The summer of scandals has kept the Internal Revenue Service in the news. According to the U.S. Treasury’s Inspector General, the IRS inappropriately targeted 298 groups seeking tax-exempt status – most of them Tea Party organizations – for further review. The agency’s selective enforcement of tax laws and maltreatment of conservative political groups have prompted a healthy debate on the proper reach of government. While the full extent of the problem may never be known, the scandal demonstrates the dangers of an overly complex tax code and the bureaucratic discretion it promotes.
Fundamental tax reform is required to clear out the special interests and political favoritism that have been baked into the current code. The Internal Revenue Code should be eliminated, root and branch, and replaced with a simple, fair, and transparent tax code.
The IRS is tasked with processing the 239 million tax returns that generated $2.5 trillion in tax collections in 2012. To do this, the agency has a budget of roughly $12 billion, and employs around 90,000 people. With the federal government strapped with debt and continuing to run deficits, the IRS works to ensure that all taxes are collected, leaving nothing on the table. Yet the tax code itself makes this challenging. The 74,000-page code, along with all the rulings and interpretations, produces a vast gray area, creating a constant struggle between taxpayers and the federal government.
This complexity makes it difficult, even for taxpayers earnestly trying to comply, to determine an individual’s tax burden. In 2010, taxpayers spent 7.6 billion hours filling out their taxes – that’s the equivalent of 3.8 million full-time workers dedicated to nothing but filing tax reforms. In dollar terms, simply complying with the tax code costs taxpayers $193 billion per year, according to a 2006 study. As the Taxpayer Advocate for the IRS stated, “The most serious problem facing taxpayers is the complexity of the Internal Revenue Code.”
Even worse, the current tax code is a poor return for the government. Compliance costs are equivalent to 14 percent of aggregate tax receipts. Adam Smith, the founder of modern economics, wrote in 1776, “Every tax ought to be so contrived as both to take out and keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury.” By this time-worn standard, the current Internal Revenue Code is an utter failure.
If even the IRS admits that the code is too complex, and any economist can quickly conclude that the current system is grossly inefficient and wastes resources, why does the current tax code persist? Quite simply, the current tax code has become a favored system for doling out political favors that benefit both politicians and special interests. Lobbyists and tax lawyers have made careers in the halls of Congress, tweaking the tax code to quietly insert favors for their clients.
For their part, politicians are rewarded handsomely with fundraisers and campaign contributions that shore up their chances for re-election. In fact, one recent study found that members of the House Ways and Means Committee — responsible for writing the tax laws – were able to raise an average of $250,000 more than other members of Congress. It would seem complexity is a feature, not a bug.
Clearly, fundamental reform is necessary to wrest the tax code away from special interests and social engineers. The primary goal of a tax system is to fund the necessary functions of government. This requires an overhaul that eliminates the current politicized tax code in favor of one that focuses exclusively on collecting the revenues to finance government activity in the most efficient manner.
Perhaps the most effective way to re-orient tax policy is to adopt a simple flat tax. Only a post card-sized tax return would be required, eliminating hundreds of forms, instructions and tax rulings. A flat tax establishes one, flat tax rate on personal and business income, while allowing deductions based on marital status and number of dependents. Individuals would simply calculate income from wages, salary and pensions, subtract personal allowances, and pay a flat rate (most plans call for a 17 percent rate) on that income. It is simple, transparent, honest and fair.