A Bigger IRS or a Smaller Tax Code?

This week, the Internal Revenue Service announced a new program to combat tax avoidance by teaming up with state tax authorities. The new plan provides for greater information sharing between state and federal tax authorities in order to ensure compliance with state and federal tax laws. Yet in many ways such policies perpetuate the existing tax system, piling on greater authorities for tax collectors rather than addressing the root problem: an overly complex and obtuse tax code that invites creative accounting and shady practices. A simpler, flatter tax code would eliminate such opportunities, improve compliance, and reduce the need to continually expand the authority of the IRS.

The Treasury Department’s Assistant Secretary for Tax Policy, Pam Olson, views the new program as a way to restore the public’s faith in the tax system. Yet a tax code that treats neighbors making the same income differently based on particular circumstances is not likely to garner public confidence. Nor is a tax code that has five different definitions of a “child,” leading many taxpayers to guess or hire a professional to determine whether they are eligible for benefits such as a dependent child exemption, child tax credit, or a dependent care tax credit.

The Internal Revenue Service has a budget of roughly $10 billion for 2003, with over 100,000 employees. It handles more than 100 million individual income tax returns every year, and imposes a paperwork burden of 6.7 billion hours on the economy. Of this, 25 percent falls on individuals—1.6 billion hours. The tax code itself has more than 1,395,000 words, 693 sections applicable to individuals and 1,501 sections applicable to businesses, and, as of June 2000, the IRS has issued 20,000 pages of regulations, according to the Congress’s Joint Committee on Taxation.

None of this, however, bodes well for the taxpayer. When contacting the IRS for assistance, which taxpayers did more than 117 million times in 1999, it is not guaranteed that they will provide the correct information. In 2002 only 68 percent of all taxpayer requests were answered, and, of those, only 81 percent of the tax law answers conformed to IRS quality standards. As an indication of the magnitude of complexity and confusion, more than half of all taxpayers rely on a professional preparer to fill out their return.

The tax code’s complexity is symptomatic of tax policy driven by politics rather than common sense. At the most basic level, a tax code should be designed to collect revenues fairly, efficiently, and in a way that does not hamper economic growth. After years of special interest politics and political deal making, the tax code falls short on all these measures. A tax code that is punitive and arbitrary invites avoidance, and increasing complexity opens the door to accounting practices that may fail IRS scrutiny.

The solution to these problems lies with a simplified tax code, not an expanded IRS. While there has been some discussion of fundamental tax reform, the agency seems intent on expanding the reach of IRS enforcement. In addition to the new compact for information sharing with state tax authorities, the IRS also included in its budget a request to hire private collection agents, and there has been interest in reviving the exhausting, random line-by-line audits to determine where taxpayers fall short of compliance in their annual returns. The IRS is also seeking to expand its authority in the name of “cooperation” with tax collectors in other countries. The agency is seeking to finalize Clinton-era regulations that would require banks to report to the IRS interest that foreigners accrue on deposits in the United States—even though it is not taxable income that the IRS can collect.

The alternative to an IRS that must keep expanding to enforce and increasingly complex tax code is fundamental tax reform. A simple, fair, and flat tax code would ease the burden of compliance tremendously, and with it, the need for a larger IRS. The Treasury Department has acknowledged the need for a simplified tax code, but until reform becomes a reality, it seeks to expand and “modernize” the IRS in order to keep pace with the changes in tax law. Unfortunately this means greater scrutiny by the government of all taxpayers, and an increasing bureaucracy that may prove difficult to dismantle in the wake of fundamental tax reform. A simple and fair tax code would be a far more pleasing option for the American taxpayer.