Politicians Love the Tax Code We Hate

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Every year at this time we seem to have two distinct conversations about our tax system: Whether it is fair or not, and whether it is too complicated.

The first discussion is really an ideological debate about what’s equitable for government to take from us. Are we taxed too much, or too little? Are the rich paying their fair share? How much taxation is right for the private economy?

The second conversation, however, doesn’t seem so controversial. Nearly everyone agrees that our tax system is too complicated for just about all filers. And yet, ironically, Washington is far more likely to pass legislation that either raises or lowers tax rates than it is to do anything to make our system less complex. Why? Because legislators of all stripes like the code the way they now use it. They have turned it into an agent of cultural change which they employ to make political promises and payoffs, in the process making simplification unattractive to them and the tax code ever more painful to us.

About the complexity of the code there is little debate. In a recent Wall Street Journal opinion piece Nina Olson, the IRS’s taxpayer advocate, noted that 80 percent of all filers now require some help, either using paid tax preparers or software, to complete their forms, and as a country we spend (waste) an extraordinary 7.6 billion hours on tax compliance, which now costs us nearly $200 billion annually. So complex is the system that it’s becoming increasingly difficult to judge whether inaccuracies on forms are intentional efforts to cheat or legitimate errors. Even the percentage of forms signed by paid preparers which have mistakes on them is growing rapidly, something that should be a source of embarrassment and concern to the profession.

What’s worse is that we’re going in the opposite direction from the rest of the world. A survey of the 30 member nations of the Organisation for Economic Co-Operation and Development found that most enacted some type of simplification of their tax systems in the current decade. We haven’t simplified ours in 23 years. That’s one reason why another study ranked the U.S. as 122nd in tax complexity out of 175 nations.

Most countries opt for simplification by flattening out their tax code, that is, by reducing the number of tax rates and eliminating most, if not all deductions and credits, so that it’s much easier to figure out your taxable income. Reforms of this sort also involve lowering tax rates because the new code exposes much more income to taxation.

Why does the U.S. continue to go in the opposite direction and make our code ever more complex? Because it is through deductions and credits that legislators manipulate the system. When you hear a politician touting a cause these days--whether it is making us more energy efficient, getting more kids to go to college, expanding educational opportunities in inner cities, or increasing home ownership--you can assume he intends to pursue his cause at least in part through changes in our tax code.

Credits and deductions are also a way for office holders to pay back the always-growing number of rent-seekers in Washington, from lobbyists to advocacy groups, by crafting adjustments in the tax code favorable to their industry or constituency. That’s one reason for the 3,125 changes in the tax code since 2001, an average of more than one a day. Imagine what a loss most politicians would be at on the campaign trail or in K Street meetings with lobbyists if we had a tax code that didn’t permit deductions and credits.

It’s only going to get worse in the near-term. The first Obama budget makes a series of adjustments to the code that the administration claims will make our system fairer, but at the price of even more complexity. Nothing is more illustrative of the problem than Obama’s proposal to reduce the value of the deduction for charitable contributions made by those in the top tax bracket, whom the administration argues benefit disproportionately from their giving. To do this the government must add yet another calculation to the process of determining a tax bill which treats charitable donations at a different rate from a filer’s other deductions. If something as benign as charitable donations get this treatment, you can be sure that many other deductions will soon be similarly indexed. The potential for slicing and dicing the system when you think this way is never ending, so that soon every deduction may have its own rate schedule.

Ironically, this approach makes the tax system more inequitable, not less. That’s because the cost of increasing complexity falls heaviest on the lowest-income filers. A 2001 study by the Tax Foundation estimated that individuals who earn under $20,000 annually spend the largest percentage of their income on preparation and compliance of any group—an average of 4% at the time of the study.

Another problem with complexity is the cost of unintended consequences in a system where change is so common. Exhibit A is the Alternative Minimum Tax, enacted in 1969 to target 155 high-income filers whom news reports said were benefiting from huge deductions. The original AMT raised just $122 million in income (the equivalent of $671 million today) by capping the value of certain deductions, according to the Tax Policy Center. But because the AMT was not indexed to inflation and has progressively applied to more and more taxpayers, some 3.8 million filers now must pay it, to the tune of $30 billion. In two years, that sum is projected to rise to $100 billion. The AMT has grown so large that Washington can no longer afford simply to repeal it, even though it was never designed to operate as it now does.

Faced with this mess, we can derive many benefits from simplification: It would produce savings for most Americans without an actual tax cut. The largest gains would accrue to lower-income filers. Simplification would cut down on mistakes by filers and make IRS audits much simpler.

There’s only one reason not to change the system. The pols love it.

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