The Biggest Tax Problem Facing Households and the IRS is…The Tax Code

By :: January 6th, 2011

Each year for the past decade, Nina Olson, the National Taxpayer Advocate at the Internal Revenue Service, has issued a report to Congress on the most serious problems facing taxpayers. She usually focuses on individual provisions of the code, such as the Alternative Minimum Tax, or vexing tax administration problems. This year, Nina reached a quite different conclusion: The most serious problem encountered by taxpayers is…the Tax Code. The whole damn thing.

As the report says, “The most serious problem facing taxpayers—and the IRS—is the complexity of the Internal Revenue Code.”

Olsen estimates that individuals and businesses spend 6.1 billion hours preparing their returns. That equal to a year’s labor by three million full-time workers. Individual taxpayers are so befuddled by the Code that she reports 89 percent either pay a preparer or buy commercial software to help with the paperwork. The total cost of compliance in 2008, Olsen estimates, was $163 billion, or more than 11 percent of total income tax collections. The average out-of-pocket cost per taxpayer: $258. Something is very wrong when we have to pay a vendor $258 just to perform the most basic of civic duties.

Not only is the Tax Code massive—3.8 million words by Olsen’s count—but it is a constantly moving target. Her report estimates there have been more than 4,000 changes in the law over the past decade, and 579 last year alone. It is no wonder nobody understands it.

More troublingly, all this complexity is driving people to cheat. More than 60 percent of self-employed workers (whose income tax is not withheld) either under-report income or over-report deductions. Olsen attributes at least some of this behavior to taxpayers’ belief that they are paying more than their fair share while others are avoiding tax. Nobody, she says, wants to be a “tax chump.”

Of course, complexity isn’t the only reason to rewrite the tax code. It is also hideously inefficient and grossly unfair. It picks economic winners and losers, subsidizing those activities that politicians think are “good” and penalizing those that are deemed “bad.” Often, the more money you make, the more you are rewarded. And far too often, two households making exactly the same amount of money and living in roughly similar circumstances find themselves paying wildly different amounts of tax.

Nina is wrong about one thing. She says the time to reform the tax code is now. Actually, it was long before now. But that’s no reason why President Obama and Congress shouldn’t get started.