the complexity of applying for tax credits like the Earned Income Tax Credit.

And then there is simply the benefit of reducing the stress and anxiety levels that more and more people feel trying to deal with a tax code which becomes increasingly likely to trap you into making the kind of mistake that generates an unexpected big bill for back taxes, interest and penalties. If Geithner is guilty of nothing more than screwing up his tax returns, what does that say about a system that has become so dense and obscure that even a trained economist and president of the New York Federal Reserve Bank, and the accountant who advised him, got his tax situation wrong?

That we find so little support for tax simplification is a testament to how much politicians of both parties, and perhaps ordinary citizens, have come to see the IRS code not merely as a means for raising government revenues, but as a tool of social policy. Pick a cause on the Left, Right or in the Center—from encouraging home ownership to supporting working families to subsidizing higher education to incentivizing investment in environmentally-friendly energy—and we use the tax code to support it through deductions and credits. Many of those causes are no doubt worthy—who can argue about helping spur home ownership?—but once you make the tax code your agent of change you are on a slippery slope. The more deductions, credits, rates and alternate taxes we fold into our system in search of perfect equity and the promoting of worthy causes, the more likely we make it that ordinary Americans who get audited will get hit with big bills for back taxes.

A number of Geithner’s supporters have argued that it would be a shame to kill the nomination of someone so well qualified to run Treasury because of simple tax oversights. But as long as we keep passing off the tax blunders of sophisticated, well qualified individuals, we condemn the rest of Americans to an increasingly frustrating and counterproductive wrestling match with our unwieldy tax code.

Maybe, if Geithner is confirmed, this experience will make him the advocate for tax simplification that we need.