Post tax-day blues: Our nightmare tax code and the IRS

Post tax-day blues: Our nightmare tax code and the IRS

Our growing tax code / Image by Wolters Kluwer
Our growing tax code / Image by Wolters Kluwer

WASHINGTON, April 16, 2014 – CDN columnist Judson Phillips observes that the U.S. tax code is a byzantine horror. He further observes that the IRS fails in its mission of raising revenues for the operation of the United States government.

He uncharacteristically understates the situation.

The ideal tax (“ideal” from whose point of view is a discussion for another day) has four properties: It is simple; it is transparent; it is horizontally equitable; it is vertically equitable.

Simplicity means just that. The tax should be easy to administer, collect and pay. Simplicity reduces the cost of obeying the tax law for both taxpayers and tax collectors. It reduces the likelihood of fraud and tax avoidance.

The U.S. income tax code is about 74,000 pages long and growing. American individuals and business spend billions of dollars every year on accountants and lawyers, not just to avoid paying taxes, but to figure out the taxes they owe. An error can land you in a world of legal and bureaucratic misery, and errors are very easy to make.

The cost of our tax codes complexity isn’t just money paid to accountants, but time spent collecting and organizing receipts, time spent working on taxes rather than more pleasant or productive activities, and probably more than a few ulcers and bouts of high blood pressure.

For all the expenditure, the code’s complexity and contradictions mean that probably no one who earns too much to file a 1040EZ is in full compliance with the law. If you file returns with any complexity at all, you are almost certainly a tax-law breaker. Pray that the IRS either chooses to ignore you or to treat you with compassion when it notices you.

Transparency means that taxpayers don’t have their attention drawn to the fact that they’re paying taxes. Withholding makes income tax relatively transparent, until it comes time to fill out your returns. If you discover that you owe money, writing out the check may be both painful and a cause of resentment. The government would like taxes to be transparent; with the income tax, they’ve failed.

Horizontal equity means that people who earn about the same amount of money pay about the same amount of tax. Our tax code fails miserably at this. If you rent a house for $2,000/month and your neighbor pays that on a mortgage, your neighbor gets a tax credit that you don’t. The reason for this is that government policy is to encourage home building buy subsidizing home buying.

Children reduce your tax burden (they increase your other burdens, so don’t run out and have kids just to cut your taxes), as can medical expenses. Gentleman farmer Ted Turner saves himself a great deal on his taxes by owning thousands of acres of trees. Installing photovoltaic panels on your roof can earn you a tax credit.

Our attempts to subsidize good industries and harm bad ones, to subsidize good behavior and punish bad behavior have introduced huge complexities to the tax code at the same time they’ve reduced horizontal equity. In the world of tax law, farmers are more virtuous than grocers, so they will pay lower taxes even if they earn the same amount of income.

Vertical equity is tricky. It means that the code is fair to people of different income levels. Since my idea of fair isn’t necessarily yours, we may not agree on whether a flat tax is more or less equitable than a progressive tax. But one thing we can all agree on is that, however you define “fair,” our tax code doesn’t fit the definition (unless you define “fair” as arbitrary, unpredictable and cruel).

Our tax code fails to be “ideal” because we don’t really know what we want it to do. You might think that a tax code should primarily function to raise money for the government. If that were all we wanted ours to do, the government could withhold 30 percent of everyone’s income and call it a day.

But we also want the code to be a tool of social engineering. We want to punish evil and reward virtue; to take from the rich and give to the poor; to discourage spendthrift behavior and reward thrift; to punish sloth and reward hard work; to encourage consumption and punish miserly money-hoarding.

This list is full of contradictions, and so is the tax code. It’s grown to suit the needs of a thousand special interests and the dreams of a thousand reformers. It does its job badly, but that’s because we can’t agree on the job. And on top of that, politicians use the tax code and the IRS as a political bludgeon, throwing the entire enterprise into disrepute.

Our tax code is awful, but it could always be worse. And the odds are good that it will be. Given the option to reform it, our top priority should be simplicity. Without that, the other properties will either be unattainable, or they will be unstable and quickly vanish in layers of complexity. “Fair” tax, flat tax, national sales tax – take your pick. None is perfect, but all are better than what we have.

A final point to consider: If we keep the system we have, and if you make enough that your taxes are complicated, a good accountant is worth his weight in gold. And that is the voice of experience.


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