The complexity of the federal Tax Code can engender errors and underpaid taxes, according to a new government study.
Max Baucus
The study, by the Government Accountability Office, noted that the GAO has documented millions of taxpayer errors in following complex rules for determining taxpayers’ “basis”—generally the taxpayer's investment in a property—in securities they sold or corporations they own.
The study was presented during a hearing Tuesday by the Senate Finance Committee on tax reform. The GAO study noted that the complex rules in the federal tax system may be necessary, for example, to ensure proper measurement of income, target benefits to specific taxpayers, and address areas of noncompliance.
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However, these complex rules also impose a wide range of recordkeeping, planning, computational, and filing requirements upon businesses and individuals. Complying with these requirements costs taxpayers time and money, the GAO noted.
In 2005 the GAO reviewed existing studies and reported that even using the lowest available compliance cost estimates for the personal and corporate income tax, combined compliance costs would total $107 billion (roughly 1 percent of gross domestic product) per year; other studies estimate costs 1.5 times as large.
Economic efficiency costs, which are reductions in economic well-being caused by changes in behavior due to taxes, are estimated to be even larger. Although many taxpayers have simple forms of income, others do not—especially those who receive income from capital gains, rents, self-employment, and other sources—and they may be required to do complicated calculations and keep detailed records.
Tax expenditures add to Tax Code complexity in part because they require taxpayers to learn about, determine their eligibility for, and choose between tax expenditures that have similar purposes. Tax expenditures also complicate tax planning, as taxpayers must predict their own future circumstances as well as future tax rules to make the best choice among provisions.
Taxpayer errors contribute to the tax gap. For example, in 2001 taxpayers underreported $6.3 billion in net income due to misreported Individual Retirement Arrangement distributions. But taxpayers also may underclaim benefits to which they are entitled. According to GAO's past analysis, of tax filers who appeared to be eligible for a higher-education tax credit or tuition deduction in tax year 2005, about 19 percent, representing about 412,000 returns, failed to claim any of them. No single approach is likely to fully and cost-effectively address the tax gap, but several strategies could improve taxpayer compliance.
These strategies could require actions by Congress or the IRS, the GAO noted. For example, Congress can simplify the tax code by eliminating some tax expenditures and by making definitions more consistent across the tax code. IRS and Congress could take steps to enhance information reporting by third parties or expand compliance checking before refunds are issued.
“The Tax Code has grown far too complex, and it’s becoming much too difficult for honest Americans to calculate and pay their tax bill,” said Senate Finance Committee Chairman Max Baucus, D-Mont. “We should make determining a taxpayer’s responsibility as easy as possible so we are able to collect more of the $345 billion in taxes that are owed but unpaid each year. Especially in these tough economic times, $345 billion is far too much to waste. A simpler Tax Code will ease the burden of compliance on honest Americans and help them meet their responsibilities.”
At the hearing, Baucus discussed the problems caused by the Tax Code’s increasing complexity and how that contributes to the tax gap. According to the IRS, he noted, taxpayers and businesses spend more than six billion hours each year complying with their tax responsibilities. And the Taxpayer Advocate added that if those six billion hours were dedicated to a given industry, it would be one of the largest in the U.S., and it would employ more than three million full-time employees.
Baucus asked whether the complexity of the Tax Code discourages compliance and to what extent it contributes to the tax gap by making it hard for taxpayers to calculate their bill accurately. He also discussed the importance of equipping the Internal Revenue Service with the right technology to help it identify errors on returns and minimize audits. Baucus asked what kinds of changes would need to be made to the tax code to reach a goal of a 90 percent voluntary compliance rate by 2017, and he reiterated his commitment to easing the demands of compliance on taxpayers.
The Finance Committee began its examination of the code last September with a review of the lessons of the 1986 Tax Reform Act and considered historical trends in income and revenue last December. More recently, the Committee held hearings to discuss options to simplify tax administration and ease filing burdens for individuals and businesses, to look at changes to the tax environment over the last two decades, to consider whether the tax code could do more to incentivize economic growth and job creation and to examine ways to increase how much people respond to specific tax incentives for individuals and businesses.
