This year, for the first time in more than a decade, I ventured outside the reassuring realm of TurboTax while preparing my return, looking for a late-arriving form at the IRS website. It's scary out there.
Staring at bewildering forms and instructions, I flashed back to the days when I did my taxes by hand, based on my uncertain understanding of what was required, and hoped for the best—"the best" being a future free of audits, interest on back taxes, liens, fines, and prison. Although clever software has helped shield me from the infuriating, nerve-wracking complexity that the Taxpayer Advocate Serviceidentifies as "the most serious problem facing taxpayers," it has not changed the underlying reality.
The federal tax code, which in 1913 could be published as a single 400-page book, today occupies some 72,000 pages. In the last 10 years alone, reports National Taxpayer Advocate Nina Olson (your designated friend at the IRS), "there have been approximately 4,428 changes to the tax code." Theinstructions for filling out Form 1040, which took up two pages 75 years ago, are 179 pages long this year.
No wonder that nine out of 10 taxpayers use software or professional preparers to do their taxes. Olson estimates that the process consumes 6.1 billion hours and costs $163 billion a year. "If tax compliance were an industry," she writes, "it would be one of the largest in the United States."
And what do we get for all this effort? Well, the federal government gets about $1.5 trillion in revenue (meaning that Americans pay 11 cents in compliance costs for every dollar they surrender). At the same time, according to the Joint Committee on Taxation, the government forgoes $1.1 trillion in credits, deductions, and exemptions that reduce people's tax bills.
The enormous magnitude of these "tax expenditures," the main factor driving the tax code's mind-boggling complexity, represents an enormous opportunity for reform. In December the president's fiscal commission estimated that eliminating all credits and deductions would make it possible to reduce the top individual and corporate rates, both currently 35 percent, to 23 percent and 26 percent, respectively, even while setting aside $80 billion a year for deficit reduction.
Tellingly, the commission immediately retreated from the idea of zeroing out tax expenditures, saying "the new tax code must include" child credits, the earned income tax credit, the exemption for employer-provided medical coverage, and the deductions for mortgage interest, charitable contributions, and retirement savings. This list includes some of the biggest tax preferences, which not only complicate the code but distort the economy.
The mortgage interest deduction, for instance, contributed to the recently burst housing bubble by driving up the cost of homes, benefiting builders, real estate agents, and homeowners at the expense of renters. The policy of not counting employer-provided health insurance as income feeds medical inflation by cutting off price signals to consumers. The deduction for state and local taxes (as well as the one for interest on municipal bonds) encourages state and local governments to spend more than they otherwise would.
Such preferences nevertheless remain highly popular, since their benefits are more obvious and immediate than the benefits of lower rates. "The dirty little secret is that the largest special interests are us—the vast majority of U.S. taxpayers," Olson writes. "We cannot pretend that broadening the tax base means eliminating someone else's tax break while preserving our own."
Here is another pretense that stands in the way of a simpler, fairer, more efficient tax code: the idea that politicians can improve our decisions by using tax preferences to encourage officially approved behavior, whether it's giving to charity, going to college, adopting children, investing in research, converting corn into fuel, or buying a house, a hybrid car, or a health insurance policy. It's bad enough that the government forcibly extracts a share of our income; it should not presume to direct the spending of the rest.