“Year after year, the Tax Code becomes more complex,” said Sen. Orrin Hatch, R-Utah, the ranking Republican member of the committee. “This has contributed to two separate, but related, problems. First, the complexity of the code undercuts compliance. Complying with the Tax Code should not be a Choose Your Own Adventure story, where the complexity of the code leaves citizens guessing their tax liability. As Chief Justice John Marshall explained, the power to tax is the power to destroy. The power to tax is massive and intrusive. And given our constitutional commitment to personal liberty and the right to property, citizens should be well aware of what their tax liability is.”
15 Comments
Suggest start one topic at a time and simplify; eg education credits can and should be combined into one simplified credit calculation, this approach is probably too easy to be adopted by the politicians
Posted by: retpro | July 3, 2011 3:02 PM
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A couple suggestions:
Have any effective dates be ONLY the first day of a calendar quarter (fiscal-year filers will still have problems) but the bulk of calendar-year filers would catch some ease. Eliminates sentences like: "effective for tax years beginning or or after December 17....."
NO laws passed after September 30 that are effective for the current calendar year. Gives the IRS time to prepare their forms and tables, gives the software providers time to program their computers.
Posted by: GreenMain | June 30, 2011 3:16 PM
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bcmcall.... calls for a bigger police state more IRS monitoring... my god what will we co when Obamacare hits, and the penalties are worked into the tax forms.... more paperwork simplification or another study? Max Bacus and the rest of Congress are dumber than a bag of rocks "study shows complexity of tax code contributes to tax gap".... Mr. Bacus who read the 70,000 pages and the regulation that interpret this foreign language????? Then throw in the 20,000,000 Mexicans that have no idea "that a dollar earned is only equal to 60-cents"... and an ever increasing Somali and African populations which I have experienced over the past couple of years suggests that tax education is getting to be a challenge.... more so today.
Posted by: jfkequal | June 30, 2011 10:56 AM
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Smart tax people CHOOSE not to pay their tax, even when they know or make the law. Ask Geitner and Rangle.
Posted by: bschames | June 30, 2011 9:51 AM
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The tax code is not complex for most individuals, corporations, partnerships, etc. Yes, some provisions are complex, for a reason, such as the IP transfer rules, or reorg/Section 367 regs, but overall the code makes perfect sense. The problems is many, not all, but many Tax Preparers have no clue about what they are doing. I have reviewed tax returns where the client is paying thousands in unnecessary taxes because the Tax Preparer treated this client as a commodity. Pay me $150 dollars for your tax return as I am the cheapest preparer around, of course I than will cost you thousands in taxes that your not aware of but heck you will have no idea.
This problem can be fixed if you require Tax Preparers to have a minimum of a four year college degree, AND require that all prepares whether CPA's or attorneys pass an extensive tax exam similar to the CPA exam. This test should be administered by the IRS every six years AND be required in-addition to a CPA or attorney license whether you had previously passed it or not, plus CPE classes every year.
Also require that all tax returns MUST be co-signed by a licensed Tax Preparer.
Posted by: Truth | June 29, 2011 5:34 PM
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If you study history, there is nothing new. Please revisit 1986.
The federal government already has bloated payrolls and this project is just going to add to their deficit spending. 97 years ago the 1040 was 4 pages including instructions. There is no way we are ever going back to the days of our grandparents and any effort to overhaul the tax code will be wasted money, the same as in 1986.
Posted by: WCSCPA | June 29, 2011 12:25 PM
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The current complexity of the U.S. Tax Code only benefits (aside from - or maybe including - the Tax Lawyers who litigate tax cases for enormous fees) the "sociopaths" both in and out of the government. The people in power can use/interpret the law against their political enemies (does the name Richard Nixon remind you of anything - re: his enemies list and his choice of IRS Commissioner??). Outside (as well as inside)of government, sociopaths use the complexities and ambiguities to "work the system" leaving only the(shrinking)number of law abiding taxpayers to pay the correct tax amounts.
Posted by: efhcpa | June 29, 2011 12:07 PM
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So Congressman wants to "simplify" the Tax Code again? Remember the "Paper Reduction Act"? Companies are filling more paper works now than before the Act was passed. Any thing that Congress passes as "Simplication" is an oxymoron. Leave the Code as it is for a long time and let the people get used to it.
Posted by: Linor34b | June 29, 2011 10:52 AM
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The tax code will be complex no matter how much "simplification legislation" is used. The tax code is a combination of law, interpretations, revenue rulings, revenue procedures, and court decisions. Another synonym of code is law. Law is complex that is why we have law school.
Attorneys, CPAs and EAs have special knowledge of the tax code and procedures. All of these professionals are allowed to practice (a form of "administrative law") before the Internal Revenue Service. Each of these professionals are extensively trained, tested and monitored. The average self-prepared preparer (the public) cannot expect any legislation or simplification to improve this situation.
Perhaps congress wants to simplify the practice of law? Whenever congress attempts to "simplify" any law, this "simplification" process always makes the laws more complicated. The more laws congress passes the more confusing the laws that are effected become.
Congress loves to pass a law a year to make things "simpler, easier, or better" for the public. In most if not all cases the system becomes more complex, difficult, and worse for the public. Perhaps if Congress would leave the tax law alone for ten years and stop making "temporary changes" that have to be "phased in and phased out" the law would become more understandable simply because it would not be changing every time congress passes a law.
Posted by: Agiovetti | June 29, 2011 10:00 AM
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Yes, its's complicated. Now what are you going to do about it? I think they like it to be confusing as it makes for fertile hunting ground for audit adjustments. If they wanted it to be simple, they wouldn't have exceptions and limits to every section of the code.
Posted by: Darla E | June 29, 2011 9:52 AM
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Don't we see this all the time? Another study, another hearing, another study, another hearing. You guys sat there and preached about the problem now whats on your calendar today? Probably nothing to do with yesterday's hearing. Stop wasting taxpayer money and just go home. Nothing will ever be done even though our tax code results in the most archaic system for a civilized society.
Posted by: MCS1957 | June 29, 2011 9:15 AM
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First- Is this really news? Congress just woke up one day and realized, "Hey this Internal Revenue Code is pretty complex!"
From the way these congressmen talk, its as if the Internal Revenue Code grows complicated on its own.
Unfortunately, there are too many beneficiaries of the current Code to get any real change through. Nobody wants to give anything up.
Posted by: BillMcGovern | June 29, 2011 8:55 AM
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Strange how year after year Congress comes to the same conclusion and spending tax dollars to analyze what basically any mass merchandise tax preparer could tell them in 30 seconds. And to review the tax simplification of 1986 leaves me other than optomistic tax simplification will actually happen. While touted as tax simplification in 1986 it added dozens of new code sections and several hundred new tax forms. Maybe they should assign the tax to tax practitioners and not Treasury or politicials with vested interests. Or at least only allow Congressman who fill out their own tax returns to sit on the tax revision committee.
Posted by: BrianL | June 29, 2011 8:41 AM
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This practitioner of over 30 years believes the previous comment hints more at the source of the problem than any solution. Such testing will do nothing to improve compliance for the self-prepared returns. Nor will it help all those that have someone assist with the return but said "assister" does not sign as a paid preparer, whether because they are just helping out or are getting paid 'under the table'. And the problem is truly the complexity of the Internal Revenue Code which necessitates that 70% or more of the people turn to paid preparers in order to file returns.
Posted by: Bruce1953 | June 29, 2011 7:49 AM
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Tax reporting accuracy will be improved as the monitoring of tax preparers is implemented and administered in an effective manner.
As a practitioner for more than 30 years, I can attest to the need to prevent subversive individuals from preparing tax returns.
Posted by: bmcall@verizon.net | June 29, 2011 7:38 AM
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